OREANDA-NEWS. August 31, 2015. Fitch Ratings has affirmed the 'BBB+' rating on the Indiana Finance Authority's approximately \\$97.9 million revenue bonds, series 2010, issued on behalf of King's Daughters' Hospital and Health Services' (KDH).

The Rating Outlook is Stable.

SECURITY

The bonds are secured by all accounts, including accounts receivable, as well as a mortgage on the property and a debt service reserve fund.

KEY RATING DRIVERS

RETURN TO SOLID OPERATIONS IN 2014: KDH implemented a number of initiatives that helped the hospital achieve profitability in 2014, after a year of increased start-up and capital costs from opening its new hospital as well as soft volumes and elevated bad debt and charity care in 2013. Operating margin was 1.4% in 2014 and 2.0% through June 30, 2015 (six month interim), above 'BBB' category median of 0.6%. Debt service coverage by EBITDA was solid at 3.1x in 2014, favorable to 'BBB' category median of 2.7x.

HIGH DEBT BURDEN: Maximum annual debt service (MADS) represents a high 6.0% of fiscal 2014 revenue as compared to the 'BBB' category median of 3.6%. Positively, debt to EBITDA improved to 4.4x through the six month interim from 7.0x year prior and is now in line with the 'BBB' category median.

CONTINUED LIQUIDITY GROWTH LIKELY: Fitch expects that KDH's low age of plant and limited capital spending requirements will allow strong cash flow to augment its balance sheet over the medium term, continuing a positive trend of liquidity growth over the past five years.

LEADING MARKET SHARE: KDH has utilized an employed physician model for almost 20 years which Fitch believes has allowed the corporation to maintain a strong market share position. KDH controlled 47.3% of the market in fiscal 2014. Norton Healthcare (rated 'A-'; Outlook Positive) is KDH's next competitor with just 6.6% market share in the primary service area.

EXPOSURE TO GOVERNMENTAL PAYORS: The service area population demographics and wealth levels are unfavorable to state and national averages, reflected in a weak payor mix. KDH's exposure to government payors is relatively high at 62.5% as of June 20, 2015 (six-month interim). Positively, self-pay has declined as a result of Healthy Indiana 2.0. A high level of supplemental funding is a further concern, as KDH is vulnerable to cuts in governmental funding.

RATING SENSITIVITIES

BALANCE SHEET IMPROVEMENT: Despite very strong profitability, upward rating movement on King's Daughters' Hospital and Health Services is predicated on further strengthening of cash relative to debt and further moderation in capital-related ratios.

CREDIT PROFILE

KDH is an 86 licensed bed acute care facility located in Madison, Indiana, approximately 90 miles southeast of Indianapolis and about 60 miles northeast of Louisville, Kentucky. In fiscal 2014, KDH had \\$119.4 million in total revenue.

FINANCIAL RECOVERY IN 2014

Operations recovered in 2014, with solid 1.4% operating margin and 15.9% operating EBITDA margin, favorable to 'BBB' category medians. Management reduced full time equivalent employees by 8.8%, improved revenue cycle processes, and enhanced certain service lines in response to financial challenges from opening its new hospital in 2013. This recovery comes well ahead of Fitch's prior expectations of breakeven performance in 2017.

Performance recovery was sustained in 2015, with a 2% operating margin and 17% operating EBITDA margin. Topline revenue grew 5.7% in the interim while expenses held steady. Contributing to positive operations is KDH's opening of its new cancer center in February 2015 and recruitment of two orthopedic surgeons. KDH saw some decline in inpatient volumes year-on-year, which were offset by higher acuity, improved outpatient volumes, and increased emergency visits.

HIGH DEBT BURDEN

KDH has about \\$98.3 million of debt outstanding issued to finance the replacement facility, resulting in a high debt burden and moderate leverage metrics for the rating level. MADS accounted for 6% of total revenue in fiscal 2014, which is high compared to the 'BBB' category median of 3.6%. Favorably, debt to EBITDA improved to 4.5x in 2014, in line with the 'BBB' category median and much improved from year prior (8.0x). Debt to capitalization continues to moderate, to 43.90% in 2014, favorable to the category median 'BBB' of 48.1%. Positively, strong EBITDA resulted in sound debt service coverage of 3.1x in 2014, up from 1.7x year prior and favorable to the category median.

POSITIVE LIQUIDITY TREND

KDH had \\$82.4 million in unrestricted cash and investments as of the six month interim, which equates to a strong 287 days cash on hand. KDH's cash-to-debt ratio continued to improve and was 84.8%, below the category median, reflecting KDH's high debt burden.

Management expects forward capital spending to be muted from recent highs, which Fitch believes will allow for balance sheet growth. Continued increases in liquidity metrics relative to debt may allow for positive rating momentum over the medium term.

SOLID MARKET POSITION

Because of strong recruitment efforts combined with the opening of its new hospital, KDH has grown its market share in the primary service area (PSA) significantly since 2011. KDH controls 47.3% of its PSA market in 2014, up from 42.6% in 2011. Norton Hospital-Louisville (part of Norton Healthcare) was the next competitor with just 6.6% of market share. Nearby competitors are smaller facilities.

KDH has been engaged in an integrated physician alignment strategy since the mid-1990's and over 95% of the active medical staff is employed by the hospital, helping to align the hospital and the physicians' interests. Recruitment efforts have been successful and KDH continues to successfully expand service lines. Oncology programs have been enhanced further with a new cancer center opening, allowing KDH to offer additional treatment modalities.

SMALL REVENUE BASE AND UNFAVORABLE PAYOR MIX

KDH's relatively small revenue base coupled with its exposure to governmental payors (approximately 62.5% of gross revenues in fiscal 2014) is a credit concern as hospital operations are more sensitive to minor operating disruptions. Self-pay has declined to 4.2% from 5.9% through the six-month interim as a result of Indiana's Medicaid expansion; the full effects may be greater for KDH over the coming year. KDH received sole-community provider status in fiscal 2009, which garners additional Medicare reimbursement (about \\$1 million annually). KDH also received \\$2.1 million in Medicaid DSH and net state provider tax revenue in 2014, some of which was for prior year reimbursement. Fitch expects revenue from these programs to be stable through at least 2016.

DISCLOSURE

KDH covenants to provide bondholders with annual disclosure within 150 days of the close of each fiscal year and quarterly disclosure within 60 days of each quarter end.