Fitch Affirms Banner Health's (Arizona) Revs at 'AA-'; Outlook Stable

The 'AA-' rating is supported by Banner's strong operating performance that is buoyed by its leading market position in core markets and its excellent management practices. Lending further strength is Banner's large size, yielding benefits of scale. Historically, Banner's operating profitability has been solid and consistent with Fitch's 'AA' medians. After a slight decline in Fiscal Year 2008 (FY08), operating profitability rebounded strongly in the first five months in FY09. Having averaged a four-year 5.3% operating margin through FY07, Banner's operating margin dipped to 3.2% ($125.7 million) in FY08, reflecting increased interest and depreciation expenses, associated with the system's heavy capital investment. While operating EBITDA margin dipped to 9.4% in FY08 from 9.7% in FY07, Banner generated $371.4 million in operating EBITDA in 2008 versus $327 million in the prior year. However, 2008 net income was adversely affected by large realized losses on investments which led to a bottom line loss of $26.8 million (-0.7%).

Due to the negative impact from the recent turbulence in the global financial market on certain Banner's financial indicators, management implemented several initiatives in the fourth quarter of FY08 to improve operating profitability. As a result, Banner's profitability has rebounded strongly through the five months ended May 31, 2009, with a 7.6% operating margin ($147.7 million) and an operating EBITDA margin of 13.4% ($261.4 million). Excess income through the interim period totaled $163.3 million (8.3% net margin).

The system's ability to address softening economic variable and turbulent capital markets is in no small measure, a reflection of Banner's exceptional leadership, scale and service line breadth. In light of softening patient demand, higher costs of capital, low liquidity, and heavy capital investments, Banner's management revised its strategic financial plan in an effort to rebound profitability and enhance liquidity. Through sizable cost savings, labor force adjustments, and capital budget reductions, management succeeded in producing strong results, without compromising outcomes. Lastly, the system derives its strength from its scale and geographic diversity as it generates approximately $4 billion in revenues and maintains market share leadership in two core markets of Phoenix, Arizona and northern Colorado.

Primary credit concerns center around Banner's low liquidity for the rating category. As of Dec. 31, 2008, Banner had $1.2 billion in unrestricted cash and investments, equating to 125.7 days cash on hand (DCOH), dramatically lower than the 246.3 days at prior year's end. Aside from the dilutive effect of Banner's acquisition of Sun Health in 2008 (see Fitch's new issue report dated Aug. 13, 2008, for more information regarding the Sun Health acquisition), large realized and unrealized investment losses, coupled with approximately $273 million in collateral posting requirements on its swap contracts, eroded Banner's unrestricted cash and investments position. However, improved investment performance and a sizable reduction in collateral posting requirements, helped restore Banner's DCOH to around 150.3 days by May 31, 2009. While also low for the rating category, Banner's cash to debt position improved to 68.7% in the interim period and its cushion ratio rose to 10.6 times (x). While Fitch remains concerned about Banner's low liquidity, such concerns are mitigated by Banner's healthy cash flow generation, strong operating EBITDA results, and planned sizable reductions in its capital expenditures.

The Stable Rating Outlook is based on Fitch's expectation that Banner will meet its targets as projected under a revised strategic financial plan and maintain strong operating profitability. Although Banner's liquidity metrics are not consistent with its 'AA-' rating, a rating downgrade is precluded due to management's effective and timely response to the impairment to its liquidity position. Banner's revised five-year financial forecast projects operating and operating EBITDA margins to average around 4% and 10%, respectively, while liquidity indicators are expected to improve in a measured fashion. Fitch notes that failure to maintain such strong profitability, coupled with persistently low liquidity, may result in negative rating pressure.

Headquartered in Phoenix, Arizona, Banner is a large, integrated health care provider that owns, leases, and/or manages 22 hospitals and several other related health care entities. Banner had total revenues of $4 billion in fiscal 2008. Banner has agreed to provide certain quarterly financial information to bondholders, which Fitch views positively. The content of Banner's annual disclosure to NRMSIRs includes utilization statistics, balance sheet, income statement, and statement of cash flows, but does not include management discussion and analysis.

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Fitch Ratings
Michael Borgani, +1-415-732-5620 (San Francisco)
James LeBuhn, +1-312-368-2059 (Chicago)
Cindy Stoller, +1-212-908-0526 (Media Relations, New York)
cindy.stoller@fitchratings.com