OREANDA-NEWS. Fitch Ratings has affirmed the 'BBB+' rating on the following bonds issued on behalf of Catholic Health System, Inc., NY (CHS):

--$93,800,000 Buffalo and Erie County Industrial Land Development Corporation Obligated Group revenue bonds (Catholic Health System, Inc. Projects), series 2015;

--$16,292,500 Dormitory Authority of the State of New York Catholic Health System Obligated Group revenue bonds, series 2012A and 2012B;

--$21,150,000 Dormitory Authority of the State of New York Catholic Health System Obligated Group revenue bonds, series 2008(a);

--$9,840,000 Erie County Industrial Development Agency variable rate demand bonds, series 2007A and 2007B;

--$39,672,000 Dormitory Authority of the State of New York Catholic Health System Obligated Group revenue bonds, series 2006(a).

(a) Underlying Rating. Bonds are supported by a direct-pay letter of credit (LOC) from HSBC Bank USA (rated 'AA-/F1+'; Stable Outlook.)

The Rating Outlook is Stable.

SECURITY
The series 2015, 2012A&B, 2008 and 2006 bonds are secured by a pledge of gross receipts of the Obligated Group (OG), mortgages on certain OG property, and a debt service reserve fund.

KEY RATING DRIVERS

WEAKER OPERATING PERFORMANCE: CHS' FY 2015 financial performance was impacted negatively by revenue decreases from a higher than expected shift to outpatient procedures, losses on risk contracts, write-off of receivables from a defunct health insurer, higher staffing costs, and lower disproportionate share funding. The system reported a 1.0% operating margin and a 6.4% operating EBITDA margin in 2015 (year-end Dec. 31, unaudited) compared to 4.3% and 9.5%, respectively, in 2014.

REGIONAL GROWTH: CHS holds the leading market position in Erie County, its primary service area, with a 44.6% market share. CHS operates in a competitive market and its main competitor, Kaleida Health (KH), has a 38.9% share. With 89% of CHS' discharges originating from Erie County, CHS has been trying to expand its geographic reach with rural hospital affiliations and the 2015 acquisition of Mount St. Mary's (MSM) in Lewiston, Niagara County.

STRATEGIC PHYSICIAN AFFILIATION: CHS' market position is enhanced by its membership in Catholic Medical Partners (CMP), which is an independent physician practice association network of almost 1,000 physicians in four western New York counties. CMP is integral to CHS' approach of aligning independent physicians with the system. The system began participating with CMP as an Accountable Care Organization (ACO) in 2012.

ADEQUATE BALANCE SHEET: Despite the decrease in EBITDA in 2015 to $64.6 million from $90.8 million in 2014, CHS grew its unrestricted cash with the acquisition of MSM and by financing its projects in 2015. Days cash on hand (DCOH) in 2015 measured 148.9, comparable to 146.3 days in 2014. Debt remains manageable for the system's size as evidenced by solid cash-to-debt of 151.1% (above the category median) and MADS at 3.8% of total revenues.

RATING SENSITIVITIES

OPERATING IMPROVEMENT EXPECTED: The 'BBB+' rating incorporates Catholic Health System's (CHS)size, sponsorship and strong operating growth in the years leading to 2015. Fitch expects that CHS' operating profitability will return to more historical levels in 2016. An inability to improve operating EBITDA margins with a resulting deterioration in balance sheet metrics may generate negative rating action.

CREDIT PROFILE

CHS is a large healthcare delivery system headquartered in Buffalo, NY, with four hospitals on five campuses, primary care centers, long-term care facilities and other healthcare sites. CHS has close co-sponsor relationships with Trinity Health (Trinity; revenue bonds rated 'AA'; Outlook Negative) and Ascension Health (revenue bonds rated 'AA+'; Outlook Stable). For the purpose of this analysis, Fitch is reporting on the consolidated system numbers. OG assets and revenues were 86.7% and 87.9% of the consolidated entity, respectively, in 2015.

WEAKER 2015 RESULTS

CHS' 2015 results include the modestly dilutive impact of six months of operations for MSM. The hospital was acquired from Ascension Health for $10 million with Ascension defeasing the remaining MSM debt. Consequently, CHS' debt did not increase as a result of the acquisition. Management reports that MSM had a slight operating loss of approximately $250,000 on total revenues of $47.5 million for the six months ended Dec 31, 2015. Fitch expects that the acquisition will be accretive to CHS in the coming years. Also in 2015, CHS had planned to divest two of its elder care facilities which had generated operating losses, St. Vincent's and St Elizabeth. The approval for the sale was delayed and the transaction did not close until March 2016.

Profitability was negatively affected in 2015 by losses on risk contracts with third-party payers, write-off of receivables from a health insurer that ceased operations, increased pension expense ($41 million in 2015 from $30 million in 2014), higher agency expense related to ICU nursing staff, and a further shift from inpatient to outpatient procedures. Inpatient admissions for 2015 dropped to 39,562 from 41,128 in 2014, slightly offset by an increase in observation stays of 471. Inpatient surgeries also decreased, but outpatient surgeries increased 1.24% to 47,674 surgeries in 2015. CHS may experience additional competition for outpatient surgeries when a Kaleida Health ambulatory surgical center opens later this year in Orchard Park.

CHS received less Medicare and Medicaid disproportionate share funding in 2015 than in 2014, which is expected to decrease again in 2016. CHS expects to improve operating profitability in 2016 by further service line expansion in orthopedics and cardiology, population health initiatives, efficiency improvements, and successful physician alignment strategy.

DEBT PROFILE
Total debt at the end of fiscal 2015 was $260.4 million, including the $38.4 million capital lease that was outstanding in December but has since been paid off with the proceeds of the series 2015 bonds. Excluding capital leases, CHS' long-term debt is 62.3% fixed-rate. The system has two swaps outstanding: an $8.5 million notional and a $21.5 million notional swap in connection with the series 2007 and 2008 bonds, respectively.

Fitch views CHS' underfunded pension obligation (52% of projected obligations as of 2014) as a credit concern. Although the plan is not subject to ERISA funding requirements, it represents a long-term liability that could have a negative impact on future performance and liquidity. Management closed the defined benefit legacy formulas to new participants in 2002, and implemented a standardized program for new participants. Based on current projections and funding policy, management expects to have the plan's pension benefit obligation (PBO) funded status reach 86% by fiscal 2022. Management has been funding the plan in excess of benefits paid.