SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BB+' rating on Palomar Health, CA's (PH) outstanding debt, which is listed at the end of the press release.
The Rating Outlook is revised to Stable from Negative.
SECURITY
The bonds are secured by a gross revenue pledge of the obligated group (OG). The obligated group is comprised of PH's acute care facilities as well as other healthcare related entities but excludes Arch Health Partners (AHP), a medical foundation. AHP was de-consolidated from the audit in fiscal 2014 (June 30 fiscal year end) so the OG and the consolidated entity were the same in fiscal 2014.
KEY RATING DRIVERS
REBOUND IN FINANCIAL PERFORMANCE: The revision in Outlook to Stable from Negative reflects improved operating cash flow in fiscal 2014 that has been sustained through the first four months ended Oct. 31, 2014, as well as growth in liquidity. The Negative Outlook was placed on PH in January 2014 due to very weak performance in fiscal 2013 that led to a violation of its liquidity covenant and barely meeting its debt service coverage covenant. The improved financial performance to date has been driven by increased volume, cost reductions (primarily reduction in force), as well as the sale of non-core assets.
NON INVESTMENT GRADE FINANCIAL PROFILE: After stabilizing its performance in fiscal 2014, PH's financial profile is characteristic of a non-investment grade credit with weak liquidity and high debt burden. At Oct. 31, 2014, PH had 79.7 days cash on hand and 22.9% cash to debt (revenue bonds only). Operating EBITDA margins compare favorably against the non-investment grade medians with an 11% operating EBITDA margin through the four months ended Oct. 31, 2014 and 10.2% in fiscal 2014, which led to adequate MADS coverage of 2.1x and 1.7x, for the respective time periods.
SIGNIFICANT CAPITAL INVESTMENT COMPLETE: In August 2012, PH opened its 288-bed Palomar Medical Center (PMC) in Escondido, California. The opening and subsequent relocation of most service lines from its downtown campus to PMC was the centerpiece of PH's significant $1.06 billion facilities master plan. PH has an agreement with Kaiser Permanente (rated 'A+') to provide bed capacity, and Kaiser volume has consistently been under budget although it has recently increased.
GOOD MARKET POSITION: Fitch believes PH's main credit strength is its location in North San Diego County, which makes it an attractive partner in any plans to develop a larger regional network and delivery model that is able to manage population health. In addition, PH has significantly invested in its medical foundation, AHP, which provides a primary care base that will be integral in care coordination.
RATING SENSITIVITIES
SUSTAINED SOLID OPERATING CASH FLOW: Fitch expects PH to sustain its solid operating cash flow due to additional operational initiatives that are underway. Although there are limited capital needs going forward, PH continues to make strategic investments, especially in AHP, which may hinder near-term liquidity growth.
CREDIT PROFILE
PH is a California hospital district that operates three hospitals in northern San Diego County. For fiscal 2014, PH's consolidated audited results excluded its medical foundation, AHP (80 physicians and 10 physician extenders), and numbers for fiscal 2013 were restated for comparative purposes. Total operating revenue in fiscal 2014 was $628 million. Since Fitch's last review, there has been a change in executive leadership with the prior CFO promoted to CEO as of August 2014. There are several vacant/interim positions that are expected to be filled in the first half of 2015.
Rebound in Financial Performance
At the time of Fitch's last review in January 2014, PH was implementing several turnaround initiatives to stem the losses from fiscal 2013 due to challenges with the transition to its new facility in August 2012. The benefits from these initiatives were realized in fiscal 2014 with a $17 million improvement in operating cash flow driven mainly by a reduction in force. PH continues to focus on reducing its cost per adjusted discharge with plans to lower this further in fiscal 2015. In fiscal 2014, operating income was negative $26.2 million compared to negative $36.2 million the prior year and operating losses are primarily driven by high depreciation and interest expense. Operating cash flow is solid with operating EBITDA margin of 10.2% in fiscal 2014 compared to 7.7% in fiscal 2013 and 11% for the four months ended Oct. 31, 2014. PH has budgeted an operating EBITDA margin of 12.1% for fiscal 2015 and ongoing operational initiatives include improved patient throughput, reduction in cost per adjusted discharge, supply savings, as well as further reduction in labor costs.
Opening of Palomar Medical Center
In August 2012, PH opened its new 288-bed Palomar Medical Center in North San Diego County and successfully relocated the majority of its service lines to the new hospital from its downtown Escondido facility. The downtown facility remains operational and houses an urgent care center, labor and delivery, behavioral, and acute rehab service lines. PMC was the key component of PH's sizable $1.06 billion facilities master plan, which also included expanding its Pomerado Hospital in Poway and building outpatient satellite clinics. PH operates a total of 508 beds and all the acute care facilities are seismically compliant.
Volume growth has consistently missed budgeted expectations especially with its agreement with Kaiser. However, year over year growth has improved especially with more obstetric and surgery volume from Kaiser. In fiscal 2014, admissions were up 8% from prior year and through the four months ended Oct. 31, 2014, admissions were up 7.1% from the same prior year period. PH's bed capacity agreement with Kaiser expires in 2020 with an upcoming renewal date in mid 2015 that will decide if either/both parties want to extend the agreement beyond 2020.
Investment in Arch Health Partners
AHP is a medical foundation located in Poway, CA with nine other locations in the service area. PH is the sole corporate member of AHP and aligned with the medical foundation in 2010. PH has provided significant support to AHP over the last two years and ongoing support is expected at approximately $16 million a year, which may hinder liquidity growth.
Weak Liquidity
As of Oct. 31, 2014, unrestricted cash and investments totaled $134.6 million, which equated to 79.7 days cash on hand and 22.9% cash to debt, which is a slight improvement from fiscal 2013 with 73.3 days and 20.6% cash to debt. PH remains challenged by high accounts receivable with 71.5 days in accounts receivable as of Oct. 31, 2014 and there is new oversight in revenue cycle, which should improve cash collections.
PH's days cash on hand covenant calculation excludes interest expense from total expenses and the bond covenant calculation for fiscal 2014 was 91 days, above the 80 days cash on hand covenant for the series 2006 insured bonds (65 days cash on hand covenant for uninsured bonds).
High Debt Burden
PH has a very high debt burden due to the funding of its facilities master plan. As of June 30, 2014, total debt outstanding was $1.1 billion and included $560 million of revenue bonds and $574 million of general obligation (GO) bonds. Fitch rates the GO bonds 'A+'. The revenue bonds are 68% fixed rate and 32% variable rate (auction mode; series 2006). MADS of $41.4 million accounted for 6.6% of total revenue in fiscal 2014 compared to the non-investment grade median of 4%.
PH has three fixed payor interest rate swaps with Citi related to the series 2006 bonds and the swaps are insured by Assured Guaranty. There are currently no collateral posting requirements, but requirements would be implemented if Assured Guaranty's rating falls below the 'A' category and would be at a zero threshold based on PH's current rating. The mark to market valuation as of June 30, 2014 was negative $26.5 million. In addition, there is an additional termination event if Assured Guaranty's rating falls below 'BBB'.
Property Tax Revenue
As a California hospital district, PH receives unrestricted property tax revenues from a fixed share of the 1% property tax levied by the County of San Diego on all taxable real property in PH's boundaries. PH received $13.5 million and $12.9 million in unrestricted property tax revenues in fiscal 2014 and 2013, respectively. This tax revenue is included in other operating revenue. PH also receives ad valorem tax revenues generated by the separate voter-approved tax levy that is pledged solely for the payment of principal and interest on PH's series 2005, 2007, 2009, and 2010 GO bonds. Fitch's financial analysis excludes the GO bonds and related property tax revenue and interest expense.
Disclosure
PH covenants to provide annual audited financial reports and unaudited quarterly financial statements to bondholders. Quarterly information, including a balance sheet, income statement, and statement of changes in net assets will be provided within 45 days after the end of each of the first three fiscal quarters.
Outstanding Palomar Health, CA Debt:
--$159,647,000 COPs series 2010;
--$228,970,000 COPs series 2009;
--$171,731,000 COPs series 2006A-C.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 30, 2014.
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=746860
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=971135
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