SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has assigned an 'AA' rating to the approximately $100 million California Health Facilities Financing Authority revenue bonds (Lucile Salter Packard Children's Hospital at Stanford [LPCH]) 2014 series A. In addition, Fitch has affirmed the 'AA' rating on LPCH's outstanding debt, listed below.
The proceeds of the series 2014A bonds in conjunction with approximately $100 million from series 2014B (direct bank loan) will fund a portion of LPCH's capital needs for its facility expansion project. The series 2014A bonds will be fixed rate and expected to price the week of April 28th.
The Rating Outlook is Stable.
SECURITY
The bonds are secured by a gross revenue pledge of the obligated group.
KEY RATING DRIVERS
PREEMINENT PEDIATRIC FACILITY: LPCH provides highly complex pediatric care with a case mix index over 2.0. LPCH is located on Stanford University's (the University; rated 'AAA' by Fitch) campus, and along with Stanford Hospitals and Clinics (SHC; rated 'AA-'; Positive Outlook), the two organizations are the primary clinical affiliates of the Stanford University School of Medicine (SOM). LPCH, SHC and the University are closely aligned, but remain distinct credit entities. LPCH recently launched a rebranding campaign and the organization is now known as Stanford Children's Health.
EXPANDED MARKET FOOTPRINT: LPCH has had strong regional relationships with various adult providers in the community, which has been important especially in a consolidating environment. LPCH has significantly expanded its network by adding a medical foundation in 2011 that allowed community physicians to become aligned with LPCH, in addition to an aggressive ambulatory care strategy to have presence within 10 miles of most family households in the Bay Area. LPCH now has approximately 1,000 physicians (768 faculty) and several multi-specialty centers as well as primary and specialty care clinics throughout the Bay Area.
STRONG PROFITABILITY: LPCH has consistently produced strong operating and operating EBITDA margins as a result of its focus on lean management, good payor mix for a children's hospital, and recent benefit from the provider fee. Medi-Cal accounted for 42.5% of gross revenues in fiscal 2013, which is on the low side for children's hospitals.
SIZABLE CAPITAL PLAN: LPCH is capacity constrained and is in the midst of a $1.2 billion hospital expansion project. The project will add 149 beds, provide expanded surgery, imaging and diagnostic capabilities, allow for the move to 100% private rooms and add shelled space for future growth. The total sources of funds include $70 million from series 2003 and 2008 bond proceeds, $97 million from Proposition 3 funds (state funds; voter-approved ballot initiative for children's hospital construction), $410 million from series 2012 and 2014 bond proceeds, $200 million from board designated funds, $222 million from fundraising and $202 million from cash flow. $300 million has been spent through the end of FY 2013.
INCREASED LEVERAGE: With this debt issuance, LPCH's financial profile is more leveraged for the rating level. Pro forma unrestricted cash and investments-to-debt is 139.4% compared to Fitch's 'AA' category median of 173.6%. No additional debt is expected.
RATING SENSITIVITIES
PRESSURED BALANCE SHEET: The new facility is expected to open in summer 2017 and Fitch's main concern is the impact of the remaining spend for the facility on the balance sheet through fiscal 2017. Approximately $200 million will be funded from cash and $80 million from cash flow in fiscal 2016 and 2017. Fitch expects operating cash flow to remain healthy over the short term to mitigate the capital spending; however, a material weakening of balance sheet metrics or profitability could result in negative rating pressure.
CREDIT PROFILE
LPCH operates a 266 bed pediatric and obstetric hospital on the Stanford University campus in Palo Alto and 36 beds in several inpatient care units on its license in nearby community hospitals in addition to a number of outpatient physician clinics. The obligated group includes only the hospital, which accounted for 98% of total assets and 96% of total revenue of the consolidated entity in fiscal 2013 (Aug. 31 year end). Fitch's analysis is based on the consolidated entity. In fiscal 2013, LPCH reported $1.16 billion in total operating revenue.
Expanded Market Footprint
LPCH has the highest case-mix index compared to other freestanding children's hospitals in California and its high acuity of services has been driven by its centers of excellence as well as its regional outreach with adult providers that has leveraged its depth of pediatric subspecialists and allows lower acuity care to be kept in the community setting.
LPCH has significantly grown its ambulatory care network recently. A medical foundation (Packard Children's Health Alliance [PCHA]) was formed in 2011, which has approximately 100 physicians and other providers in 11 practices around the Bay Area. PCHA combined with the faculty practice group (768 physicians) is known as the Stanford Children's Health Physician Network. Physician outpatient visits totaled 290,931 in fiscal 2013 compared to 155,932 in fiscal 2012 (prior to formation of PCHA) and annualized visits based on activity through the six months ended Feb. 28, 2014 total 361,446. Ambulatory care settings include a range of multispecialty centers and primary and specialty care clinics with new sites planned in the East and South Bay.
LPCH will be on Epic beginning in May 2014 with the installation complete by July/August 2014. The electronic medical record is expected to improve efficiency and coordination of care and several of LPCH's partners as well as SHC and SOM are also on Epic. The total cost of Epic is $98 million with $66 million spent through February 2014.
Sizable Capital Plan
LPCH has started its facility expansion project and construction is expected to be complete in late 2016 with the opening of the facility in summer 2017. There are two six-story towers with 72 ICU beds and 77 acute care beds in addition to six surgery suites, imaging and cardiac cath labs.
The total sources of funds include $70 million from series 2003 and 2008 bond proceeds, $97 million from Proposition 3 funds, $410 million from series 2012 and 2014 bond proceeds, $200 million from board designated funds, $222 million from fundraising, and $202 million from cash flow. Of the $300 million that has been spent through the end of fiscal 2013 - $122 million has been from cash flow, $11 million from 2012 bonds, $97 million from Proposition 3 funds, and $70 million from series 2003 and 2008 bonds.
In addition to the facility expansion project and Epic costs, routine capital spending totals approximately $35 million-$55 million a year.
Track Record in Fundraising
LPCH has a strong record in fundraising with the last two capital campaigns raising over $1 billion. In the most recent campaign, $250 million was raised for the project and $140 million has been received in cash. Management expects that the fundraising proceeds will be spent mostly in fiscal 2016 for the project, and Fitch believes all the funds will be in hand by that time. Another capital campaign is expected to be launched shortly.
Strong Profitability
LPCH has consistently had strong operating performance with an operating margin of 12.7% in fiscal 2013, 7% in fiscal 2012, and 10.1% in fiscal 2011, compared to Fitch's 'AA' category median of 4.2%. Through the six months ended Feb. 28, 2014, operating margin was 6.7% compared to 5.6% the same prior year period. The strong performance has been driven by good volume growth and focus on lean management. LPCH also benefited from the provider fee, which California enacted in 2010 to draw down additional federal funds for Medi-Cal services. The total net benefit was $59.1 million in fiscal 2013, $35.1 million in fiscal 2012, and $32.9M in fiscal 2011. A three-year extension of this program to December 2016 was approved by the state and is awaiting CMS approval. If this is approved, it would result in a net benefit of approximately $108 million to LPCH. LPCH's fiscal 2014 budget is a 4.3% operating margin.
Leveraged Balance Sheet
At Feb. 28, 2014, LPCH had $756 million unrestricted cash and investments which translated to 273.6 days cash on hand and 209.7% cash-to-debt. With the series 2014 debt issuance, pro forma cash-to-debt drops to 139.4%. Fitch expects LPCH's balance sheet to be pressured over the short term due to the heavy capital investment, which may limit balance sheet growth. However, Fitch does not expect the cash-to-debt ratio to decline further. LPCH's investments are managed by the University's investment management company.
Conservative Debt Profile
After the series 2014 issuance, LPCH's outstanding debt totals $542 million and the debt mix is conservative with 82% fixed rate and 18% variable rate. There are no swaps outstanding. The series 2014B direct bank loan is the only variable rate exposure and will be at an indexed floating rate for an initial period of 10 years. The $93 million series 2008A-C bonds were remarketed in 2012 as five-year fixed rate put bonds, and will be remarketed in 2017.
Maximum annual debt service remained at $31.3 million with this issuance, since debt service was backloaded with the series 2012 issuance. Debt service coverage is adequate at 4.5x through the six months ended Feb. 28, 2014 compared to 6.6x in fiscal 2013 and 3.8x in fiscal 2012 and Fitch's 'AA' category of 5.0x.
Disclosure
LPCH has covenanted to provide annual disclosure within 150 days of fiscal year end and quarterly disclosure for the first three quarters within 60 days of quarter end through the Municipal Rule Making Board's EMMA system.
Fitch has affirmed the following outstanding debt at 'AA':
$249,015,000 California Health Facilities Financing Authority (CA) (Lucile Salter Packard Children's Hospital at Stanford) revenue bonds series 2012A&B;
$93,450,000 California Health Facilities Financing Authority (CA) (Lucile Salter Packard Children's Hospital at Stanford) revenue bonds series 2008A-C.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 20, 2013.
Applicable Criteria and Related Research:
U.S. Nonprofit Hospitals and Health Systems Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708361
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=827436
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