Fitch Downgrades Tulare Local Health Care Dist (CA) Revs to 'B'; Placed on Negative Watch

NEW YORK--()--Fitch Ratings has downgraded to 'B' from 'B+' the rating on $15,230,000 series 2007 fixed rate bonds issued by the Tulare Local Health Care District d/b/a Tulare Regional Medical Center (TRMC).

The bonds have been placed on Rating Watch Negative.

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 for bondholders.

KEY RATING DRIVERS

SUSTAINED OPERATING LOSSES: The downgrade to 'B' reflects a continued trend of operating losses driven by declining revenues from persisting challenges in patient utilization. Operating losses were sustained in the fiscal year ended (FYE) June 30, 2013 and through the interim period ended Dec. 31, 2013, though somewhat improved from 2012 levels. Due to negative cash flow, TRMC violated its debt service covenant in fiscal 2012, and a 'going concern' was expressed in the last two audited financial statements.

VERY WEAK LIQUIDITY: TRMC's liquidity position is very weak, resulting from negative cash flow and complications with its ongoing construction project. Unrestricted cash and investments were $6.3 million at Dec. 31, 2013 compared to $10.5 million at Dec. 31, 2012 and $24.4 million at FYE 2010. Management indicated that a large part of the decline through the interim period was due to timing of intergovernmental transfers (IGTs), and reported an unrestricted cash balance of $9.8 million at the end of Feb. 2014.

OPERATIONAL TURNAROUND EXPECTED: In Jan. 2014, TRMC entered into a management agreement with HealthCare Conglomerate Associates (HCCA), an organization that was formed specifically to address operational and construction challenges at TRMC. HCCA recruited a number of industry experts in operational, financial, clinical, and construction efforts, and began operating TRMC on Jan. 13, 2014 under a short-term management contract. HCCA is projecting TRMC to break even by the end of calendar year 2014, which Fitch believes is relatively attainable.

ONGOING CONSTRUCTION DELAYS: The completion of the new bed tower that was initially scheduled for Oct. 2012 has yet to be completed. The remaining cost and sources of funding for the project is unknown at this time but will likely pose a significant demand on already weak liquidity. TRMC is leveraging HCCA's expertise to renegotiate contracts and develop a recovery schedule.

RATING SENSITIVITIES

CLARITY ON CONSTRUCTION PLANS: The Negative Watch reflects the uncertainty around the timing and funding sources of the construction project. Management expects to have a construction completion plan in the next 60 days which is expected to provide greater clarity on TRMC's ability to meet all its financial commitments.

CREDIT PROFILE

Tulare Local Health Care District, d/b/a Tulare Regional Medical Center owns and operates a 112-bed hospital in the city of Tulare, California. Total operating revenue in FYE June 30, 2013 was $76.4 million (exclusive of tax revenues related to GO bonds debt service).

Sustained Operating Losses from Erosion in Patient Volume

TRMC posted operating losses for the second year in 2013 with an operating loss of $2.3 million, which includes annual district tax revenues of approximately $1.5 million that can be used to support operations and debt service requirements. This is significantly improved from a loss of $9.9 million in fiscal 2012, from significant expense reductions in areas such as labor and supply costs. As a result, operating margin improved to a negative 3.1% in fiscal 2013 compared to a negative 13% in fiscal 2012. Similarly, operating EBITDA margin improved to a positive 3.3% in 2013 compared to a negative 7.8% in 2012. As a result of its poor financial profile, a 'going concern' on the ability to continue hospital operations was expressed in 2012 and 2013 in the audited financial statements.

Significant losses continued through the six-month interim period ended Dec. 31, 2013, with operating and operating EBITDA margins of negative 12% and negative 3.8%, respectively, compared to a negative 10% and negative 4.5% in the prior year period. A number of financial improvement plans are in place, with a goal of arriving at breakeven performance within this calendar year.

Management Agreement with HealthCare Conglomerate Associates

In December 2013, the board of TRMC selected HCCA as an affiliation partner. HCCA is a management organization formed with the purpose of addressing the issues at TRMC, including financial and operational turnaround, improving physician relationships, and completing its construction project. Under a 12-month management contract, HCCA began managing TRMC in Jan. 2014 with the goal of entering into a long-term lease within this calendar year. As the potential transaction is in its early stages and no details were provided, Fitch's analysis assumes the bonds will remain outstanding in its current form.

Under the management contract, HCCA has several executives on-site that will manage the day-to-day operations. The turnaround plan focuses on three key areas - operational/financial, clinical, and construction. A chief restructuring officer from HCCA is at TRMC full-time, assuming the responsibilities of CEO, as well as several other professionals focusing on physician integration and construction management.

A thorough review of revenues and expenditures began once HCCA came onsite in Jan. 2014, and several initiatives are being executed to improve operating profitability. Projected growth in revenue is estimated at 5% for this calendar year, with a focus on recovering patient volumes and improving clinical documentation and revenue cycle. Targeted expense reductions total 8%, which is distributed across most expense items including labor, supplies, and maintenance. Management believes these targets are achievable, and should bring TRMC back to near breakeven operations in the next 12 months. Fitch believes financial improvements will largely be driven by TRMC's ability to recover physician relationships and patient volume. While somewhat optimistic, Fitch believes these targets are reasonably attainable over time with a well-executed strategy, especially given TRMC's historical utilization and profitability.

Weak Liquidity

TRMC's liquidity has weakened over the last four audited periods driven by IT investments, other capital spending, and negative cash flow. Unrestricted cash and investments totaled $6.3 million at Dec. 31, 2013, compared to $10.6 million at Dec. 31, 2012 and $24.4 million at FYE 2010. Days cash on hand of 34 days, cushion ratio of 2.5x, and cash to debt of 33.2% reflect a sizable decline from 48.5 days, 4.1x, and 51.2% one year ago, and are very weak compared to Fitch's median for below investment-grade ratings. Given ongoing operating expenditures, other infrastructure investments, and future spending needs related to the construction project, Fitch believes the ongoing demand on liquidity poses a serious threat to the solvency of the organization.

According to management, a large part of the year-over-year decline is due to the timing of IGT receipts. Management indicated that roughly $3.2 million of matching IGT funds were delayed this year, negatively impacting liquidity at Dec 31, 2013. The IGT matching funds were subsequently received, and as of Feb. 26, 2014, management reported unrestricted cash and investments of $9.8 million.

Fitch also notes a debt service reserve account is in place for the series 2007 bonds, with approximately $1.3 million held by a Trustee.

Ongoing Construction Delays

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 Oct. 2012, but suffered disruptions due to delamination issues. Renegotiating with contractors and putting a makeup schedule in place is one of HCCA's priorities, and is expected to be complete in the next two months.

As of Dec. 31, 2013, there was approximately $6.8 million of restricted funds remaining for the construction project, which Fitch believes is insufficient to complete the project. TRMC will likely need to procure additional funding in addition to existing funds to complete the project. The Negative Watch reflects the uncertainties around construction completion and funding, and the impact on TRMC's solvency. Fitch will evaluate the impact of the new construction plan and new debt, if any, after plans are finalized in the next two months.

Weak Debt Metrics Despite Moderate Debt Burden

At Dec. 31, 2013, Tulare's revenue supported debt burden totaled $19.1 million, consisting of $15.2 million in series 2007 bonds and $3.9 million in capital leases. The debt is 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 on the capital lease.

Debt burden is relatively low, as measured by debt to capitalization of 27.3%. However, due to poor cash flow, MADS coverage was very low at negative 2.1x in 2012, positive 1.4x in 2013, and negative 0.8x through the six-month interim period, compared to the average of 4x in 2009-2011. TRMC violated its debt service covenant in 2012, which resulted in a consultant-call in. The debt service covenant was met in fiscal 2013, but the ability to pass in fiscal 2014 is uncertain. Fitch believes TRMC has sufficient resources to pay its obligations over the next year.

Not included in Fitch's calculation of Tulare's long-term debt are $85 million in general obligation (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.

DISCLOSURE

TRMC covenants to disclose annual financial statements within six months of year-end and quarterly unaudited financial statements within 30 days through the MSRB EMMA website.

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

Applicable Criteria and Related Research:

--'Revenue Supported Rating Criteria', June 3, 2013

--'U.S. Nonprofit Hospitals and Health Systems Rating Criteria', May 20, 2013

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

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=822129

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Contacts

Fitch Ratings
Media Relations
Elizabeth Fogerty, New York
Tel: +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com
or
Primary Analyst
Jennifer Kim
Associate Director
+1-212-908-0740
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Emily Wong
Senior Director
+1-415-732-5620
or
Committee Chairperson
James LeBuhn
Senior Director
+1-312-368-2059

Sharing

Contacts

Fitch Ratings
Media Relations
Elizabeth Fogerty, New York
Tel: +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com
or
Primary Analyst
Jennifer Kim
Associate Director
+1-212-908-0740
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Emily Wong
Senior Director
+1-415-732-5620
or
Committee Chairperson
James LeBuhn
Senior Director
+1-312-368-2059