Fitch Downgrades Palomar Pomerado Health's (CA) Rev Bonds to 'BB+'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings assigns a 'BB+' rating to $160 million in series 2010 certificates of participation (COPs) expected to be issued by Palomar Pomerado Health (PPH). In addition, Fitch downgrades to 'BB+' from 'BBB' the rating on the following outstanding PPH bonds:

--$224,000,000 certificates of participation, series 2009;
--$172,000,000 certificates of participation, series 2006A,B & C;
--$35,475,000 insured revenue refunding bonds, series 1999.

The series 2010 COPs will finance the remaining construction costs of PPH's master facility plan, fund capitalized interest and a debt service reserve fund, and pay costs of issuance. The COPs are expected to sell the week of Nov. 9, 2010.

The Rating Outlook is stable.

RATING RATIONALE:
--The downgrade to 'BB+' from 'BBB' reflects PPH's heightened leverage position, reduced debt service coverage and lowered debt-related liquidity metrics as a result of planned issuance of the series 2010 COPs.

--Though financial projections after completion of PPH's new facility show breakeven profitability, PPH's markedly increased debt load, reduced coverage, and low debt-related liquidity metrics produce a financial profile that is inconsistent with an investment grade rating.

KEY RATING DRIVER:
--Successful completion of PPH's master facility plan without further deterioration of PPH's liquidity and leverage positions.

SECURITY:
Debt payments are secured by a pledge of the gross revenues of the obligated group. A fully funded debt service fund provides additional security for the bond issue.

CREDIT SUMMARY:
The two-notch downgrade to 'BB+' from 'BBB' reflects PPH's deteriorating leverage, reduced debt service coverage, and lower debt-related liquidity ratios as a result of a planned new debt issuance of $160 million. The series 2010 COPs are being issued to complete funding needs for PPH's $1.06 billion master facility plan (FMP). Management informs Fitch that the unanticipated 2010 issuance is related to a need to fund a $77.4 million central utility plant that was to be financed by a third party, a $30 million project cost escalation, and a downward revision to the philanthropy component to $7.1 million from $45 million. PPH anticipates using future philanthropy receipts to pay down a portion of the 2010 COPs.

Palomar Pomerado's pro forma leverage, debt service coverage, and debt-related liquidity metrics are indicative of a very high debt burden and are in line with Fitch's 'BB' category medians. Post financing, PPH's long-term debt will total $588.5 million. With this financing, maximum annual debt service (MADS) increases to $41.9 million from $31.9 million. On a pro forma basis for the fiscal year ended June 30, 2010, MADS accounts for a very high 7.8% of total operating revenues. Pro forma MADS coverage by EBITDA, at 1.3 times (x), is weak and compares unfavorably to Fitch's 2.5x median for the 'BBB' category. Lastly, pro forma debt to capitalization, estimated at 65.2%, is quite high.

The planned financing further exacerbates Palomar Pomerado's already low liquidity position related to its debt. Although PPH's $171.6 million in unrestricted cash and investments equates to a solid 144 days of expenses, cash-to-debt (40%) and the cushion ratio (5.4x) are low. On a pro forma basis, PPH's cash to debt position and cushion ratio fall to 29.2% and 4.1x, respectively. While financial projections provided to Fitch by management show measured improvements to PPH's financial profile, Fitch believes that the markedly increased debt load, low MADS coverage, and decreased debt-related liquidity will remain below investment grade metrics.

The elevated revenue-secured debt load is mitigated by PPH's good operational management practices, leading market share in a large primary service area, and taxing authority (for operations and GO bond repayment) over a large and diverse tax base. Profitability continues to benefit from management actions that focused on cost containment and revenue enhancement, resulting in two years of very good and increasing operating margins - in FY 2009 and 2010, PPH reported operating margins of 3.4% and 4.7%, respectively.

PPH's operations benefit from its leading (54%) market share in the large and highly populated north San Diego County area. Additionally, PPH has entered into a hospital service agreement with Kaiser Foundation Hospitals (rated 'A+' by Fitch) to provide inpatient and outpatient hospital services to Kaiser's Health Plan members, which Fitch views as a positive credit factor. Further, as a California Hospital District (i.e., a political subdivision of the State of California), PPH derives 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 PPH's boundaries. In FY 2010, PPH received $12.9 million in unrestricted property tax revenues. Fitch notes that these revenues are in addition to, and are separate from, the ad valorem tax revenues resulting from the separate voter-approved tax levy that is pledged solely to the payment of principal and interest on PPH's series 2005, 2007, 2009, and 2010 GO bonds (rated 'AA').

The Stable Outlook reflects Fitch's expectation that management will successfully complete its master facility plan without further deterioration in PPH's liquidity and leverage positions.

Palomar Pomerado operates two acute care hospitals, the 324-bed Palomar Medical Center (PMC) in Escondido and the 107-bed Pomerado Hospital in Poway, two skilled nursing facilities, a surgery center, and an ambulatory care center. In FY 2010, PPH had $540.1 million in total health care revenues. PPH 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.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:
--Revenue-Supported Rating Criteria', dated Oct. 8, 2010;
--Nonprofit Hospitals and Health Systems Rating Criteria', dated Dec. 29, 2009.

Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=564565
Nonprofit Hospitals and Health Systems Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493186

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Contacts

Fitch Ratings
Primary Analyst
Michael Borgani, +1-415-732-5620
Director
650 California Street
San Francisco, CA 94108
or
Secondary Analyst
Carolyn Tain, +1-415-732-7576
Senior Director
or
Committee Chairperson
Jeff Schaub, +1-212-908-0680
Managing Director
or
Media Relations:
Cindy Stoller, +1-212-908-0526 (New York)
cindy.stoller@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Michael Borgani, +1-415-732-5620
Director
650 California Street
San Francisco, CA 94108
or
Secondary Analyst
Carolyn Tain, +1-415-732-7576
Senior Director
or
Committee Chairperson
Jeff Schaub, +1-212-908-0680
Managing Director
or
Media Relations:
Cindy Stoller, +1-212-908-0526 (New York)
cindy.stoller@fitchratings.com