Fitch Affirms City of Hope (CA) Revenue Bonds 'AA-/F1+'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings affirms the 'AA-/F1+' rating on City of Hope, California's outstanding debt:

--$350,000,000 City of Hope direct obligation notes series 2013 (taxable) at 'AA-';

--$234,635,000 California Health Facilities Financing Authority, revenue bonds (City of Hope) series 2012A at 'AA-';

--$65,000,000 California Health Facilities Financing Authority, variable-rate revenue bonds (City of Hope) series 2012B and 2012C at 'AA-/F1+'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by gross receivables of the obligated group (OG), excluding royalty receivables. The OG includes City of Hope, City of Hope National Medical Center, the Beckman Research Institute of the City of Hope, and City of Hope Medical Foundation. The OG accounted for over 99% of total assets and over 97% of total revenue of the consolidated entity in fiscal 2014 (Sept. 30 year end). Fitch's analysis is based on the consolidated entity.

KEY RATING DRIVERS

HIGHLY SPECIALIZED SERVICES: City of Hope is nationally known for its cancer care and its position in a highly competitive market is differentiated by its focus on translational research. The organization has been successful in capitalizing its intellectual property with the receipt of a significant stream of royalty income. City of Hope is the market leader in three inpatient cancer service lines - leukemia, myeloma, and lymphoma.

STRONG BALANCE SHEET AND PROFITABILITY: City of Hope's balance sheet has grown significantly and liquidity ratios are favorable for the rating level. Profitability has also been strong due to good volume growth, receipt of royalty revenue, ongoing fundraising and focus on expense management.

IMPLEMENTATION OF STRATEGIC PLAN: The organization's 10-year strategic plan seeks to sustain City of Hope's current financial performance over the next decade. Fitch views the strategic plan favorably as it addresses the backfill of the expected reduction in royalty revenue with the 2018 expiration of its Cabilly patents. City of Hope has been successful in the implementation of its plan over the first three years.

SIZABLE CAPITAL PLAN: In response to growing capacity constraints, City of Hope is planning for a new ambulatory facility on the main campus. At the time of Fitch's last review in June 2014, capital spending for 2015-2022 was projected to total $717 million and City of Hope maintains $350 million of funds available from a taxable bond issue in 2013.

STRONG FUNDRAISING ABILITY: City of Hope completed a $1 billion capital campaign over a year-and-a-half ago and changes are being made to its fundraising program with a new Chief Philanthropy Officer and it is expected that fundraising targets will be increased. City of Hope's fundraising ability provides additional financial flexibility.

RATING SENSITIVITIES

UPDATED STRATEGIC PLAN: Fitch expects that City of Hope will maintain current profitability and liquidity trends over the medium term and will continue to grow its balance sheet to offset the loss of royalty revenue beginning in fiscal 2019. An update to the strategic plan is underway and Fitch will assess the updated plan when it is available in fall 2015. Any significant additional debt without a commensurate increase in cash flow could result in negative rating action.

CREDIT PROFILE

City of Hope is a prominent and nationally recognized biomedical research, treatment, and teaching institution dedicated to the comprehensive treatment of cancer. The organization comprises City of Hope, the City of Hope Medical Center, the City of Hope Medical Foundation, and the Beckman Research Institute. The Medical Center owns and operates a 217-licensed bed acute care tertiary referral facility. The Medical Foundation is aligned with the Medical Center, with over 200 affiliated physicians employed by the City of Hope Medical Group and operates various outpatient clinic facilities. The Beckman Research Institute owns and operates a number of major research facilities on City of Hope's main campus and conducts basic scientific research in support of and in conjunction with the patient care activities of the Medical Center and the Medical Foundation.

Strong Balance Sheet and Profitability

City of Hope has a strong balance sheet and sustained solid profitability, which should provide the organization some flexibility as it implements its strategic plan and prepares for the anticipated loss of a royalty revenue stream from expiring patents.

As of March 31, 2015, City of Hope had $1.9 billion of unrestricted cash and investments, which translated to 618.2 days cash on hand and 275.3% cash-to-debt compared to Fitch's respective 'AA' category medians of 277.1 days, and 178.5%. The balance sheet has grown significantly from $713 million unrestricted cash and investments at fiscal year-end 2009 due to strong profitability and good investment returns. In addition, the proceeds from the $350 million taxable debt issuance in 2013 was invested in City of Hope's long-term investment portfolio and included in unrestricted cash and investments.

Total operating revenue in 2014 includes $798 million net patient service revenue (66% of total revenue), $250 million royalty income (21%), $73 million research grants (6%), $86 million unrestricted contributions and net assets released from restrictions (7%) and other revenue. The royalty income stream has totaled over $1 billion since 2006 and 97% of the royalty stream is derived from the Cabilly patents. The Cabilly patents expire in 2018 and the net impact on City of Hope's income statement is approximately $173 million as a third of the royalty stream belongs to the inventors (operating expense).

Profitability is strong with an operating income of $83.8 million in fiscal 2014 (6.9% operating margin) and $152 million (12.6% operating margin) in fiscal 2013. Operating performance remained strong through the six months ended March 31, 2015, with a 14.9% operating margin. Profitability has been driven by strong volume growth especially in outpatient. City of Hope has benefited from the provider fee and the receipt of these funds has been volatile given the timing of the approval of various components of the program by the Centers of Medicare and Medicaid Services. The net benefit booked through the six months ended March 31, 2015 was $70.4 million compared to $7 million in fiscal 2014, $23.1 million in fiscal 2013, $47.2 million in fiscal 2012 and $37.1 million in fiscal 2011.

Expanding Clinical Reach

The market for highly specialized cancer care in City of Hope's primary service area remains fragmented and competitive. City of Hope faces strong competition for inpatient services from Cedars-Sinai Medical Center (rated 'AA-' by Fitch), Ronald Reagan UCLA Medical Center, and Keck Medical Center at USC. City of Hope has a leading market share in leukemia, myeloma, and lymphoma inpatient service lines.

City of Hope has been successful in expanding its clinical reach by partnering with various community hospitals and operating outpatient facilities in outlying areas and providing access to City of Hope's expertise to an expanded population. The number of community sites increased to 13 from seven during Fitch's last review. City of Hope has an arrangement with Kaiser to perform Kaiser's transplant cases in Southern California.

Proactive Strategic Plan

City of Hope's 10-year strategic plan adopted in 2012 was designed to respond to operational and financial challenges related to healthcare reform and an expiring royalty revenue stream. The plan focuses on leveraging City of Hope's national reputation in key service lines to expand both inpatient and outpatient operations, investing in translational research capabilities, and prioritizing philanthropy.

On the clinical side, City of Hope will expand its signature programs in hematology and bone marrow transplants, selectively invest in solid tumor programs, and expand community sites in existing and new strategic markets. Research strategies will focus on growing signature research programs in diabetes and stem cell research, reinforcing translational research infrastructures, and cultivating funding and philanthropic support of cancer research.

The strategic plan also incorporates revenue enhancement and cost reduction initiatives necessary to maintain financial performance. City of Hope plans to add additional outpatient sites, in addition to increasing inpatient capacity by reducing length of stay.

City of Hope is in the process of updating its strategic plan to refine targets and goals for the next two to four years and will focus on clinical growth, investment in innovation and scientific discovery, capital investments, new and expanded philanthropy programs, and cost structure efficiency.

Conservative Debt Profile

Total debt outstanding at March 31, 2015 was $704 million and includes a capital lease for office space. The bonded debt portfolio is 90% underlying fixed rate and 10% underlying variable rate demand bonds (VRDBs). The VRDBs are supported by City of Hope's self-liquidity.

City of Hope has two floating- to fixed-rate swaps, which do not require collateral posting at the current mark-to-market valuation. Including its swaps, the debt profile is 100% fixed rate.

City of Hope issued $350 million of taxable bonds in 2013 to take advantage of the current interest rate environment and unrestricted cash and investments will be inflated over the next few years as bond proceeds will be held on the balance sheet until spending on its capital plan ramps up.

The series 2013 taxable bonds are structured as one bullet maturity in 2043 and the maximum annual debt service (MADS) of $46.3 million incorporates the amortization of the series 2013 bonds consistent with the treatment of balloon indebtedness under the master trust indenture and also includes the debt service on the capital lease.

City of Hope's debt burden is above average for its rating level as MADS accounted for 3.8% of total revenue in fiscal 2014 compared to the 'AA' category median of 2.6%. Debt service coverage is solid at 6.3x in fiscal 2014 compared to 6.2x in fiscal 2013 and was 9x for the six months ended March 31, 2015.

Short-Term Rating Based on Self-Liquidity

The 'F1+' short-term rating is supported by the adequacy of City of Hope's highly liquid resources available to fund any un-remarketed puts on $65 million in weekly VRDBs. Based on Fitch's rating criteria on self-liquidity, City of Hope has sufficient liquid resources to cover the maximum tender exposure on any given date. City of Hope has liquidation procedures in place detailing the process by which internal funds would be liquidated to meet the tender obligations.

Disclosure

City of Hope covenants to provide an annual audit within 150 days of fiscal year-end and quarterly disclosure within 60 days of quarter-end for the first three quarters and within 75 days of fourth quarter-end via the MSRB's EMMA system.

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

Applicable Criteria

Rating U.S. Public Finance Short-Term Debt (pub. 07 Jan 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=846969

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=988697

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=988697

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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Emily Wong
Senior Director
+1-415-732-5620
Fitch Ratings, Inc.
650 California Street
San Francisco, CA 94108
or
Secondary Analyst
Michael Burger
Director
+1-415-659-5470
or
Committee Chairperson
Jim LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Emily Wong
Senior Director
+1-415-732-5620
Fitch Ratings, Inc.
650 California Street
San Francisco, CA 94108
or
Secondary Analyst
Michael Burger
Director
+1-415-659-5470
or
Committee Chairperson
Jim LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com