Fitch Downgrades Tulare Local Health Care District (CA) Revenue Bonds to 'B+'; Outlook to Negative

NEW YORK--()--Fitch Ratings has downgraded the following bonds issued by Tulare Local Health Care District (Tulare) to 'B+' from 'BB+':

--$15.7 million refunding revenue bonds, series 2007.

The Rating Outlook is revised to Negative from Stable.

SECURITY

Debt payments are secured by a pledge of the gross revenues of Tulare Local Health Care District. A fully funded debt service reserve fund provides additional security.

KEY RATING DRIVERS

CONTINUED FINANCIAL WEAKENING: The multi-notch downgrade is driven by a rapid decline in Tulare's overall financial profile in fiscal year ended June 30, 2012 (unaudited interim financials), with continued deterioration through the six-month interim period ended Dec. 31, 2012. Performance has resulted in negative debt service coverage for both periods and Tulare is likely in violation of its debt service coverage covenant for fiscal 2012. The fiscal 2012 audit and debt service coverage covenant calculation are still unavailable.

LARGE OPERATING LOSSES: Impacted by challenged patient utilization and increased bad debt, profitability took a sharp turn as the district posted large operating losses of $7.3 million in fiscal 2012 and $3.8 million through the interim period, respectively.

WEAK BALANCE SHEET: Unrestricted cash and investments declined sharply to $10.5 million at Dec. 31, 2012 from $24.5 million at fiscal year-end (FYE) 2010 due to increased capital investments and negative operating cash flow. Additionally, debt load increased in December 2011 due to a $6 million loan to finance certain equipment. Expected further demand on liquidity for the construction project presents significant concerns.

CONSTRUCTION PROJECT DELAYED: The completion of the new bed tower that was initially scheduled for October 2012 has been delayed due to structural problems related to the concrete used on certain floors. Tulare is currently developing a recovery schedule and evaluating the amount of additional funding necessary to complete the project.

RECENT MANAGEMENT TURNOVER: Tulare experienced considerable management turnover in the last two years. Following the November 2012 election of three new board members, the current CEO rejoined the organization in December 2012 after having resigned in April 2012 due to differences with the previous board. The current CFO joined the organization in August 2012, replacing an interim CFO that had been in place since January 2012.

COMMUNITY SUPPORT: As a California health care district, Tulare benefits from a pro rata allocation of property taxes collected in Tulare County in support of operations and capital outlays.

RATING SENSITIVITY

FURTHER WEAKENING OF FINANCIAL PROFILE: Further balance sheet deterioration or inability to curb ongoing operating losses and improve cash flow would lead to negative rating action.

CREDIT PROFILE

The rating downgrade to 'B+' from 'BB+' reflects dramatic decline in unrestricted liquidity beginning fiscal 2011 followed by material deterioration in profitability and debt metrics in fiscal 2012. The apparent, yet unanticipated need for additional funding related to the delayed construction project adds further pressure on the already week balance sheet.

Operating profitability took a sharp turn in fiscal 2012, posting an operating margin of negative 9.3% after solid margins of 7% in 2011 and 5.8% in 2010 (including District tax revenues not related to the general obligation bond debt service). Operating income was primarily impacted by lower than budgeted volumes, lower supplemental funding receipts, increase in bad debt, and elevated expenses related to IT and capital projects. Bad debt increased 33% from 2011 to 2012 and doubled from 2008 to 2012, reflecting the service area's poor economic characteristics. Through the six-month interim period ended Dec. 31, 2012, level of bad debt moderated somewhat to $6.6 million versus $9.5 million the prior year period. However, due to continued challenges in utilization, operating margin weakened further to negative 10% in the interim period. Similarly, operating EBITDA margins were low at negative 4.3% in fiscal 2012 and negative 4.5% through the interim period.

Management is in the process of planning and executing various strategies to improve profitability such as enhancing revenue cycle management, strengthening contracts, and reducing overall expenses. The initiatives are being implemented throughout the 2013 calendar year, and benefits are expected to be realized somewhat in fiscal 2013 and in full over fiscal 2014. Management expects break-even performance for fiscal 2013. Fitch believes this will be challenging based on current performance, but recognizes the strong operating results posted from 2009 to 2011 under the current CEO's leadership.

Driven by a combination of capital spending and negative cash flow, unrestricted cash and investments declined further from $24.5 million at FYE 2010 to $10.5 million at Dec. 31, 2012. Over $6 million of the $14 million decline is attributable to IT related investments. Days cash on hand of 48.5, cushion ratio of 4.1x, and cash to debt of 51.2% are weak compared to Fitch's median for below investment grade ratings. Given future capital needs related to the construction project and other infrastructure investments, Fitch expects ongoing negative pressure on liquidity levels.

Tulare has a major construction project in progress, which plans to feature a 24-bed emergency department, a new diagnostic department, a 16-bed obstetric unit, four surgery suites, and 27 new private patient rooms meeting seismic requirements. This new expansion tower was initially slated to open October 2012. However, due to problems related to the concrete structure on the third and fourth floors discovered in April 2012, construction has been at a standstill. Tulare is working with the Office of Statewide Health Planning and Development in rectifying the issue to move forward on an accelerated recovery schedule. Remaining funds available include approximately $15 million from the general obligation (GO) bond financing, $2.2 million from the 2011 Bank of America loan, and $1.4 million from philanthropy. Tulare will likely need to procure resources in addition to existing funds to complete the project, but the amount remains under evaluation. As Tulare has purchased nearly all of the equipment and materials for the new tower, remaining costs are primarily labor related.

Management indicated that the area's population growth and projected demand for healthcare services beyond 2030 dictate the need for a second hospital tower. Tulare is currently in the planning and design stage for the five-story tower, which Fitch does not believe is feasible given its current performance and utilization trends. A schedule or financing plan is not yet in place, however, there is no additional debt capacity at the current rating level. Aside from the first tower construction, Tulare continues to invest in its IT platform and is in the process of opening two rural clinics. Annual capital spending is budgeted at $1.5 million, addressing routine operations and maintenance needs.

At Dec. 31, 2012, Tulare's revenue supported debt burden totaled $20.5 million, consisting of $15.7 million in series 2007 bonds and $4.8 million in capital leases. The bonds are all fixed rate and produces a maximum annual debt service (MADS) of $2.5 million, which declines to $1.3 million in fiscal 2017 following the final payment of the capital lease. Debt burden is relatively low, with debt to capitalization of 27%. However, MADS coverage declined to negative 1.1x in fiscal 2012 and negative 1.2x through the interim period compared to 4.4x in fiscal 2011. The alarming drop in debt service coverage is one of Fitch's main concerns, and a key driver in the rating action. Fitch does not expect Tulare to meet its debt service coverage covenant for fiscal 2012, which is not an event of default but will require a consultant call-in.

Not included in Fitch's calculation of Tulare's long-term debt are $85 million in GO bonds, which are not rated by Fitch. Since Tulare's GO debt is secured by a special assessment on property taxes in the district, Fitch's calculation of financial ratios excludes Tulare's GO debt and related receipts.

The Negative Outlook reflects the apparent need for additional capital expenditure in order to complete Tulare's current construction project, putting further strain on balance sheet and profitability metrics. Failure to improve its overall financial condition will lead to further negative rating action.

Tulare Local Health Care District owns and operates a 112-bed hospital in the City of Tulare, California. Total revenues in fiscal 2012 were $78.5 million (exclusive of tax revenues related to GO bonds debt service). The district covenants to provide annual and quarterly disclosure through the Municipal Rule Making Board's EMMA system.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria', June 12, 2012;

--'Non-Profit Hospital and Health System Rating Criteria', July 23, 2012.

Applicable Criteria and Related Research

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015

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Contacts

Fitch Ratings
Primary Analyst
Jennifer Kim
Associate Director
+1-212-908-0740
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Michael Borgani
Director
+1-415-732-5620
or
Committee Chairperson
Emily Wong
Senior Director
+1-212-908-0651
or
Media Relations:
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Jennifer Kim
Associate Director
+1-212-908-0740
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Michael Borgani
Director
+1-415-732-5620
or
Committee Chairperson
Emily Wong
Senior Director
+1-212-908-0651
or
Media Relations:
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com