SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings affirms the following ratings on the City of Hope (CA)'s outstanding debt:
--$350,000,000 City of Hope Direct Obligation Notes series 2013 (taxable) at 'AA-';
--$229,715,000 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.
The bonds are secured by gross receivables of the obligated group, excluding royalty receivables. The obligated group 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 obligated group accounted for over 99% of total assets and over 97% of total revenue of the consolidated entity in fiscal 2015 (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, lymphoma, and prostate.
STRONG BALANCE SHEET AND PROFITABILITY: City of Hope's balance sheet has grown significantly over the last five years 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 implemented a new 10-year strategic plan in 2012 that seeks to sustain City of Hope's current financial performance over the next decade. Key plan components include expansion of community and ambulatory capabilities, enhancement of clinical service lines, and cost reduction of clinical and research activities. 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 with the growth of its hematologic and transplantation programs, expanded presence in outlying southern California communities, continued growth of its medical foundation and continued expense management.
SIZABLE CAPITAL PLAN: City of Hope is experiencing capacity constraints and major capital projects include a new ambulatory facility on the main campus, expansion of research facilities, and investment in a common electronic medical record (Epic). Capital spending is projected to total $1 billion over the next five years with no additional debt planned.
STRONG FUNDRAISING ABILITY: City of Hope has continued to raise over $100 million a year in philanthropy and its last capital campaign of $1 billion was completed almost three years ago. City of Hope's fundraising ability provides additional financial flexibility.
MAINTENANCE OF SOLID FINANCIAL PERFORMANCE: Fitch expects that City of Hope will maintain profitability in line for the rating level due its strong growth in clinical activity, which should continue to support its research activities. Current operating margins are not expected to be sustained with the upcoming expiration of its Cabilly patents, but expected to remain consistent with 'AA-' rated peers. Balance sheet strength is expected to be maintained despite an increase in capital spending over the next five years.
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 the City of Hope National 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 250 aligned 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, 2016, City of Hope had $2.05 billion of unrestricted cash and investments, which translated to 585.2 days cash on hand and 287.6% cash-to-debt compared to Fitch's respective 'AA' category medians of 289.4 days, and 201.7%. The balance sheet has doubled since fiscal 2012 due to strong profitability and good investment returns. Fitch notes that the proceeds from the $350 million taxable debt issuance in 2013 was invested in City of Hope's long term investment portfolio and is included in unrestricted cash and investments.
Total operating revenue in 2015 includes $1 billion net patient service revenue (70% of total revenue), $291 million royalty income (20%), $72 million research grants (5%), $85 million unrestricted contributions and net assets released from restrictions (6%) 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 $200 million as a third of the royalty stream belongs to the inventors (operating expense).
Profitability is strong with an operating income of $176 million in fiscal 2015 (12% operating margin) and $92 million (7.6% operating margin) in fiscal 2014. Operating performance remained strong through the six months ended March 31, 2016, with an 11.3% 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, 2016 was $29.3 million compared to $95.9 million in fiscal 2015, $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, lymphoma, and prostate inpatient service lines. Due to its high percentage of bone marrow transplant cases (long average length of stay), City of Hope has the leading market share in its primary service area and the state for cancer patient days.
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 14 from seven two years ago. 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 has exceeded the plan the first three years and updated the financial long range plan in the fall of 2015. Strong balance metrics are expected to be maintained while profitability ratios decline, but still consistent for the rating level.
Increased Capital Spending
Capital spending is projected to total $1 billion over the next five years. Capital investment priorities include Epic ($183 million), a new ambulatory facility, and additional research space. City of Hope recently acquired a building close to its main campus through lease financing (with the expectation to purchase in June 2017), which will be converted to research space. No additional debt is anticipated.
Conservative Debt Profile
Total debt outstanding at March 31, 2016 was $713.6 million and includes capital leases for office and research 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 and proceeds are in unrestricted cash and investments. The series 2013 taxable bonds are structured as one bullet maturity in 2043 and maximum annual debt service (MADS) of $48 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 leases.
City of Hope's debt burden is above average for its rating level but has been moderating with MADS accounting for 3.3% of total revenue in fiscal 2015 compared to 4.3% in fiscal 2012 and the 'AA' category median of 2.4%. Debt service coverage is solid at 7.6x in fiscal 2015, 6.3x in fiscal 2014, and 5.8x in fiscal 2013. Through the six months ended March 31, 2016, debt service coverage was 6.5x.
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.
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'.
Rating U.S. Public Finance Short-Term Debt (pub. 17 Nov 2015)
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