NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BB+' rating on Palomar Health, CA's (PH) outstanding debt, which is listed at the end of the press release.
The Rating Outlook is Stable.
The bonds are secured by a gross revenue pledge of the obligated group (OG). The OG consists of PH's acute care facilities as well as other healthcare related entities but excludes Arch Health Partners (AHP), a medical foundation.
KEY RATING DRIVERS
CONTINUED IMPROVED PERFORMANCE: PH's financial performance continues to improve and financial metrics through the nine months ended March 31, 2016 have been the strongest in recent history, with an 11.5% operating EBITDA margin, 2.1x debt service coverage and 104.3 days cash on hand. The decision to close its downtown campus should continue to have a favorable impact on financial performance with the full benefit realized in fiscal 2017, as PH is still in the process of consolidating services.
GOOD MARKET POSITION: Fitch believes PH's main credit strength is its location in North San Diego County, which makes it an attractive partner in any plans to develop a larger regional network and delivery model that is able to manage population health. In addition, PH has significantly invested in its medical foundation, AHP, which provides a primary care base that will be integral in care coordination.
HIGH DEBT BURDEN: Due to its significant investment in its master facility plan, PH's debt burden is high (revenue bonds only). As a hospital district, PH has the ability to issue tax supported bonds (GO debt) and Fitch's calculations exclude the GO debt and associated interest and property tax revenue from its analysis. Maximum annual debt service (MADS) on the revenue bonds accounted for a high 5.8% of total revenue and cash to debt is weak at 32.7% as of March 31, 2016.
COSTLY MASTER FACILITY PLAN: PH's master facility plan totaled over $1 billion and included a new 288-bed Palomar Medical Center (PMC) in Escondido, California that opened in 2012 as well as other capital investments.
STRATEGIC RELATIONSHIPS: PH has an agreement with Kaiser Permanente (rated 'A+') to provide bed capacity and has a partnership with Rady Children's (rated 'AA-') to provide pediatric and neonatal services at PMC. PH is in discussions with Kindred Rehabilitation and has been a Mayo Clinic Network affiliate since 2013.
UPWARD RATING MOVEMENT: Upward rating movement would be dependent on Palomar Health improving its financial metrics more in line for a 'BBB-' rated credit. Fitch believes this could be achievable over the next two to three years if strong operating cash flow is sustained and debt service coverage and liquidity ratios improve especially as the full benefits from the consolidation of facilities/service lines are complete.
PH is a California hospital district that currently operates three hospitals in northern San Diego County: Palomar Health Downtown campus,288-bed Palomar Medical Center in Escondido and 107-bed Pomerado Hospital in Poway. PH also has Villa Pomerado - a 129-bed skilled nursing facility that is located adjacent to Pomerado Hospital. In 2015, PH announced that it would close its downtown campus and began transitioning services to its other two facilities. These services include labor and delivery, behavioral and acute rehab. The standby emergency department closed in March 2016.
Arch Health Partners is a medical foundation with about 59 physician FTEs and was reconsolidated in PH's financial results in fiscal 2015 after being de-consolidated in fiscal 2014. Arch is not a member of the OG. Fitch's analysis is based on the consolidated entity. Total operating revenue in fiscal 2015 (June 30 year end) was $704 million.
Continued Improvement in Operating Performance
PH was in a turnaround situation from fiscal 2013 due to large losses related to challenges with the transition to the new facility, which opened in August 2012. However, performance has stabilized and is on an upward trajectory with very strong operating EBITDA margins through the nine months ended March 31, 2016 of 11.5% compared to 7.3% in fiscal 2015, 6.7% in fiscal 2014 and 4.8% in fiscal 2013. Ongoing operational improvement initiatives are in the areas of patient throughput, supply savings, revenue cycle, and process improvement.
Campus Consolidation Plan
In June 2015, PH announced that it would be closing its downtown campus and consolidating all services within either PMC or Pomerado Hospital. All services are expected to be consolidated by the end of 2016. Fitch views this decision favorably as it better utilizes the resources within the system and should result in $15 million-$20 million of annual savings beginning in fiscal 2017. The downtown campus is also expected to be monetized.
Due to the transition, PH has seen a large reduction in outpatient surgeries, especially related to Kaiser volume as consolidation plans finalize. Through the nine months ended March 31, 2016, outpatient surgeries were down 11.9% from the prior year. Fitch expects this to be temporary, as further discussions are underway regarding the potential build-out of shelled space at PMC. PMC has two shelled floors and the build-out of this space is in PH's capital plan. However, management stated that they would only proceed with this capital investment if it was funded by another funding source (not from PH).
Investment in Arch Health Partners
AHP is a medical foundation located in Poway, CA with 15 clinics in the service area. PH is the sole corporate member of AHP and aligned with the medical foundation in 2010. PH has provided significant support to AHP over the last two years and ongoing support is expected. However, Arch is a critical component of its integrated delivery system and PH is in the process of developing a clinically integrated network that will also align other physicians in the area.
As of March 31, 2016, unrestricted cash and investments totaled $189.5 million, which equated to 104.3 days cash on hand (DCOH) and 32.7% cash to debt, which has steadily improved from a low in fiscal 2013.
PH's DCOH covenant calculation excludes interest expense from total expenses and the bond covenant calculation for fiscal 2015 was 112.6 days, above the 80 DCOH covenant for the series 2006 insured bonds (65 DCOH covenant for uninsured bonds). Capital spending is elevated in fiscal 2017-2019 due to one-time capital relocation costs and the build-out of shelled space. However, management has reiterated that the build-out will only occur if it is funded by another funding source. Total capital expenditures are $41.5 million in fiscal 2017, $41 million in fiscal 2018, and $43 million in fiscal 2019. Excluding the one-time capital relocation costs and the build-out of shelled space, ongoing routine and strategic capital spending is about $20 million-$30 million a year.
High Debt Burden
As of June 30, 2015, total debt outstanding was $1.15 billion and included $560.8 million of revenue bonds and $589.2 million of GO bonds. Fitch rates the GO bonds 'A+'. The revenue bonds are 68% fixed rate and 32% variable rate (auction mode; series 2006). MADS on revenue bonds is $41.4 million and debt service coverage was improved at 2.1x through the nine months ended March 31, 2016 compared to 1.3x in fiscal 2015 and 1.2x in fiscal 2014. Per bond covenant calculation, debt service coverage was 1.98x in fiscal 2015.
PH has three fixed payor interest rate swaps with Citi related to the series 2006 bonds and the swaps are insured by Assured Guaranty. There are currently no collateral posting requirements, but requirements would be implemented if Assured Guaranty's rating falls below the 'A' category and would be at a zero threshold based on PH's current rating. In addition, there is an additional termination event if Assured Guaranty's rating falls below 'BBB'.
Property Tax Revenue
As a California hospital district, PH receives 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 PH's boundaries. PH received $14.3 million and $13.5 million in unrestricted property tax revenues in fiscal 2015 and 2014, respectively. This tax revenue is included in other operating revenue. PH also receives ad valorem tax revenues generated by the separate voter-approved tax levy that is pledged solely for the payment of principal and interest on PH's series 2005, 2007, 2009, and 2010 GO bonds. Fitch's financial analysis excludes the GO bonds and related property tax revenue and interest expense.
PH 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.
Fitch affirms the following outstanding debt at 'BB+':
--$159,844,000 COPs series 2010;
--$229,217,000 COPs series 2009;
--$171,781,000 COPs series 2006A-C.
Additional information is available at www.fitchratings.com
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 09 Jun 2015)
Dodd-Frank Rating Information Disclosure Form