TEXT - Fitch affirms California's Palomar Health revs
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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