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Fitch Ratings: Rates Froedtert Health (WI) 'AA-'; affirms rev bond rating; outlook revised to positive
5/10/2019

Fitch Ratings has assigned an Issuer Default Rating (IDR) of 'AA-' to Froedtert Health, WI (Froedtert). Fitch has also affirmed the 'AA-' revenue bond rating on approximately $810 million bonds issued on by Froedtert or on behalf of Froedtert by the Wisconsin Health Facilities Authority.

Bond series include:

--Froedtert Health, Inc., (WI) taxable series 2015A revenue bonds;

--Wisconsin Health & Educational Facilities Authority, series 2009C revenue bonds:

--Wisconsin Health & Educational Facilities Authority, series 2012A revenue bonds;

--Wisconsin Health & Educational Facilities Authority, series 2017A revenue bonds.

The Rating Outlook has been revised to Positive from Stable.

SECURITY

Bond payments are secured by a security interest in the pledged revenues of the obligated group.

ANALYTICAL CONCLUSION

Froedtert's 'AA-' rating is attributable to a very strong financial profile combined with the system's midrange revenue defensibility and very strong operating risk profile. Froedtert is sizable, but is not the largest acute care system located in the Milwaukee (WI) service area, with extensive service offerings and access points. Froedtert has consistently improved year-over-year market share, demonstrating the ability to successfully execute on strategic and tactical plans within the market. The Positive Rating Outlook reflects Fitch's expectation that Froedtert will sustain strong operating EBITDA margins and maintain very good liquidity discipline over the near to long term, and continue to build on already strong leverage metrics.

KEY RATING DRIVERS

Revenue Defensibility: 'bbb'; Continued Market Share Improvement

The system is a very significant provider in their Milwaukee (WI) market, and has an extensive network of access points in their immediate service area. Froedtert's payor mix is excellent, as is Froedtert's physical location on the campus of the Medical College of Wisconsin and the Children's Hospital of Wisconsin, which also enhances Froedtert's market essentiality. Demographics in much of the service area are mixed, with flat to declining population in some areas, but wealth and income measures that are more commensurate with state and national levels.

Operating Risk: 'aa'; Very Consistent and Solid Operations; Moderate Capital Needs

Froedtert's operating risk profile is very strong, reflecting a track-record of robust operating EBITDA and EBITDA margins, manageable capital spending plans and a healthy average age of plant.

Financial Profile: 'aa'; Very Strong Financial Profile Even Through a Potential Period of Stress

Froedtert's financial profile is very strong. Capital-related ratios should remain strong through the cycle in the Fitch's forward looking scenario analysis, including in a hypothetical stress case scenario.

Asymmetric Additional Risk Considerations

There are no asymmetric risk factors associated with Froedtert's rating.

RATING SENSITIVITIES

CONTINUED LIQUIDITY STRENGTHING: Fitch expects Froedtert to sustain strong operating margins leading to continued liquidity growth, even while continuing to invest in ambulatory and "off campus" assets in the marketplace. A higher rating is likely over the two year outlook period as Froedtert continues to grow unrestricted liquidity, while balancing capital spending. Although not expected, should profitability or liquidity decline significantly below current levels, the system could face downward rating pressure and a return to a Stable Rating Outlook.

The rating may be affected by the recent appeals court ruling regarding the protections provided to holders of bonds secured by pledged special revenues. Fitch believes those protections warrant a distinction in ratings above the IDR regardless of the outcome of the case. However, a final decision consistent with the First Circuit's ruling may result in security ratings closer to the IDR. Given state constitutional and statutory restrictions, Fitch believes potential rating changes would be modest.

CREDIT PROFILE

Froedtert is an integrated health system headquartered in Milwaukee, WI. Operations include an academic medical center, two community hospitals, over 30 ambulatory clinic sites, ambulatory surgical centers, a free standing emergency room, a digital innovation hub, a third-party administrator (TPA) called Exceedent, and a laboratory services company. Joint venture relationships provide additional pre- and post-acute care services for home care, hospice, dialysis, pharmacy, rehabilitation and sports medicine. In addition, Froedtert owns a 50% interest in Network Health, Inc., a provider-sponsored health plan covering 120,000 lives (including 65,000 in Medicare Advantage Plans), with commercial, individual and Medicare Advantage products. Total consolidated operating revenue has increased consistently over the past five years, increasing at a compound annual growth rate of 8.8% to $2.5 billion (estimated for fiscal 2019 based on unaudited third quarter results).

Revenue Defensibility

Froedtert's payor mix is very good, with Medicaid and self-pay patients consistently representing less than 15% of gross revenues. This level has remained in a similar range for an extended period of time, and Fitch believes that there is little chance of the payor mix deteriorating over the next several years. In fact, given Froedtert's continued ambulatory and community expansions off the main tertiary campus, there would be an expectation by Fitch that payor mix could actually improve slightly.

Froedtert maintains a solid -- moving up to number two in the market -- position in a competitive service area. Froedtert's primary service area (PSA) market share increased to 26.1% in fiscal 2018, which marks the fourth straight year of improvement. Froedtert maintains the second-leading market share in its PSA behind Advocate-Aurora (37.4%) and Ascension Health (24.8%), although both larger systems have many more hospitals in the Wisconsin market. No other provider holds over 10% of the remaining market share in the PSA, and Froedtert's more core market, the immediate surrounding service areas and up the I-45 corridor, is far stronger, estimated at around 40%.

Froedtert's market position is bolstered by their status as the only academic medical center in Eastern Wisconsin, as the primary teaching affiliate of the Medical College of Wisconsin, and operator of one of only two level-one trauma centers in the state. Froedtert has received national recognition in many clinical areas for its quality, safety and cost effectiveness. In addition, Froedtert's location on the campus of the Medical College of Wisconsin and the Children's Hospital of Wisconsin helps increase visibility and essentiality in the competitive service area.

Fitch considers Froedtert's service area characteristics to be stable, with little risk of transitioning over the near term. As a major metropolitan area, Milwaukee benefits from a diversified economy. Population growth in both the city of Milwaukee and Milwaukee County, are flat, to slightly declining, although recent Froedtert activity in the far southern market (Kenosha) should balance out population growth. The median household income level in the service area lags both state and national trends, while the unemployment rate is generally commensurate with both state and national averages. Fitch does not expect Froedtert's payor mix to change materially in the coming years as a result.

Froedtert entered into a strategic agreement with the former United Hospital System, in order to expand Froedtert's reach into the southern (Kenosha) market - a strategic growth area for many providers in Wisconsin. The campuses have been legally renamed as Froedtert South, and provide healthcare services under the brand name of Froedtert & MCW Health Network and are known as the Kenosha Medical Center and St. Catherine's Medical Center Campus, respectively. Froedtert health has a 25% equity interest in Froedtert South, and the two campuses have adopted Froedtert & MCW's quality protocols and will join Froedtert's instance of the Epic electronic health record. Fitch views this strategic alignment as a successful growth and market capture strategy, given the physical location of Froedtert South - essentially on the state border - likely securing Wisconsin patients who many have otherwise traveled to the Chicago-land area for healthcare services.

Operating Risk

Froedtert's operating cost flexibility is very strong. The system's operating EBITDA margin averaged a very robust 12.3% between fiscal 2014 and fiscal 2018, and EBITDA margins were even stronger for the same time period, averaging 14.8%. Management reports continued volume growth and market share capture in their service area should continue, which will support additional revenue growth, with "same store" volumes also increasing in the region in addition to newly accessed patients through both Froedtert South and other sites off the main campus.

The recent spate of mergers in the service area -- Aurora merging with Advocate and Wheaton merging with Ascension -- has increased the overall competitiveness in the region; however, Froedtert has spent significantly on capital over the last several years, and has successfully expanded its reach throughout the market.

Froedtert's capital spending ratio averaged over 210% between 2016 and 2018, and its average age of plant is a very healthy 8.4 years at fiscal year-end 2018. Most recent construction involves the Froedtert Center for Advanced Care (CFAC), which has opened in stages since October 2015. Additional and ongoing construction at the Froedtert Hospital is in incremental stages, finishing out shelled in space, with additional capacity opening in the CFAC in the summer of 2019 and spring of 2020.

Off the main campus, future capital projects include the Bluemound hospital campus, neighborhood hospitals and additional community health centers and surgical centers, in order to continue to both meeting the needs of their surrounding markets, and to place care at the most appropriate setting, allowing the most complex cases to be admitted at their main academic inpatient facility (Froedtert Hospital). These multiple projects are more numerous, but much smaller in scale than spending on the main campus. This will allow Froedtert greater flexibility on timing of spending, and opening of the facilities.

Going forward, Froedtert plans to spend about $1.0 billion on capital over the next five years (all from cash flow), which should translate to an average capital spending ratio (as compared with annual depreciation) of about 130%, which will keep Froedtert's average age of plant very favorable.

Financial Profile

Froedtert's financial profile is very strong in the context of the system's midrange revenue defensibility and very strong operating risk profile assessments. Capital-related ratios remain strong in Fitch's forward-looking scenario analysis.

Froedtert currently has approximately $810 million of direct debt, using fiscal 2019 unaudited March 31, 2019 third-quarter results and adjusted to create a 2019 year-end, at which point the system's unrestricted cash and investments measured $1.74 billion.

Debt equivalents are very limited. Froedtert does not have a defined benefit (DB) pension obligation that adds to debt equivalents. Froedtert's does have operating lease expense measured just over $16 million in fiscal 2018 (and used as the same for our 2019 year-end estimate, translating to a debt equivalent of just more than more than $80 million (based on 5x lease expense method). Consequently, Froedtert's adjusted debt (direct debt plus operating leases) measured just over $890 million as of fiscal 2019 (on an annualized basis). Net adjusted debt (adjusted debt minus unrestricted cash and investments) was favorably negative at roughly $850 million, or a cash to adjusted debt ratio of 195%.

Froedtert's capital-related ratios are strong through the cycle in Fitch's stress case scenario. Based on expected fiscal 2019 results, Froedtert's net adjusted debt-to-adjusted EBITDA measured a favorably negative 2.3x and cash-to-adjusted debt of 195%. Through the cycle, net adjusted debt-to-adjusted EBITDA remains favorably negative in every year in the stress scenario (which assumes normal economic recession followed by a recovery and then stability) and measures (favorably) around negative 3.0x by year four. Cash-to-adjusted debt dips just below 190% in years one and two in the stress case scenario and exceeds 200% by year three of the stress scenario, and continues to improve in the out years of a stress scenario.

Asymmetric Additional Risk Considerations

Unrestricted cash and investments measures $1.74 billion as of unaudited third-quarter results of fiscal 2019. Cash on hand measured over 275 days and does not pose an asymmetric risk. Froedtert has approximately $810 million of direct debt for the same time period, and maximum annual debt service (MADS) is $55.7 million. MADS coverage based on fiscal 2019 results is 6.4x based on operating EBITDA, and also does not pose an asymmetric risk. In addition, Froedtert's debt mix, or asset allocation are considered standard to conservative for the sector.

Contact:

Primary Analyst

Kevin Holloran

Senior Director

+1-512-813-5700

Fitch Ratings, Inc.

111 Congress Avenue

Austin, TX 78701

Secondary Analyst

Matthew Shapiro

Associate Director

+1-212-908-0823

Committee Chairperson

Paul Rizzo

Senior Director

+1-212-612-7875

In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Lumesis.

Media Relations: Sandro Scenga, New York, Tel: +1 212 908 0278, Email: sandro.scenga@thefitchgroup.com

Additional information is available on www.fitchratings.com
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