Fitch Downgrades Loma Linda University Med Center (CA) Bonds to 'BBB-'; Outlook Stable
Fitch Ratings has downgraded the ratings on Loma Linda University Medical Center's (LLUMC) outstanding debt to 'BBB-' from 'BBB'. A complete list of ratings is provided at the end of this release.
The Rating Outlook is revised to Stable from Negative.
The bonds are secured by a gross revenue pledge and mortgage pledge. In addition, LLUMC has a debt service reserve fund.
KEY RATING DRIVERS
HISTORY OF MISSED TARGETS: LLUMC's financial profile is more reflective of a 'BBB-' credit with weak liquidity and a high debt burden and the rating was held at the 'BBB' level for several years as benefits from its strategic initiatives were expected to be realized but are still yet to be achieved.
SIGNIFICANT MEDI-CAL BURDEN: LLUMC is challenged by its unfavorable payor mix with over 30% of its gross revenues from Medi-Cal. This has led to a reliance on disproportionate share funding (DSH) for operating profitability. In addition, although LLUMC has greatly benefited from the additional funding through the provider fee, these funds are still temporary and a long term solution to inadequate Medi-Cal funding will need to be addressed.
SOLID MARKET POSITION: LLUMC's main credit strength continues to be its leading market position and role as an academic medical center providing tertiary and quaternary services for a sizeable service area. LLUMC's market share increased in 2011 and this trend is expected to continue with the opening of its new 106 bed hospital in Murrieta.
LOOMING LONG TERM LIABILITIES: LLUMC needs to address the buyout of an operating lease (which financed Murrieta) and also has significant capital needs driven by its seismic requirements, which is estimated to cost $800 million. The financing for these needs have not been incorporated to the rating at this time.
HIGH DEBT BURDEN: Although debt ratios are high, LLUMC may have some additional debt capacity at the lower rating level. Maximum annual debt service (MADS) coverage in fiscal 2011 was 3.1x (2.3x without provider fee) and was 2.9x through the nine months ended Sept. 30, 2012 (1.6x without provider fee).
WEAK LIQUIDITY: LLUMC's balance sheet has historically been weak and is unusually low at $232 million unrestricted cash and investments as of Sept. 30, 2012, which translated to days cash on hand (DCOH) of 66.2 days and cash to debt of 42% compared to Fitch's 'BBB' medians of 138.9 days and 82.7%, respectively. Liquidity is understated by $96 million of receivables, of which $66 million is related to the provider fee.
Downgrade Reflects History of Missed Targets
LLUMC's financial profile is more reflective of a 'BBB-' credit and the rating was held at the 'BBB' level for several years as benefits from its strategic initiatives were expected to be realized but are yet to be achieved. Its most recent investment, Murrieta, has a significant drag on overall financial performance with a bottom line loss of $61 million in fiscal 2011 and $33 million through the nine months ended Sept. 30, 2012. The ability to improve Murrieta's performance over a short time period would be viewed favorably and could result in positive rating action.
Major Beneficiary of Provider Fee
California enacted a hospital provider fee in 2010 to draw down additional federal funds for Medi-Cal services. Given LLUMC's high Medi-Cal load, LLUMC has been a major beneficiary of the program, which has boosted profitability. The 2010 provider fee (for the period April 2009 to December 2010) resulted in a net benefit of $85 million in fiscal 2010. Two subsequent periods have been approved with a net benefit of $43 million in fiscal 2011 and $52 million through the nine months ended Sept. 30, 2012. The provider fee program currently expires in December 2013. Although Fitch views the benefit from the provider fee favorably, these funds are still temporary and a long term solution to inadequate Medi-Cal funding will need to be addressed. Management indicated that efforts are underway to implement a permanent provider fee. If this is successful, positive rating action could be warranted.
Profitability (including provider fee) is strong for the rating level with a $46.9 million operating income (4.3% operating margin) through the nine months ended Sept. 30, 2012 compared to $79.2 million operating income (6% operating margin) in fiscal 2011. The fiscal 2013 budget is not available yet. Of note, given its payor mix, LLUMC receives a large share of DSH funds, which has totaled approximately $35 million-$36 million a year.
LLUMC's core operating performance (without provider fee) continues to be inconsistent with a decline in performance through the nine months ended Sept. 30, 2012 compared to an improved year in 2011. Management stated that the decline was related to reduced reimbursement given a predominantly per diem reimbursement methodology under its managed care contracts as patient days declined given its length of stay initiatives.
LLUMC's core operating performance dropped to a negative 0.5% operating margin ($5.2 million operating loss [without provider fee]) through the nine months ended Sept. 30, 2012, compared to 2.9% operating margin ($36.2 million operating income) in fiscal 2011. Fitch believes LLUMC needs to demonstrate solid and consistent core operating performance especially given its weak balance sheet.
New Hospital Has Opened
LLUMC opened its new 106 bed hospital in Murrieta in April 2011 in a market that has traditionally seen a lot of outmigration. Since its opening, volumes have continued to increase. The run rate of operating losses has decreased to $ 3.7 million a month for the nine month period ended Sept. 30, 2012 from $6.7 million a month in fiscal 2011.
When the hospital was planned, it was initially intended to be a joint venture with physicians and the construction was financed through a real estate investment trust (REIT) at a cost of approximately $220 million. Due to provisions under the PPACA regarding physician ownership, LLUMC bought out the physician ownership in 2011. The facility is currently being leased under a 15 year term that expires in March 2026. LLUMC will need to address the buyout of the lease at some point. The current operating lease expense is approximately $19 million a year.
Other Strategic Investments Continue to Operate at a Loss
LLUMC has invested significantly in a strategic growth strategy, employing a hub-and-spoke model in its neighboring communities, which is expected to improve its payor mix over time. These investments continue to be unprofitable and have taken longer than initially projected to produce the benefits that management initially forecasted.
Highland Springs Medical Plaza is an outpatient facility located in Beaumont that opened in 2009 and includes a medical office building and an ambulatory surgery center. The ambulatory surgery center at Highland Springs is operated jointly by LLUMC faculty staff, the Beaver Medical Group - the largest independent medical group in Beaumont, and Redlands Community Hospital. LLUMC also acquired a heart hospital in 2008, which continues to be unprofitable.
Increased Market Share
LLUMC's main credit strength continues to be its leading market share position and role as an academic medical center. LLUMC is the market share leader in its primary service area in the Inland Empire. It offers quaternary and tertiary services and has the only level-I trauma center and level-III neonatal intensive care unit in the service area. LLUMC's Medicare case mix index is very high at 1.9. LLUMC's market share in its primary service area (by patient days) increased in 2011 to 12.5% in 2011 compared to 11.7% the prior year. The next closest competitor, Arrowhead Regional Medical Center, had 7% market share. Fitch expects market share to continue to increase especially as LLUMC continues to capture outmigration from the Murrieta market.
Weak Balance Sheet
LLUMC's weak liquidity is a primary credit concern. LLUMC's liquidity indicators have always been light for its rating level and there are various demands on its liquidity including swap collateral posting requirements and its future capital needs. LLUMC's unrestricted cash and investments ($232 million) at Sept. 30, 2012 is lower than usual due to outstanding receivables of $66 million related to the provider fee and $30 million related to a settlement with the IRS. Management expects to end the year with $327 million of unrestricted cash and investments.
Large Capital Needs
LLUMC's capital needs total $800 million, which is mainly driven by the state seismic compliance requirements. A seismic compliance extension bill was passed and gives LLUMC to 2020 to meet the state requirements. Capital needs include the construction of two new patient towers and a new children's hospital. The funding sources are expected to include cash flow, additional debt, fundraising, and funds from Proposition 61 and 3 (voter approved ballot initiatives for children's hospital construction). Fitch has not incorporated a potential debt issuance into the rating at this time and will evaluate when financing plans are finalized. LLUMC anticipates starting construction in 2015-2016.
Significant Use of Note Payables and Capital Leases
Total outstanding debt for the system was $572 million in fiscal 2011 and includes $349 million of bonded debt and $223 million of notes and capital leases. The significant use of note payables and capital leases creates a front loaded aggregate debt structure and MADS of $53.8 million in 2013 drops to $37 million in 2015.
Of the bonded debt, $105 million is variable rate and $40 million were variable rate demand bonds (VRDBs) that were converted to a direct bank loan (Union Bank) with an initial term of seven years. The remaining $65 million of VRDBs are supported by two LOCs from Bank of America ($40 million series 2007B2 and $25 million series 2008B) and these bonds are also in the process of being converted to a direct bank loan. The current expiration of the series 2007B-2 LOC is June 2013 and for the series 2008 is November 2014. LLUMC has two fixed payor swaps for a total notional amount of $100 million, which required collateral posting of $35.1 million as of Sept. 30, 2012.
The Rating Outlook is Stable. Fitch believes LLUMC has more flexibility at the lower rating level given its operational challenges and upcoming capital needs.
About the Organization
LLUMC is an 815 bed (available; 881 licensed) acute care teaching hospital in Loma Linda, California, 60 miles east of Los Angeles. LLUMC houses the nation's first hospital-based proton treatment center for cancer. LLUMC is the only member of the obligated group and includes four hospitals - University Hospital, Children's Hospital, East Campus Hospital, and the Heart and Surgical Hospital. Other non-obligated group affiliates include Loma Linda University Behavioral Medicine Center, Loma Linda University Children's Hospital Foundation, Loma Linda Healthcare Properties, Physicians Hospital of Murrieta, and Loma Linda University - Urgent Care. LLUMC accounted for 90% of total assets ($1.4 billion) and 94% of total revenues ($1.2 billion) of the consolidated entity in 2011. The financial analysis was based on the consolidated entity, Loma Linda University Medical Center and Affiliates. LLUMC covenants to provide annual audited and quarterly information for the obligated group to bondholders. Quarterly information, including a balance sheet, income statement, and statement of changes in net assets will be provided within 60 days after the end of each of the first three fiscal quarters.
--$70,000,000 Loma Linda, CA hospital revenue bonds (Loma Linda University Medical Center), series 2008A;
--$25,000,000 Loma Linda, CA hospital variable rate revenue bonds (Loma Linda University Medical Center), series 2008B (bonds supported by letter of credit (LOC) from Bank of America);
--$80,000,000 Loma Linda (CA) (Loma Linda University Medical Center Project) variable rate hospital revenue bonds, series 2007B-1 and B-2; (series 2007B-1 bonds supported by LOC from Union Bank of California, series 2007B-2 bonds supported by LOC from Bank of America);
--$148,525,000 Loma Linda (CA) (Loma Linda University Medical Center Project) hospital revenue refunding bonds, series 2005A;
--$25,515,000 Loma Linda (CA) (Loma Linda University Medical Center Project) hospital revenue refunding bonds, series 1999A.
For the series 2007B-1, 2007B-2, and 2008B bonds, the rating is an underlying rating, given without consideration of bank credit enhancement.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria', dated June 12, 2012;
--'Nonprofit Hospitals and Health Systems Rating Criteria', dated July 23, 2012.
For information on Build America Bonds, visit 'www.fitchratings.com/BABs'.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
Nonprofit Hospitals and Health Systems Rating Criteria
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