OREANDA-NEWS. Fitch Ratings has affirmed the 'A' rating on Dignity Health's outstanding debt, as listed at the end of the press release.

The Rating Outlook is Stable.

SECURITY
The bonds are secured by a gross revenue pledge of the obligated group. The obligated group accounted for 99% of total revenue and 96% of total assets of the consolidated entity in fiscal 2015 (June 30 year-end). Fitch's analysis is based on the consolidated entity.

KEY RATING DRIVERS

LARGE AND DIVERSE HEALTH SYSTEM: Dignity Health's key credit strength is the size and diversity of its operating profile with a focus on integrating and consolidating its acute care business in each respective market while diversifying its growth in certain business verticals to support population health. Dignity Health's total revenue base was $12.4 billion in fiscal 2015 and acute care operations are concentrated in California, Arizona, and Nevada.

TRANSFORMATIVE GROWTH STRATEGY UNDERWAY: Dignity Health has strategic initiatives underway to reposition the organization for a value-based reimbursement environment with a focus on integration, growth, and diversification. These strategies are in the areas of brand development, employee engagement, quality and patient experience, physician alignment and integrated delivery networks, and innovation and technology.

LIGHT PROFITABILITY AND ELEVATED DEBT METRICS: Dignity Health's profitability and debt metrics have historically lagged Fitch's 'A' category medians. However, fiscal 2015 performance was strong due largely to the timing of the approval of the current provider fee program. Operating margin and operating EBITDA margin improved to 3.6% and 9.7%, respectively, compared to 0.4% and 6.9% in fiscal 2014. Performance normalized for the provider fee indicates stable performance from fiscal 2014 to fiscal 2015. Debt service coverage over maximum annual debt service (MADS; historical pro forma) is light for the rating category at 3.4x in fiscal 2015 despite the stronger operating performance, and 2.6x in fiscal 2014 relative to the 'A' category median of 4.2x.

ADEQUATE BALANCE SHEET: Liquidity metrics have weakened as of Sept. 30, 2015 due to a pending receivable from the provider fee program and investment losses. Total unrestricted cash and investments were $5.06 billion at Sept. 30, 2015 compared to $5.12 billion the prior year, which translated to 156.3 days cash on hand and 93.3% cash-to-debt.

RATING SENSITIVITIES
MAINTAIN CONSISTENT CASH FLOW: Fitch expects Dignity Health's operating cash flow to be consistent with historical performance (normalized for the provider fee) over the near term. Over the longer term, Dignity Health should realize the benefits from its investments in its transformational strategies. A decline in operating performance (normalized for the provider fee) could result in negative rating pressure.

LIMITED DEBT CAPACITY: After Dignity Health's additional debt issuance in late 2014, Fitch believes debt capacity is limited at the current rating level without a commensurate improvement in cash flow and cash position.

CREDIT PROFILE
Dignity Health is a not-for-profit health system with 39 hospitals, 32 of which are located in California, four in Arizona, and three in Nevada. Dignity Health has 9,000 affiliated physicians and 596,000 attributable members in its system. The service areas (including U.S. HealthWorks) by revenue size (largest to smallest) include Greater Sacramento, Southern California, Arizona, Central California, Bay Area, Central Coast, Nevada, North State, and U.S. HealthWorks. On Aug. 10, 2012, Dignity Health acquired U.S. HealthWorks - a multi-state for-profit operator of occupational health and urgent care centers with 220 sites spanning 20 states to date.

Large and Diverse Health System
Dignity Health's main credit strength continues to be its size and increasing diversity from acute care. Its acute care markets are in competitive service areas and the organization is focused on developing integrated delivery networks in its service areas, which include having a health plan infrastructure and aligned physicians in place. Greater Sacramento is Dignity Health's largest service area and there have been issues with a deteriorating payor mix in that market due in part to CalPERS offering more health plan choices with narrow networks to its beneficiaries. Management is addressing this issue.

Dignity Health is focused on increasing its investments in other various healthcare related entities that further diversify its revenue and profitability while supporting population health. These investments focus on expanding access, data analytics, diagnostic and treatment, physician alignment, integration, digital technology, and post acute care.

Although still a small percentage of its overall revenue, Dignity Health has been active in value based contracting and the majority of its agreements only have upside risk. Dignity Health expects these new payor arrangements to continue to increase. A key to the success of this strategy is Dignity Health's physician alignment and there are various models in place across its regions with almost 1,000 employed physicians and over 5,500 clinically integrated physicians.

Volatile Profitability Due to Timing of Provider Fee
Dignity Health's profitability has historically lagged the 'A' category medians and performance was particularly distorted year over year for fiscal 2014-2015 due to the timing of recording the provider fee net income since there has been a significant lag in receiving the various approvals from CMS. The current provider fee program is in place for the Jan. 1, 2014 - Dec. 31, 2016 period. Dignity Health booked a total net benefit of $632.6 million in fiscal 2015, which included $233.6 million related to prior year periods. Assuming a normalized provider fee, EBITDA was stable in fiscal 2014 and 2015 and improved from levels in fiscal 2011-2013.

Volume growth was strong in fiscal 2015 and there was an improvement in the payor mix due to the benefit of Medicaid expansion. There was a 2.9% growth in inpatient and 5.9% in outpatient on acute-based adjusted admissions. There was a significant decline in self-pay and other, which dropped to 5% of gross revenues in fiscal 2015 from 8% the prior year, while Medicaid increased to 27% from 23%.

Adequate Liquidity
Dignity Health's balance sheet is adequate for the rating level and metrics have declined due to a pending provider fee receivable (over $500 million) in addition to a decline in unrealized investment gains. Total unrestricted cash and investments was $5.06 billion at Sept. 30, 2015, compared to $5.44 billion at FYE 2015 and $5.26 billion at FYE 2014. The investment portfolio is well diversified and liquid with 70% available within one month.

Debt Profile
Total debt outstanding as of December 2015 is $5.25 billion with 72% underlying fixed rate and 28% underlying variable rate. Dignity Health has $769.4 million of variable-rate demand bonds that are supported by letters of credit that expire between July 2016 and December 2019. Unrestricted cash and investments-to-demand debt is strong at 6.6x. Fitch notes that Dignity Health has more restrictive covenants in its bank documents (letter of credit and direct bank loans) than what is in the master trust indenture including rating covenants.

Dignity Health has 16 floating-to fixed-rate swaps and five fixed-to-floating risk participation agreements. Dignity Health is prohibited from posting collateral on derivative instruments under its master trust indenture. MADS of $408 million occurs in fiscal 2026 and debt service coverage is weak for the rating level. Debt-to-capitalization was 44.4% in fiscal 2015 compared to 51.2% in fiscal 2012.

Healthy Capital Spending
Dignity Health has been spending almost 1.5x of depreciation expense on capital investments mainly driven by seismic requirements and its electronic medical record implementation. Capital spending totaled $663.3 million in fiscal 2015, $716 million in fiscal 2014, and $640 million in fiscal 2013. The projected capital plan is under review but current estimates are around $700 million a year. As seismic requirements wane, the main areas of spending continue to be information technology as well as other major projects and equipment replacement.