OREANDA-NEWS. November 18, 2015. Fitch Ratings has affirmed the 'AA' rating on the following revenue bonds issued by the North Carolina Medical Care Commission on behalf of Duke University Health System (DUHS):

--\\$180,000,000 health care facilities revenue bonds series 2009A;
--\\$120,000,000 health care facilities revenue bonds series 2010A;
--\\$281,515,000 health care facilities revenue bonds series 2012A.

The Rating Outlook is Stable.

SECURITY

Debt payments are unsecured, general obligations of the obligated group.

KEY RATING DRIVERS

ROBUST OPERATING PROFITABILITY: DUHS achieved record levels of operating profitability in fiscal 2015 with operating and operating EBITDA margins equal to 11.6% and 17.8%, respectively.

MANAGEABLE DEBT BURDEN: The system's manageable debt burden, with MADS equal to 2.7% of operating revenues, and robust cash flow produced strong MADS coverage by EBITDA of 7.9x in fiscal 2015.

STRONG LIQUIDITY POSITION: Unrestricted liquidity remains strong with 417.1 days cash on hand, 35.8x cushion ratio and 244.8% cash to debt at June 30, 2015. With a planned transfer of \\$510 million to Duke University in fiscal 2017, projected liquidity metrics remain favorable compared to Fitch's 'AA' category medians.

LEADING CLINICAL REPUTATION: DUHS maintains a strong national reputation and an academic affiliation with Duke University School of Medicine, one of the nation's leading medical schools.

RATING SENSITIVITIES

MAINTAINED CREDIT PROFILE: Fitch expects that Duke University Health System's cash flow will be sufficient to offset both the planned fund transfer to Duke University in fiscal 2017 and potential capital plans without materially impacting the system's overall credit profile.

CREDIT PROFILE

DUHS is a large integrated delivery system, based in Durham, NC, with total operating revenues of \\$3.1 billion in fiscal 2015 (June 30 fiscal year end). Operations include three hospitals, home care and hospice services, a large primary care practice and ambulatory care centers. Fitch's analysis is based upon DUHS' consolidated financial statements. The credit group accounted for 94.4% of total consolidated operating revenues and over 95.3% of consolidated total assets in fiscal year 2015.

ROBUST OPERATING PROFITABILITY

The system achieved record operating profitability in fiscal 2015 with operating and operating EBITDA margin equal to 11.6% (\\$355 million operating income) and 17.8%, respectively. Profitability has been consistently strong, with operating EBITDA averaging a robust 14.2% since fiscal 2009, exceeding Fitch's 'AA' category median of 11.5%. Operating revenue increased 17.3% in fiscal 2015. The revenue growth reflects increased volumes, strengthened acuity, enhanced collection processes and clinical documentation improvements. Continued cost control initiatives limited expense growth to 7.6% including favorable malpractice claims experience.

Management has been consistently focused on operating improvement initiatives since 2008, achieving approximately \\$160 million in operating improvements through fiscal 2013. DUHS' latest operating improvement initiative targets an additional \\$200 million in improvements. Management expects to achieve \\$369 million in cumulative improvements by the end of fiscal 2017. Major focus areas include care redesign, clinical operations, supply chain and revenue cycle.

The North Carolina Medicaid program is currently undergoing a transition that may impact DSH funding. DUHS received \\$86.4 million in net Medicaid DSH in fiscal 2015 compared to \\$69 million in fiscal 2014 and \\$78.7 million in fiscal 2013.

MANAGEABLE DEBT BURDEN

DUHS' debt burden remains manageable with MADS equal to 2.7% of fiscal 2015 operating revenue relative to Fitch's 'AA' category median of 2.4%. The manageable debt burden combined with the record setting operating profitability achieved in fiscal 2015 produced strong MADS coverage by EBITDA equal to 7.9x, easily exceeding Fitch's 'AA' category median of 5.7x.

STRONG LIQUIDITY POSITION

Unrestricted cash and investments continued to grow, increasing 6.4% to \\$2.9 billion at June 30, 2015, despite \\$229 million in academic support cash transfers to Duke University in fiscal 2015 (see below) and relatively low investment returns. Liquidity metrics are strong across the board with 417.1 days cash on hand, 35.8x cushion ratio and 244.8% cash debt, exceeding Fitch's 'AA' category medians of 289.4 days, 27.0x and 201.7%. Days in accounts receivable moderated to 51.1 in fiscal 2015 after increasing to 55.4 in fiscal 2014. The increase was primarily due to a slow-down in receivables collection related to both DUHS and payer implementation of new IT systems. The issues have been resolved. Management expects days in accounts receivable to continue to decrease to approximately 48 days.

Capital spending may increase in fiscal years 2016 to 2018 as the system addresses potential capacity constraints due to the strong volume growth. However, capital plans are preliminary. If the projects are pursued, DUHS may issue additional debt over the next two years. Fitch will assess the impact of additional debt, if any, upon DUHS' overall credit profile as more details become available.

DUHS provides academic support to Duke University and the School of Medicine. Total unrestricted transfers equaled \\$231 million and \\$69 million in fiscal years 2015 and 2014, respectively. The 2015 transfer included a one-time transfer of \\$150 million to the School of Medicine to support research and development. Additionally, DUHS plans to complete a one-time transfer of \\$510 million to the university on July 1, 2016 to fund future support. Projected liquidity metrics remain favorable to Fitch's 'AA' category medians including the increased academic support.

LEADING CLINICAL REPUTATION

The system's strong clinical reputation and academic affiliation with one of the nation's leading medical schools are additional credit strengths. Duke University Hospital (DUH), DUHS' flagship facility, has been consistently ranked as one of the top hospitals in the nation for over a decade. The strong clinical reputation is supported by the high acuity of services provided at DUH, with a high Medicare case mix index of 2.3 in fiscal 2015, and is bolstered by DUHS' solid market share in its primary service area. Additionally, DUH is the principal teaching affiliate of Duke University School of Medicine, which is consistently recognized as one of the nation's top medical schools.

DEBT PROFILE

Total debt outstanding equaled \\$1.2 billion at June 30, 2015 and was comprised of 55% underlying fixed rate bonds and 45% underlying variable rate bonds. The variable rate bonds are swapped to fixed rate through three fixed payor swaps and are directly placed with four banks. The direct placement covenants are substantially similar to those contained in the master trust indenture. In addition to the three fixed payor swaps, DUHS is counterparty to a basis swap. DUHS had \\$14.5 million of collateral posted related to the swaps at June 30, 2015.

DISCLOSURE

DUHS covenants to provide annual and quarterly financial disclosure within 180 days and 60 days. Disclosure is provided through the Municipal Securities Rulemaking Board's EMMA system.