OREANDA-NEWS. Fitch Ratings has downgraded Health Net Inc.'s (HNT) $400 million of 6.375% senior notes due June 1, 2017 to 'BB-' from 'BB'. Fitch has also downgraded HNT's Issuer Default Rating (IDR) to 'BB' from 'BB+' and affirmed the 'BBB' Insurer Financial Strength (IFS) ratings of various Health Net insurance companies. The Rating Outlooks are Negative.

Today's rating actions follow HNT's March 24, 2016 announcement that it and Centene Corp. (CNC) have closed on the companies' previously announced merger agreement. Prior to today, Fitch's last review of HNT's ratings occurred on Nov. 5, 2015. At that time Fitch affirmed the companies' subsidiaries' IFS ratings and said it expected to downgrade the ratings on HNT's senior notes and IDR by one notch upon the merger's close.

Going forward, Fitch expects HNT's ratings to primarily be shaped by CNC's post-HNT acquisition consolidated credit-quality. Fitch does not currently maintain public ratings on CNC.

KEY RATING DRIVERS

The downgrade of HNT's senior notes and the company's IDR reflects CNC's post-close consolidated financial leverage and interest coverage metrics, which do not support Fitch's standard notching between insurance operating company and holding company ratings. The Negative Outlooks reflect potential execution risks as CNC integrates the HNT organization.

Including on a pro forma basis the approximately $2.4 billion of senior notes CNC issued in January 2016 to partially fund its purchase of HNT and the repayment that occurred upon the merger's close of $285 million outstanding under HNT's revolving credit facility at year-end 2015, Fitch estimates CNC's year-end 2015 debt-to-EBITDA and debt-to-capital ratios at 3.0x and 45% respectively and the company's EBITDA-based interest coverage ratio at 6.0x. HNT's comparable ratios at year-end 2015 were 1.3x, 27%, and 15.3x.

The affirmation of the HNT's insurance companies' 'BBB' IFS ratings reflects the effect of the combined HNT-CNC organization's higher financial leverage and lower interest coverage balanced against the favorable ratings aspects of the combined HNT-CNC's geographically more diverse enrollment and improved market position and size and scale characteristics.

In comparison with HNT's pre-close membership, the combined HNT-CNC organization's membership is more geographically diverse, which Fitch views as reducing the company's exposure to economic, competitive, and regulatory conditions in any single market. CNC has members in 23 states while HNT has members in four and HNT's Western Region operation is heavily concentrated in California from which it derives roughly 90% of its membership. Additionally, while the combined HNT-CNC organization's membership consists primarily of Medicaid members it will also include meaningful commercial and TRICARE membership.

At year-end HNT and CNC had approximately 11.2 million members and in 2015 the companies generated $39 billion of revenues and $543 million of net income. Fitch estimates the companies' combined 2015 EBITDA-to-revenue margin on a pro forma basis at 3.7%.

RATING SENSITIVITIES

--Rating downgrades could result from deterioration of financial leverage ratios from post-merger close levels.

--Material earnings disruptions where EBITDA margins and return on capital fall below 3X and 3%, respectively for an extended period could result in a rating downgrade.

--Evidence that the HNT-CNC merger is being effectively integrated from an operational and financial perspective would likely lead to a revision of the Rating Outlooks to Stable. Fitch will look for membership and revenue and EBITDA and net income trends that are consistent with HNT's and CNC's recent organic rends as well as operational and key personnel continuity as evidence that merger is being effectively integrated.

--Opportunities for an upgrade will be most sensitive to CNC's consolidated mid- to long-term financial leverage metrics and ability to generate consistent earnings in light of its larger and more diversified market position.

--Debt-to-EBITDA and financial leverage ratios approximating 2.5x and 35% could lead to an upgrade of the ratings on HNT's senior notes reflecting a return to Fitch's typical notching between insurance operating company and holding company ratings.

--An EBITDA margin exceeding 4x and return on capital of approximately 5% would place upward pressure on the IFS ratings.

Fitch has downgraded, removed from Rating Watch Negative, and assigned Negative Outlooks to the following ratings:

Health Net Inc.
--Long-term IDR to 'BB' from 'BB+';
--6.375% senior notes due June 1, 2017 to 'BB-' from 'BB'.

Fitch has affirmed the following ratings with Negative Outlooks:

Health Net Of California, Inc.
Health Net of Arizona, Inc.
Health Net Health Plan of Oregon, Inc.
--IFS at 'BBB'.