TEXT - Fitch affirms California's Palomar Health revs

Tue Feb 5, 2013 5:46pm EST

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Feb 5 - Fitch Ratings has affirmed its 'BB+' rating on the following bonds
issued by Palomar Health (PH), California: 

--$159,252,000 certificates of participation COPs series 2010;
--$228,477,000 COPs series 2009;
--$171,607,000 COPs series 2006A-C;
--$22,190,000 insured refunding revenue bonds series 1999. 

The Rating Outlook is Stable. 

SECURITY 

The bonds are secured by a general revenue pledge of the obligated group. 

SENSITIVITY/ RATING DRIVERS

COMPLETED SIZEABLE CAPITAL SPENDING: In August 2012, Palomar Health opened its 
288-bed Palomar Medical Center (PMC) in Escondido, California. The opening and 
subsequent relocation of most service lines into PMC signals the end of capital 
spending on PH's large and ambitious $1.06 billion master facilities plan. 
Capital needs going forward will drop dramatically to $17 million budgeted in 
fiscal 2013 from an average of $197.1 million over the last four fiscal years.

WEAKENED PROFITABILITY: Interim fiscal 2013 financial results (six months ended 
Dec. 31, 2012) have been negatively impacted by one-time move-in costs to the 
new facility, negative variance to budget due to continued shift of inpatient 
admissions to observation cases and rising depreciation and interest expense 
related to the new facility. Fitch expects PH to reduce the sizable operating 
losses over the near term through aggressive cost management and revenue 
optimization measures. Losses have been reduced month to month since the new 
facility opened and operating performance is projected to be at least breakeven 
for the remainder of the year.

HIGH DEBT BURDEN: PH's debt burden remains very high and is inconsistent with an
investment-grade rating. Debt service coverage was below 1x for the interim 
period due to weak cash flow, however, Fitch expects PH's measures to improve 
cash flow during the second half of fiscal 2013 will result in coverage in 
excess of its debt service coverage requirement (1.15x). 

LOW LIQUIDITY: Liquidity has dropped as of Dec. 31, 2012 mainly due to the 
remaining spend on the master facilities plan from equity. In addition, debt 
service was paid from cash due to negative cash flow. Fitch expects liquidity to
rebuild due to modest capital needs going forward. 

WHAT COULD TRIGGER A RATING ACTION

FAILURE TO IMPROVE CASH FLOW: It is imperative that PH improve its cash flow in 
order to cover its high debt service requirements. Fitch will monitor PH's 
progress over the next few months and the failure to substantially improve cash 
flow will result in negative rating action. 

CREDIT PROFILE

Palomar Health, formerly known as Palomar Pomerado Health System, is a 
California hospital district that operates three hospitals in northern San Diego
County. For fiscal 2012 (ended June 30), Palomar Health (PH) reported $552 
million in total operating revenue.

Opening of Palomar Medical Center

In August 2012, Palomar Health opened its new 288-bed Palomar Medical Center in 
North San Diego County and successfully relocated the majority of its service 
lines to the new hospital from its downtown Escondido facility. The downtown 
facility will remain operational and house an urgent care center, labor and 
delivery, behavioral, and acute rehab service lines. Construction and completion
of Palomar Medical Center is the center piece of PH's sizable $1.06 billion 
facilities master plan. Total operated beds is approximately 508 beds.

Operating Performance Weaker Than Expectations

Financial results for the six-month interim period ended Dec. 31, 2012 show a 
large operating loss driven by increased depreciation and interest expense 
related to the new facility, one-time costs related to the transition to the new
facility and continued revenue pressures from a shift in inpatient volume to 
observation cases. Through the interim, PH reported an operating loss of $41.1 
million, or a negative 14.9% operating margin (exclusive of property tax 
income). For fiscal 2012, PH generated $6.3 million in operating income, or a 
1.2% operating margin.

In preparation for the move to its new facility, PH implemented a planned 
reduction in elective admissions and surgeries and placed its emergency 
department (ED) on diversion. Further, prior to and following the move, staff 
training and system testing were conducted to ensure a smooth and safe operating
environment. As a result, PH incurred approximately $12.5 million in one-time 
move-in costs through the interim period and $7 million in lost inpatient 
revenue. In response to the challenging financial results, PH is undertaking 
strong labor cost management effort, productivity initiatives, and revenue 
optimization measures to shore up profitability and rebuild the balance sheet. 
Management projects that fiscal 2013 will end with EBITDA of approximately $48 
million compared to $6.8 million through the six months ended Dec. 31, 2012, 
with most of the improvement expected to be realized from management of labor 
costs. Fitch expects fiscal 2013 performance to result in debt servicecoverage 
in excess of its bond covenant requirements and the inability to execute on 
these cost reduction plans will result in downward rating action.

Property Tax Revenue Benefit

PH's overall profitability is aided by its status as a California Hospital 
District, a political subdivision of the State of California. 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 $12.7 million and $12.6 million in unrestricted property
tax revenues in fiscal 2012 and 2011, respectively. These revenues are in 
addition to, and are separate from, the ad valorem tax revenues generate by the 
separate voter-approved tax levy that is pledged solely for the payment of 
principal and interest on PH's $496 million series 2005, 2007, 2009, and 2010 GO
bonds.

High Debt Burden

As of Dec. 31, 2012, PH had $581.5 million in revenue bonds and $492.4 million 
in general obligation bonds outstanding (Fitch rates the district's general 
obligation bonds A+). All but the series 2006 certificates are in fixed rate 
mode. PH has entered into three fixed payor interest rate swaps with Citi, N.A. 
As of Jan. 31, 2013, the swaps had a negative mark-to-market value of $33.9 
million. The swaps are insured by Assured Guaranty and have required no 
collateral posting. 

The district's high debt burden reflects the large amount of debt that was 
issued to fund its large $1.06 billion facility master plan. Funding sources 
have fluctuated over the last few years and have been pressured by a drop in 
philanthropy, increased project cost, and the need to fund a central utility 
plant that was initially to be financed by a third party.

Low Liquidity

At Dec. 31, 2012, PH had $130.3 million in unrestricted cash and investments, 
equating to 81.7 days cash on hand and 21.2% cash to debt, down from 124.4 days 
cash on hand 30.6% cash to debt at June 30, 2012. The declining liquidity 
reflects PH's equity contribution to its master facility plan ($27.4 million) 
and debt service payments ($24.4 million) due to weak cash flow. PH's capital 
budget for fiscal 2013 totals $17 million, down sizably from prior years, and 
will be funded from operating cash flow. With the completion of its large master
facilities plan, Fitch expects PH to rebuild its balance sheet going forward.

Expected Performance Improvement Over the Next Few Years

Fitch believes that PH's interim financial profile reflects a transition period 
for the organization as it moves to position itself as one of the key healthcare
providers in the North San Diego County through heavy capital investments and 
cash outlays. Further, Fitch views positively PH's strategic operating 
relationships with Kaiser Permanente and Rady Children's Hospital (both rated 
'A+' by Fitch). Along with PH's creation of its medical foundation, Arch Health 
Partners and its continued investments in its electronic medical records, these 
actions should enhance PH's operations and its market position in a post 
healthcare reform era. 

Stable Outlook

Despite PH's very weak financial profile through the six months ended Dec. 31, 
2012, Fitch's Outlook for PH remains Stable given management's plan to improve 
cash flow for the remainder of the year. Fitch will monitor these improvements 
and will update the rating prior to the close of PH's 2013 fiscal year. The 
failure to execute on its improvement initiatives will result in negative rating
pressure.

DISCLOSURE: 

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.
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