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Fitch Ratings: Affirms Marshfield Clinic Health System (WI) rev bonds at 'A-'; Outlook revised to negative
3/29/2019

Fitch Ratings has assigned an 'A-' Issuer Default Rating (IDR) to Marshfield Clinic Health System (MCHS) and affirmed the 'A-' on about $515 million of bonds issued by the Wisconsin Health and Educational Facilities Authority on behalf of Marshfield Clinic Health System.

The Rating Outlook is revised to Negative from Stable.

SECURITY

The bonds are secured by a gross revenue pledge of the obligated group.

ANALYTICAL CONCLUSION

The assignment of the 'A-' IDR and affirmation of the 'A-' with a Rating Outlook revision to Negative reflects MCHS's increased leverage and reduced financial flexibility as the system fully integrates acute care operations into its already well developed physician and health plan care delivery network. It is Fitch's opinion that the strategy to move toward a fully integrated health care delivery system will further position MCHS favorably in the changing healthcare industry and the growing move toward value-based care. Over time, Fitch fully expects MCHS's investment in acute care operations to be financially accretive to the system. However, at this time, the realization of improved cash flow from cost effective care in the right setting and the expected benefits of provider-based reimbursement has been slower than anticipated. The current rating anticipates swift operating profitability improvements and limited disruption from the ongoing acute care integration throughout fiscal 2019 and 2020, and relative operating stability thereafter.

A combination of midrange revenue defensibility and midrange operating performance results in MCHS's financial profile emerging from the stress scenario initially more consistent with the broad 'BBB' category. However, Fitch's criteria allow the rating to fall outside the suggested category if rating factors are present not otherwise captured in Fitch's Key Rating Drivers that Fitch believes enhance the issuers' capacity to meet financial obligations. Fitch believes several such factors exist for MCHS including its highly integrated and broad franchise, and significant service area distribution. The 'A-' rating also takes into account the stability provided by the large and established provider based health plan.

The Negative Outlook reflects Fitch's view that operating performance has just recently begun to show improvement and improvement plans are ambitious. Further, there is limited room at this rating level for falling short of expected operating improvements during the outlook period.

KEY RATING DRIVERS

Revenue Defensibility: 'bbb'; Growing Acute Care Presence in Stable but Competitive Market

MCHS has mid-range revenue defensibility. As MCHS continues its acute care integration strategy they face more direct competition with area providers, including several large national systems, in a competitive service area with no dominant provider. MCHS, with about 18% acute care market share as of fiscal 2018, distinguishes itself from the competition with its fully integrated care delivery network, quality reputation and broad ambulatory footprint. Further, the system has a good payor mix with the system's own large and established Security Health Plan (SHP) being one of its largest payors.

Operating Risk: 'bbb'; Health Plan Provides Stability during Acute Care Integration

MCHS's operating risk profile is assessed as mid-range. Operating EBITDA margins have been modest reflecting the lower margin health plan and ambulatory care businesses prior to the acute care strategy. However, Fitch expects MCHS to capture substantial benefits from the integration and current improvement plan during fiscal 2019, attaining an operating EBITDA margin of over 6% and continuing to improve then stabilize at over 8% as captured in Fitch's base case. The provider owned health plan accounts for over 50% of system revenues and provides a level of stability. Capital spending needs are high reflecting the expectation of continued investment in acute care growth.

Financial Profile: 'bbb'; Financial Profile emerges from the cycle at the broad 'BBB' rating category

Financial flexibility is assessed as mid-range reflecting adequate financial resources through the cycle despite recent increases in debt and planned borrowing to invest in the acute care strategy. The established health plan, flexibility in the large capital plan and a relatively conservative investment portfolio contribute to stability under Fitch's stress scenario. Fitch's forward look shows MCHS's financial profile metrics emerging from the initial stress years split between the broad 'BBB' category given the mid-range revenue defensibility and mid-range operating risk profile. However, if MCHS successfully executes on its current integration and improvement strategy resulting in a strong operating risk assessment as expected, metrics will be solidly consistent with the broad 'A' category.

Asymmetric Additional Risk Considerations

No asymmetric additional risk considerations affected this rating determination.

RATING SENSITIVITIES

Improvement Expected: The 'A-' rating incorporates Fitch's expectation that MCHS will realize the positive impact of the acute care integration and management's performance improvement plan on margins and cash flow during fiscal 2019, with margins stabilizing thereafter. A rating downgrade could occur if operating performance does not improve as expected and capital plans are not adjusted accordingly or if capital spending and additional borrowing exceeds current expectations.

Although sustained operating improvement with operating EBITDA margins stabilizing over 8% in conjunction with continued stable performance at the health plan could warrant a strong operating risk assessment, which would likely indicate a higher rating, positive rating movement in the two year outlook period is unlikely given the current operational challenge.

CREDIT PROFILE

Marshfield Clinic Health System (MCHS) is an integrated regional health care system comprised of Marshfield Clinic, a large multi-specialty physician group serving the market for over 100 years; Security Health Plan (SHP), a fully integrated health plan with over 235,000 members; and an expansive ambulatory footprint with over 50 locations and a recent and growing presence in acute care, with five acute care hospitals, two in development/construction and one affiliation in final stages. Marshfield serves a service area population of approximately 1.1 million, about 20% of the population of Wisconsin. SHP is the third largest health plan in the state and consistently receives high quality ratings by National Committee for Quality Assurance.

Total revenues for fiscal 2018 were about $2.4 billion derived from Marshfield's two operating divisions. The health plan accounted for about $1.3 billion in revenues, and care delivery, comprised of the medical group, acute care, ambulatory care, and research accounted for about $1.8 billion. About $700 million in intercompany revenues flow between the health plan and care delivery divisions primarily attributed to the 100,000 member lives in the health plan. Revenues have become increasingly diversified with acute care revenues accounting for about 13% of system revenues, compared to about 3% in fiscal 2016, premium revenues accounting for over 50% of system revenues, and ambulatory care accounting for about 37%. The remaining revenues come from research, philanthropy and other sources.

The Obligated Group (OG) includes MCHS, Marshfield Clinic, Family Health Center of Marshfield, Lakeview Medical Center, the MCHS Foundation, and MCHS Hospitals, Inc. The OG does not include SHP and accounted for approximately 72% of the systems total revenues and 94% of total assets in fiscal 2018. Fitch's analysis is based on the results of the consolidated entity.

Revenue Defensibility

MCHS's has a favorable payor mix with combined Medicaid and self-pay totaling about 14% of gross patient revenues. SHP makes up one of the system's largest payors with diverse product offerings including a highly ranked Medicare Advantage plan. MCHS is moving toward becoming a fully integrated care delivery network in which population health management and cost of care are key priorities.

MCHS's service area is competitive with the presence of several regional health systems and providers that are part of larger national health systems including Ascension/Ministry, Aspirus and Hospitals Sisters Health Services. MCHS, with about 18% market share compared to 23% for Aspirus and 19% for Ascension/Ministry, distinguishes itself from its competition with its fully integrated care delivery network as MCHS continues to integrate acute care into their delivery model. MCHS employs about 650 physicians and about 1,200 medical providers with 86 specialties and over 50 locations. Within the past two years, MCHS has grown from two integrated campuses, including a joint venture with Ascension in Park Falls and a 40-bed critical access hospital in Rice Lake, to five integrated campuses, two new greenspace facilities in the construction and planning stages and one affiliation agreement near finalization.

The most sizable contribution to the acute care expansion has been 504 bed Marshfield Medical Center (MMC, previously St. Joseph's Hospital), acquired from Ascension Health in July of 2017. MMC includes a Level II trauma center, a children's hospital and a skilled nursing unit and has maintained healthy utilization levels and growing surgical procedures. MCHS also acquired two 25 bed critical access hospitals in Rusk and Neillsville in August and December of 2018, respectively with commitments to extensively develop those campuses, including the construction of a replacement facility at Neillsville. MCHS recently opened a new 44-bed greenspace facility in Eau Claire and an oncology center in Stevens Point. Affiliation discussions in the new market of Beaver Damn to the south are near complete and additional acute care expansion is underway at Minocqua and being considered in other targeted markets. Growth, while rapid, has been strategic and focused on geographic locations that will complement the existing ambulatory care services and the medical staff. Fitch expects MCHS's market position to improve as the acute care services continue to grow.

Previously accredited by Accreditation Association for Ambulatory Health Care (AAAHC), the system has recently become 100% accredited by the Joint Commission on the Accreditation of Healthcare Organizations (JCAHO) for all services, creating a consistent lens across the organization and solidifying MCHS's position in the acute care space. Security Health Plan is the third largest plan in Wisconsin and with close to 235,000 members and enrollment growth of over 8% from fiscal 2017 to 2018.

MCHS's service area includes north, central and western Wisconsin and 11 counties in the Upper Peninsula of Michigan, with the main market of Marshfield, where about half of the clinics doctors practice. MCHS's service area is characterized by generally flat population growth, median income levels below and unemployment rates slightly above the state and national averages. The percentage of uninsured population compares favorably to state and national averages. Fitch expects the service area to support a stable payor mix at MCHS.

Operating Risk

MCHS's operating cost flexibility is assessed as mid-range and is stabilized by SHP, which accounts for over 50% of MCH's overall operating revenue, is accretive to the system, and has seen significant membership growth with over 235,000 members currently. Because MCHS's core operations have historically been from the health plan and ambulatory services, margins have typically been below the median for similarly rated entities as these tend to be lower margin services. As MCHS's acute care integration strategy progresses and acute care revenues continue to increase as a percentage of total revenues (having grown from 3% to 13% of system revenues from 2016 to 2018 with continued growth expected), operating EBITDA margins are expected to improve.

The health plan division experienced 9% revenue growth from fiscal 2017 to 2018, driven by strong enrollment growth of 8.3% and premium rate increases. Operating performance at the health plan was solid in fiscal 2018. Due to the seasonality of the business, the health plan experienced a loss in the first quarter of fiscal 2019 but is on track for stable operating profitability in 2019 according to management.

MCHS's operating EBITDA margin has averaged about 5% over the past four years, but fell to 3.3% in fiscal 2018 due to challenges within the care delivery division, including the implementation of a new electronic health system, startup costs associated with the new hospital in Eau Claire, and labor and reimbursement cost pressure. Specifically, a delay in Medicare certification and the resulting unreimbursed costs at Eau Claire, the electronic health records implementation and a delay in receiving budgeted provider based reimbursement at MMC contributed to non-recurring costs in fiscal 2018. Although challenges continue from labor and pharmaceutical costs, pressure on ambulatory utilization due to patient access issues and reimbursement pressures, Fitch expects significant operating improvement in 2019.

Marshfield is currently implementing a multi-year performance improvement plan with ongoing efforts to identify and implement additional savings opportunities. The system is also addressing the patient access issues and has created a new position to rework the scheduling processes, address patient backlog and improve patient turnover. Despite a weak first quarter, Fitch believes management's ambitious performance improvement plan along with benefits of integration could ultimately result in operating EBITDA margins above 8% as captured in the base case.

MCHS currently has high lifecycle investment needs as the system continues to implement its aggressive acute care integration strategy. The five year capital plan includes potential total spending of just over $1 billion in strategic and routine expenditures, some of which have not yet received board approval, and is relatively flexible. Capital expenditures have been high averaging about 260% of depreciation over the past five years reflecting the construction of the Eau Claire facility and other acute care initiatives. Over the next five years, capital expenditures are expected to be just over 140% of depreciation with flexibility to scale back or defer spending during stress years. The system's average age of plant is a low 6.8 years as of fiscal 2018 but may be skewed downward due to recent acquisitions. There are no firm debt issuance plans at this time but debt financing may occur as soon as fiscal 2020.

Financial Profile

A significant increase in long-term debt within the past two years has weakened MCHS's financial profile metrics. Cash to adjusted debt of 88% and net adjusted debt to adjusted EBITDA of 1.1x in fiscal 2018, while still sound, reflect the changing leverage profile when compared to 187% and -2.3x in fiscal 2016. Additional borrowing since 2016 includes about $310 million of 2017 B and C bonds and a term loan of about $48 million related to the MMC acquisition, $100 million of 2018 series B and C, a $75 million private placement related to the Eau Claire facility, and a $100 million 2018C (issued in fiscal 2019) draw down facility for various projects. The system also had $70 million drawn on short-term lines of credit as of fiscal 2018, which should be paid in full during 2019 as days in accounts receivable begins to trend down following the EHR implementation. Adjusted debt of $1.04 billion for fiscal 2018 includes debt equivalents of about $30 million related to operating leases calculated at a 5x multiple.

The base case assumes revenue growth consistent with acute care expansion and continued stability at the health plan. Fitch expects operating performance to improve and stabilize contributing to cash flow that will support planned investment while maintaining ample liquidity to support the current level of financial flexibility. Additional borrowing is anticipated as part of the overall acute care expansion and integration strategy and, although exact financing amounts are not known, Fitch has incorporated realistic borrowing plans totaling $400 million into the base case. Capital expenditures in the base case average about 140% of depreciation.

Fitch's stress scenario places the standard stress on MCHS's revenue growth and investment portfolio consistent with a moderate economic downturn. MCHS benefits from a conservative investment portfolio with relatively low downside portfolio risk of about 6.5% in the stress scenario. Borrowing in the stress scenario is reduced by $150 million and capital expenditures are reduced by $327 million (about 25% reduction from the base case) as management has indicated flexibility to defer and reduce capital expenditures to preserve the balance sheet.

Financial profile metrics rebound through the cycle with cash to adjusted debt of 68% in year five and net adjusted debt to adjusted EBITDA of 0.4x, supporting the broad categories of 'BBB' given the mid-range revenue defensibility and mid-range operating risk assessment.

Contact:

Primary Analyst

Madeline Tretout

Associate Director

+1-646-582-4569

Fitch Ratings, Inc.

33 Whitehall Street

New York, NY 10004

Secondary Analyst

Kevin Holloran

Senior Director

+1-512-813-5700

Committee Chairperson

Joanne Ferrigan

Senior Director

+1-212-908-0723

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