SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has assigned an 'AA' rating to the approximately $78,140,000 California Health Facilities Financing Authority refunding revenue bonds (Lucile Salter Packard Children's Hospital at Stanford) 2016 series A and $100,000,000 California Health Facilities Financing Authority Revenue Bonds (Lucile Salter Packard Children's Hospital at Stanford (LPCH)) 2016 series B. In addition, Fitch has affirmed the 'AA' on LPCH's outstanding debt, which is listed at the end of this press release.
The series 2016A&B bonds will be fixed rate and the proceeds from the series 2016A will refund the outstanding series 2008A-C bonds and the series 2016B bonds will provide approximately $100 million of funds for the hospital expansion project. The bonds are expected to price the week of March 14th.
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 Health Care (SHC; rated 'AA'), 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. In 2014, a branding campaign was launched and LPCH and its affiliated physicians are known as 'Stanford Children's Health'.
EXPANDED MARKET FOOTPRINT: LPCH has had strong regional relationships with various adult providers in the community, which continue to grow in addition to significantly expanding its outpatient presence through a primary care network of physician and multispecialty clinics throughout the Bay Area. In addition, new services that are part of LPCH (formerly part of SHC) include fertility and reproductive medicine, which complement its current obstetrics program. There has been steady growth in inpatient volume and increasing acuity while outpatient volume has also been more robust.
EXPANSION PROJECT UNDERWAY: LPCH is capacity constrained and is nearing the completion of a $1.2 billion hospital expansion project. The project will add 72 pediatric ICU and 77 acute care beds, provide expanded surgery, imaging and diagnostic capabilities, and add shelled space for future growth. This bond issuance was unexpected but should provide cash flow relief as the series 2016 bond issue is substituting for prior planned amounts to be funded from cash flow. However, Fitch is concerned about the potential for project cost overruns as the budget is currently under review. The construction is expected to be substantially complete in December 2016 with the opening of the facility in summer 2017.
PRESSURED BALANCE SHEET: LPCH's balance sheet metrics have historically been light for the 'AA' rating level and it is expected that there will be additional pressure on the balance sheet as the hospital spends its planned $200 million from cash on the project in fiscal 2016 and 2017.
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 benefit from the provider fee. Managed care payors accounted for 53.6% of gross revenues in fiscal 2015 (Aug. 31 year end) while Medi-Cal accounted for 40.2%.
ELEVATED DEBT METRICS: Debt metrics are elevated until benefits from the hospital expansion project are realized. Preliminary pro forma maximum annual debt service (MADS) of $36.6 million increased from $31.3 million at the time of the 2014 issuance. Debt service coverage is strong but inflated due to higher than normal realized gains as LPCH has been liquidating investments to cash for the funding of the project with 8.6x coverage through the three months ended Nov. 30, 2015 and 6.1x in fiscal 2015 compared to the 'AA' category of 5.7x.
RATING SENSITIVITIES
COMPLETION OF EXPANSION PROJECT: While certain metrics are weak relative to 'AA' medians and peers, Fitch is tolerant of the temporary pressure on Lucile Salter Packard Children's Hospital's financial profile due to the expected benefits of the project, which should result in strengthening key metrics over the medium term as the hospital executes on its strategic growth initiatives. However, additional increases in project cost, a delay in completion or opening or sustained deterioration in key liquidity or profitability metrics could result in negative rating action.
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, LPCH manages several neonatal and pediatric units through joint ventures with other adult providers in the region. LPCH has significantly expanded its outpatient presence with 46 clinic locations throughout the Bay Area and four multispecialty service centers in targeted markets with a goal of having a Stanford Children's Health physician office within 10 miles of every family in the Bay Area. The obligated group includes only the hospital, which accounted for 99% of total assets and 95% of total revenue of the consolidated entity in fiscal 2015 (Aug. 31 year end). Fitch's analysis is based on the consolidated entity. In fiscal 2015, LPCH reported $1.4 billion in total operating revenue.
Preeminent Pediatric Facility
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 leads the nation in the number of pediatric solid organ transplants and in fiscal 2015 performed 558 cardiac surgeries and 26 heart transplants. LPCH has adopted a strategic framework called 'Vision 2025', which will focus on advancing academic and clinical excellence, expanding their reach, and creating a value based system.
LPCH continues to grow its ambulatory care network and align with physicians especially in primary care. A medical foundation (Packard Children's Health Alliance [PCHA]) was formed in 2011, and aligned with Packard Medical Group, has over 150 physicians and other providers in 21 practices (up from 11 during 2014 review) at 46 locations throughout the Bay Area. PCHA combined with the faculty practice group (over 500 physicians) is known as the Stanford Children's Health Physician Network. Ambulatory care settings include a range of primary and multispecialty centers with additional sites and offerings (after hours) expected.
LPCH implemented Epic (an electronic medical record system) in the summer of 2014 without any issues. The total cost was $98 million and fiscal 2014 included one time operating expenses for training of approximately $10 million. PCHA and faculty practice group physicians are on Epic as well as SHC.
Other initiatives underway include participating in a narrow network contract with SHC that is offered to employees of LPCH, SHC, and the university with expectations to grow through direct contracting with local employers.
Hospital Expansion Project
LPCH's current facility was designed for lower acuity services and several ancillary services are shared with SHC. Seismic requirements and the hospital's significant growth in the last 20 years led to the decision to build the expansion project, which will allow for continued growth in high acuity care.
The expansion project includes two six story towers - an acute care pavilion (77 beds) and ICU pavilion (72 beds), diagnostic and imaging services including cardiac cath labs, six additional operating rooms, and underground parking. The fifth floor is expected to be initially shelled. The project is on time and expected to be substantially complete in December 2016 with the opening of the facility in summer 2017.
The total cost of the project is currently $1.2 billion. As the project is nearing completion, management has been in discussions with the contractor regarding the final cost and the original budget is likely to be exceeded. A major cost overrun would be of concern given LPCH's pressured balance sheet.
The sources of funding presented during the series 2014 issuance included $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. With this issuance, the new sources of funding are $70 million from series 2003 and 2008 bond proceeds, $97 million from Proposition 3 funds, $417 million from series 2012 and 2014 bond proceeds, $200 million from board designated funds, $246 million from fundraising, $100 million from series 2016 bonds and $68 million from cash flow.
The remaining spend on the project from Dec. 1, 2015 totals $523.1 million and will be funded by $196 million from fundraising, $198 million from board designated funds, $29 million from series 2014 bond proceeds, and $100 million from series 2016 bond proceeds. In addition to expansion project costs, there are annual routine capital spending needs.
Track Record in Fundraising
LPCH has a strong track record in fundraising through the Lucile Packard Foundation with the last two capital campaigns raising over $1 billion. In the most recent campaign, $264 million was raised for the project and $217 million has been received in cash ($50 million spent through Nov. 30, 2015). LPCH, SOM and Lucile Packard Foundation are currently in the planning stages for the next campaign.
Strong Profitability
LPCH has strong operating performance with an operating margin of 7.7% in fiscal 2015, 3.8% in fiscal 2014, and 12.7% in fiscal 2013, compared to Fitch's 'AA' category median of 4.9%. The strong performance has been driven by the execution of LPCH's growth strategies and resultant volume growth, in addition to the benefit of the provider fee. The decline in performance in fiscal 2014 was due to the timing of CMS approval for the current provider fee program, in addition to one time operating expenses related to the Epic implementation.
The total net benefit from the provider fee program was $36.6 million in fiscal year (FY) 2015, $9.3 million in FY 2014, $59.1 million in fiscal 2013, $35.1 million in fiscal 2012, and $32.9 million in fiscal 2011. The current program is in place till December 2016 and there will be a ballot initiative in November 2016 to make the program permanent.
Fiscal 2017 operating performance is likely to be weaker due to one time transition costs to the new facility, and added depreciation and interest expense. However, Fitch expects that fiscal 2018 and beyond will include strengthening metrics as benefits from the expansion project are realized.
Pressured Liquidity
At Nov. 30, 2015, LPCH had $827 million unrestricted cash and investments which translated to 239.5 days cash on hand and 147.9% cash-to-debt compared to the 'AA' category medians of 289.4 and 201.7%, respectively. Financial projections were unavailable, however, Fitch's expectation is that LPCH's liquidity will decline in FY 2016 and 2017 as the $200 million of board designated funds are spent on the project. LPCH has had higher than normal realized gains in FY 2015 and first quarter 2016 as the organization has been liquidating investments to cash for the funding of the project. LPCH's investments are managed by the university's investment management company.
Conservative Debt Profile
After the series 2016 issuance, LPCH's pro forma debt totals $659 million and the debt mix is conservative with only 15% variable rate exposure. There are no swaps outstanding. The variable rate exposure is the $100 million series 2014B direct bank loan that is at an indexed floating rate for an initial period of 10 years. The $90 million series 2008A-C bonds were remarketed in 2012 as five-year fixed rate put bonds, and will be refinanced by the series 2016 bonds.
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.
Outstanding Debt:
--$100,000,000 California Health Facilities Financing Authority revenue bonds (Lucile Salter Packard Children's Hospital at Stanford) series 2014A;
--$244,600,000 California Health Facilities Financing Authority (CA) (Lucile Salter Packard Children's Hospital at Stanford) revenue bonds series 2012A&B;
--$90,290,000 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
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 09 Jun 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=866807
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1000823
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1000823
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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