Fitch Rates Group Health’s New Sr. Secured Bonds ‘BBB-‘; Downgrades IFS & Existing Bonds [Health & Beauty Close – Up]

Fitch Ratings has assigned 'BBB-' ratings to Group Health Cooperative's (GHC) planned issue of $225 million of senior secured bonds with a mix of five and 10 year maturities.

Concurrent with the assignment of the ratings on the new bonds, Fitch is downgrading the ratings on GHC's currently outstanding senior secured bonds issued by the Washington Health Care Facilities Authority (WHCFA) on behalf of GHC. Fitch is also downgrading GHC's and its subsidiary Group Health Options, Inc.'s (GHO) (collectively Group Health) Insurer Financial Strength (IFS) ratings to 'BBB-' from 'BBB'. The Rating Outlooks are Stable. A complete list of rating actions follows at the end of this release.

Fitch's expectation is that GHC will use proceeds from the planned bond issue to refund its approximately $45 million of Series 2001 senior secured bonds outstanding, fund anticipated pension plan contributions, and for other general corporate purposes. After the bonds' issuance and the refunding of the Series 2001 bonds, GHC's outstanding debt will include $98 million of senior secured Series 2006 bonds and $225 million of new senior secured bonds.

The downgrade of the ratings on Group Health's currently outstanding bonds and the company's IFS ratings reflects the significant increase in financial leverage and annual interest expense that will result from the new bonds' issuance. Fitch estimates Group Health'sMarch 31, debt-to-annualized first quarter 2012 EBITDA and debt-to-capital ratios, including the $225 million of new bonds on a pro-forma basis, at 3.5x and 31 percent respectively. The ratios were 1.6x and 17 percent respectively on a reported basis at March 31.

<p>Fitch estimates that the company's annual interest expense, excluding the uncertain impact of an existing interest rate swap contract Group Health has in place, will roughly double to $15 million per year after the new issue. Fitch views the interest rate swap contract as reducing the company's reported interest rate expense as long as rates do not rise significantly from current levels but exposing Group Health to an increase in reported interest expense in a higher interest rate environment. With reported interest expense in the $15 - 25 million range, and projecting Group Health's earnings based on recent volatile results, the agency believes that near-term EBITDA-based interest coverage of 3x - 5x and operating EBITDA-based coverage of 1x - 3x are reasonable expectations.

GHC's new bonds, like the outstanding Series 2006 and Series 2001 bonds, will be secured by unrestricted receivables and a first lien pledge on certain property and equipment. While the new $225 million issuance results in a relative dilution of the amount of collateral supporting the aggregate amount of bonds outstanding, Fitch views the collateral as providing adequate security for the bonds at the existing ratings levels. The agency notes that the Series 2006 bonds also benefit from a fully funded debt service reserve fund.

Group Health's IFS ratings and the ratings on the company's senior secured bonds continue to reflect the company's small size and scale and geographically concentrated, albeit strong, market position. The ratings also reflect the company's comparatively weak profitability and interest coverage and solid risk-based capitalization.

Group Health's recent profitability has been poor as the company has struggled to cope with operational issues that resulted from its gradual expansion outside its traditional strength HMO product. The company has taken various steps to improve its financial results. However Fitch views the ultimate outcome of these actions as uncertain given the highly competitive nature of the health insurance and managed care market.

The company's NAIC Risk-based Capital ratio (on a company action level basis) and operating leverage measured by its premiums-to- surplus ratio are approximately 250 percent and 4.5x both of which are better than median guidelines for Group Health's ratings levels.

Fitch has withdrawn GHC's 'F3' short-term rating. The rating is withdrawn as it is no longer considered analytically meaningful.

Rating Triggers:

Key rating triggers that could lead to an upgrade of Group Health's ratings include run-rate:

--EBITDA/ Revenue margins approximating 7 percent;

--Net income/average capital ratios approximating 7 percent;

--Debt-to-EBITDA ratios and debt-to-capital ratios that are less than 3.0x and 35 percent respectively;

--EBITDA-based interest coverage ratios that exceed 7x.

Key rating triggers that could lead to a downgrade of Group Health's ratings include:

--Run-rate EBITDA/ Revenue margins that are less than 3 percent;

--Run-rate net income/average capital ratios that are less than 3 percent;

--Earnings charges or balance sheet adjustments that are expected to reduce the company's NAIC RBC ratios (company action level basis) below 225 percent;

--Run-rate debt-to-EBITDA ratios and debt-to-capital ratios greater than 3.0x and 35 percent respectively;

--Loss of key contracts that contribute significantly to membership.

Fitch has downgraded the following ratings:

--$99,736,000 Series 2006 revenue bonds issued by the Washington Health Care Facilities Authority on behalf of Group Health Cooperative to 'BBB-' from 'BBB';

--$54,151,000 (Check $ amount, only $45m on balance sheet at YE 2100) Series 2001 revenue bonds issued by the Washington Health Care Facilities Authority on behalf of Group Health Cooperative to 'BBB- ' from 'BBB';

--Group Health Cooperative - IFS to 'BBB-' from 'BBB';

--Group Health Cooperative - IDR to 'BB+' from 'BBB-';

--Group Health Options, Inc. IFS to 'BBB-' from 'BBB';

Fitch has withdrawn the following rating:

--Group Health Cooperative - Short-term rating 'F3'.

Additional information is available at 'fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

--'Insurance Rating Methodology' (Sept. 22, 2011);

--'Revenue-Supported Rating Criteria' (Oct. 8, 2010);

--'Nonprofit Hospitals and Health Systems Rating Criteria' (Dec. 29, 2009).

Applicable Criteria and Related Research:

Insurance Rating Methodology

http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=651018

Revenue-Supported Rating Criteria

http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=637130

Nonprofit Hospitals and Health Systems Rating Criteria

http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=648836

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