Fitch Affirms Rady Children's (CA) Rev Bonds at 'A+'; Outlook to Positive

NEW YORK--()--Fitch Ratings has affirmed the 'A+' rating on Rady Children's Hospital and Health Center's outstanding debt, which is listed at the end of the press release.

The Rating Outlook is revised to Positive from Stable.

SECURITY

The bonds are secured by a general revenue pledge of the obligated group (OG). The OG includes the parent organization and the hospital. The OG comprised 95.8% of total revenue and 97.1% of total assets of the consolidated entity. Fitch's analysis is based on the consolidated entity.

KEY RATING DRIVERS

STRONG AND IMPROVING FINANCIAL PROFILE: The revision in the Outlook to Positive from Stable reflects Rady Children's Hospital and Health Center (Rady Children's) overall strong financial performance for its current rating level. Financial performance has improved not only due to the provider fee, but also due to its strategic initiatives that has resulted in continued volume growth.

DOMINANT MARKET POSITION: Rady Children's holds a dominant 88% market share in its primary service area of San Diego County and market share has improved due to increasing adult partnerships and physician alignment initiatives. Future growth strategies include capturing more of the fast growing, favorable payor mix of Southern Riverside County.

ACADEMIC AND PHYSICIAN ALIGNMENT: Rady Children's is affiliated with the University of California, San Diego (UCSD) and serves as the primary pediatric teaching hospital for UCSD. This clinical affiliation is a major driver in Rady Children's enhanced reputation due to its teaching and research activities. Rady Children's has an exclusive arrangement through its medical practice foundation with a medical group whose members are employed by UCSD and includes most of the pediatric specialists in the market. Rady Children's is also aligned with various independent primary care physicians through physician management services and managed care contracting.

MANAGEABLE FUTURE CAPITAL NEEDS: With the completion and opening of its new acute care pavilion in October 2010, Rady Children's future capital spending needs are manageable with no additional debt plans.

HIGH EXPOSURE TO MEDI-CAL: Similar to all children's hospitals, Rady Children's has a high exposure to Medi-Cal, which accounted for 60% of its gross revenues in fiscal 2013. However, given this exposure, Rady Children's has significantly benefited from the provider fee program, which has just been extended for another three years through December 2016.

RATING SENSITIVITIES

UPWARD RATING MOVEMENT: Fitch believes Rady Children's rating would likely be upgraded if its current strong financial profile is sustained.

CREDIT PROFILE

Rady Children's is a 453 licensed bed freestanding children's hospital located in San Diego, CA. Rady Children's is the largest children's hospital in the state and is the region's only pediatric trauma facility and serves as the pediatric tertiary and quaternary referral center. Total revenue in fiscal 2013 (June 30 year end; audit) was $811 million.

Dominant Market Position

Rady Children's enjoys a strong regional reputation and a dominant market share for high-end pediatric healthcare services in San Diego County. Fitch views Rady Children's operating footprint and market share as key credit strengths. Rady Children's market share was 88.2% in 2011 compared to the next closest competitor, Kaiser Hospital - San Diego with 8.5% market share. Rady Children's market share has increased as it has been able to leverage its depth of pediatric subspecialty physicians, which is enhanced by its affiliation with UCSD. The organization continues to grow its reach in the greater San Diego County area through varying relationships with adult providers and has facilities from Murrieta to Chula Vista. There is growth potential in Southern Riverside County which has a fast growing, favorable payor mix population. Rady Children's market share in this market is 47%.

Strong Financial Profile

Rady Children's financial profile has been especially strong the last three fiscal years driven by increased volume through its strategic growth initiatives, expense management, and benefit from the provider fee. The state provider fee program has resulted in a net benefit of $44.2 million in fiscal 2011, $49.4 million in fiscal 2012 and $41.8 million in fiscal 2013. Rady Children's is projected to receive $160.2 million in fiscal 2014-2016 related to this program.

Operating income was $75.8 million in fiscal 2013 (9.4% operating margin) compared to $85.4 million in fiscal 2012 (11% operating margin). Even without the provider fee, operating margin was solid at 4.6% in fiscal 2013 and 5.1% in fiscal 2012 compared to the A category median of 3.3%.

Liquidity has fluctuated over the last two years due to an increase in accounts receivable and the timing of the paydown of bridge financing (financed with series 2011 bonds) related to the purchase of two medical office buildings adjacent to the hospital's campus. However, overall growth has been driven by the receipt of provider fee revenue as well as solid investment returns. Total unrestricted cash and investments was $617.9 million as of June 30, 2013 compared to $460.7 million the prior year. Days cash on hand was 324.6 and cash to debt was 150.4% at June 30, 2013 compared to the A category medians of 196.3 and 129.2%, respectively.

Manageable Capital Needs

Rady Children's significantly invested in its plant in fiscal 2009-2011, which brought the average age of plant down, however, this investment was necessary as some of the needs were the result of deferred capital spending. In addition to a new acute care pavilion, the hospital also implemented Epic. Future capital needs are manageable and projected to total $52.6 million in fiscal 2014, $85.4 million in fiscal 2015 and $90.5 million in fiscal 2016 (compared to depreciation expense of approximately $40 million). An additional source of funding includes the remaining state funds from Proposition 3 and $40 million of the projected capital expenditures is expected to be funded from this outside funding source. Fitch believes Rady Children's also has an area of opportunity with philanthropy with a new executive director of Rady Children's Hospital Foundation and a strategic planning process is underway.

Reducing Risk in Debt Profile

Total outstanding debt as of June 30, 2013 is $410 million with $180.2 million of underlying fixed rate bonds and $230 million of variable rate bonds. Since Fitch's last rating review, Rady Children's has converted most of its letter of credit (LOC) backed variable rate demand bonds (VRDBs) to direct bank loans that have initial put dates in 2018-2019. There were no changes in financial covenants from what was in the LOC reimbursement agreements. The covenants vary but the most restrictive include maintaining 120 days cash on hand and 1.2x maximum annual debt service (MADS) coverage and less than 60% debt to capitalization.

Of its variable rate exposure, $50.6 million remains LOC backed VRDBs (series 2008C; LOC from Northern Trust that expires May 2016).

The debt profile is 100% fixed rate including the impact of Rady Children's outstanding swaps. As of June 30, 2013, Rady Children's was posting approximately $40 million of collateral related to the swaps.

MADS coverage is strong at 7.6x in fiscal 2013 compared to 7x in fiscal 2012 and the A category median of 3.8x. The debt burden has reduced with the growth in total revenue and MADS as a percentage of revenue is now 2.8% down from 4.4% in fiscal 2009. Debt service is level and MADS is $22.6 million.

Disclosure

Rady Children's covenants to provide annual audited financial information within 120 days of fiscal year end and unaudited quarterly financial information within 60 days of quarter end for the first three quarters and within 90 days for the fourth quarter to the Municipal Securities Rulemaking Board's EMMA system. The audit is completed quickly after fiscal year end and was released at the end of September for fiscal 2013.

Outstanding Debt:

--$100,000,000 California Health Facilities Financing Authority (CA) (Rady Children's Hospital-San Diego) revenue bonds series 2011;

--$50,580,000 California Statewide Communities Development Authority (CA) (Rady Children's Hospital-San Diego) variable-rate revenue bonds series 2008D;

--$50,575,000 California Statewide Communities Development Authority (CA) (Rady Children's Hospital-San Diego) variable-rate revenue bonds series 2008C;

--$65,000,000 California Statewide Communities Development Authority (CA) (Rady Children's Hospital-San Diego) variable-rate revenue bonds series 2008B;

--$63,845,000 California Statewide Communities Development Authority (CA) (Rady Children's Hospital-San Diego) variable-rate revenue bonds series 2008A;

--$28,230,000 California Statewide Communities Development Authority (CA) (Rady Children's Hospital-San Diego) revenue refunding bonds series 2006B;

--$46,405,000 California Statewide Communities Development Authority (CA) (Rady Children's Hospital-San Diego) revenue refunding bonds series 2006A.

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=805183

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Contacts

Fitch Ratings
Primary Analyst
Emily Wong
Senior Director
+1-415-732-5620
Fitch Ratings, Inc.
650 California St.
San Francisco, CA 94108
or
Secondary Analyst
Emily Wadhwani
Associate Director
+1-312-368-3347
or
Committee Chairperson
Jim LeBuhn
Senior Director
+1-312-368-2059

Sharing

Contacts

Fitch Ratings
Primary Analyst
Emily Wong
Senior Director
+1-415-732-5620
Fitch Ratings, Inc.
650 California St.
San Francisco, CA 94108
or
Secondary Analyst
Emily Wadhwani
Associate Director
+1-312-368-3347
or
Committee Chairperson
Jim LeBuhn
Senior Director
+1-312-368-2059