CHICAGO – Illinois-based Advocate Health Care’s impending merger with Wisconsin-based Aurora Health Care prompted S&P Global Ratings to shift its outlook on Advocate to negative because the combined balance sheet would weaken Advocate’s current levels.

While shifting the outlook to negative from stable Wednesday, S&P also affirmed Advocate’s AA-plus rating. It does not rate Aurora. The merger has received Illinois and federal regulatory approval and Wisconsin’s approval earlier this week paves the way for an expected closing early next week.

Aurora St. Luke's Medical Center in Milwaukee, Wisconsin. Owned by Aurora Health Care
St. Luke's Medical Center in Milwaukee. Owner Aurora Health Care is merging next week with Advocate Health Care. Aurora Health Care

"The negative outlook reflects our assessment of the AHCN's pending consolidation with Aurora Health Care” with the combined balance sheet, while still very strong, would be meaningfully weaker than current metrics shown by AHCN, said analyst Suzie Desai.

S&P said there’s a one-in-three chance the rating could drop one notch to AA due primarily to meaningful balance-sheet dilution, including higher debt levels.

The merger has positives, S&P said, including strengthening the combined systems’ “enterprise profile” with improved operating income. Aurora's recent operating margins are stronger than those of AHCN, which has experienced slight declines in recent years

“While we view significant opportunities and strengths related to the affiliation, there could be some stress to the rating if we don't see that that the combined entity can achieve meaningful benefits--both strategic and operational--in the next couple years,” S&P added.

The rating agency could restore the stable outlook if management demonstrates the benefits of the larger organization, including benefits from possible refunding and debt restructuring, and continues to sustain operating performance consistent with recent trends in order to compensate for the lighter combined balance sheet.

The merger, announced in December will create the 10th-biggest nonprofit hospital operator nationally.

Neither system agreed to assume any liability or guarantee the other’s debt. The two plan to “evaluate optimal credit structure alternatives and whether the refinancing of all or a portion” of their existing debt “could be considered beneficial to the combined organization.”

The system will be known as Advocate Aurora Health and operate 27 hospitals, employ more than 3,300 physicians, and have combined annual revenues of $11 billion. Advocate is the largest system in Illinois with 12 hospitals in Chicago, the suburbs, and central Illinois, while Aurora has 15, mostly in southern Wisconsin.

The system will be run by a single board with equal number of members from Advocate and Aurora and the current heads of each system serving as co-chief executive officers. The Advocate and Aurora names would continue to be used and each system will maintain its current headquarters. Advocate is based in the Chicago suburb of Downers Grove and Aurora is based in Milwaukee.

The two have little overlap in their regional footprint and no job losses are expected. The healthcare sector has seen a wave of consolidation as systems adjust to federal healthcare reforms and larger scale operations help reduce costs and dilute payor dependencies.

Advocate has about $1.5 billion of debt. In a September report, Moody’s Investors Service affirmed its Aa2 rating based on Advocate's size, good geographic diversity, very strong liquidity that allows absorption of delays in state Medicaid payments, moderate leverage and very good debt metrics even during lower performance.

Aurora carries single-A ratings and has about $1.3 billion of debt. Fitch Ratings upgraded the system in 2016 to A-plus saying it was due to “sustained operating profitability through interim 2016, which reflects strong cash flow ahead of historical levels.”

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