NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed the 'A' rating on the following outstanding debt issued by the California Health Facilities Financing Authority (Children's Hospital of Orange County):
--$139,565,000 revenue bonds, series 2009A;
--$50,000,000 variable-rate revenue bonds, series 2009B; underlying rating;
--$50,000,000 variable-rate revenue bonds, series 2009C; underlying rating;
--$27,800,000 variable-rate revenue bonds, series 2009D; underlying rating;
The series 2009B-C bonds are variable rate demand bonds (VRDBs) supported by a letter of credit (LOC) from US Bank. Total outstanding debt is $267 million with 52% underlying fixed rate debt and 48% underlying VRDBs. Children's Hospital of Orange County (CHOC) has $250 million notional amount of floating to fixed rate swaps outstanding.
The Rating Outlook has been revised to Stable from Negative.
--The Outlook revision to Stable from Negative is due to several positive developments related to CHOC's facility expansion project, which should reduce the need for a significant amount of additional debt to complete its new tower. CHOC is in the middle of a major capital project, which includes the construction of a new seven story tower that will cost a total of $562 million. As of June 30, 2010 the project is 26% complete and was on time and within budget.
The Negative Outlook was assigned in June 2009 due to the possible issuance of additional debt in fiscal 2011 and uncertainties in the California economy and state budget. Since Fitch's last rating action, CHOC has received approval for full Proposition 61 and 3 funding from the state (voter approved ballot initiatives for children's hospital construction), and in addition the hospital provider fee has been approved, which will result in a one-time benefit to CHOC of approximately $51 million.
--The 'A' rating reflects CHOC's strong market position as the leading provider of pediatric services in Orange County, good liquidity, and consistent operating profitability. CHOC's total system market share has continued to increase due to successful physician recruitment and its collaborations with adult providers in the area to provide their pediatric services. Market share was 68% for 2008 (most recent data), which has increased from 55.9% in 2003.
--Liquidity is sound with $206 million of unrestricted cash that equated to 185 days cash on hand at June 30, 2010, which has increased over the last two years. Operating performance is stable with an operating margin of 2.2% for fiscal 2010 (draft audit fiscal year ended June 30, 2010) compared to 2.3% in fiscal 2009 and 2.4% in fiscal 2008.
--CHOC's debt load is high with 78% cash to debt as of June 30, 2010. Debt service coverage by operating EBITDA is light at 2.0 times (x), 1.9x and 1.8x, for fiscal 2010, 2009 and 2008, respectively compared to Fitch's 'A' category median of 3.3x. CHOC has limited debt capacity at its current rating level.
--Fitch believes CHOC's debt profile poses an additional credit concern. In addition to the exposure to risks related to its outstanding VRDBs (remarketing, renewal and put risk), CHOC is currently posting $36 million of collateral related to its swaps.
--Not unlike other children's hospitals, CHOC is vulnerable to changes in Medi-Cal funding with 59% of gross revenues from Medi-Cal payors in fiscal 2010. However, the recently approved hospital provider fee program is expected to benefit CHOC substantially.
KEY RATING DRIVERS:
--The ability to complete the project on time and without a significant amount of additional debt which would place downward pressure on the rating;
--The ability to manage the risks related to its debt profile as any acceleration of debt payments could stress the current rating.
Debt payments are secured by a gross revenue pledge and a debt service reserve fund. Covenants include a 1.2x debt service coverage and tests for additional debt and permitted liens. Fitch believes the security provided is in line with other 'A' rated healthcare credits.
The 'A' rating reflects CHOC's strong market position as the leading provider of pediatric services in Orange County, good liquidity, and consistent operating performance. CHOC's market position continues to increase due to the growth of its regional partnerships with adult providers and successful physician recruitment. CHOC is the only pediatric provider within Orange County except for one Tenet facility. Discharges increased 6% in fiscal 2010 from the prior year. CHOC is exploring further physician alignment models with its medical staff and the majority of its admissions are from a multi-specialty pediatric group that currently has 146 physicians. Future physician recruitment should be strengthened by the recent affiliation with University of California-Irvine and a combined pediatric residency program will commence July 2011.
CHOC is in the midst of completing its master facility plan, which incorporates the construction of a new seven story tower and remodeling of the existing hospital tower. Fitch views the project favorably and believes it will greatly enhance operational efficiency. The new tower will have capacity for 142 additional beds (floors will be shelled for future growth) and a new emergency department, surgical and recovery suites, imaging and diagnostic services, laboratory and other ancillary services. CHOC is located adjacent to St. Joseph Hospital of Orange (part of St. Joseph Health System; rated 'AA-' by Fitch) and has historically utilized their space for these services under a shared services agreement. The agreement will terminate on March 31, 2013. In addition, the operating costs associated with the new tower are expected to be less or equal to the amount that would be paid under the shared services agreement. The seismically compliant new tower is expected to be completed by September 2012 and open in April 2013 after a transitional planning and licensure period.
Given additional funds from the provider fee and CHOC's success in fundraising, management has revised the sources of funding for the project. The most significant change from our last review is management's projection of the need for additional debt decreased to $45 million from $128 million in 2009. Management's current sources of funding includes $145 million series 2009 bonds, $31.1 million series 2004 bonds, $85 million from cash flow, $40 million from provider fee, $40 million from extended provider fee, $130.5 million from Prop 61 and 3 funds, $45.4 million from fundraising and $45 million from additional debt. California enacted a hospital provider fee program to draw down additional federal funds for Medi-Cal services, which was just approved by the Centers for Medicare and Medicaid Services. CHOC expects to receive approximately $51 million from the hospital provider fee and will use $40 million of the funds on the project. A pending ballot initiative in November would extend the provider fee program beyond 2010. Since this revenue stream is uncertain, Fitch will monitor the developments and management's plan regarding the sources of funding for the project. The amount of additional debt issued will be dependent on CHOC's success with fundraising, the implementation of the extended provider fee, and management's ability to complete the project within budget. Fitch believes CHOC has limited debt capacity at its rating level. CHOC has launched a $125 million capital campaign of which $80 million is expected to be raised for the project. Management has only included $45 million of fundraising as a source of funds for the project since that is the amount that is expected to be available in cash.
Fitch views CHOC's debt profile as a credit concern. CHOC has $128 million of VRDBs outstanding that are supported by a LOC from US Bank that expires on July 2, 2012. Under the LOC agreement, if there is a draw on the LOC, the term out period is three years. Management plans to evaluate LOC renewal options within the next year. CHOC is over hedged with $250 million of floating to fixed rate swaps outstanding compared to $128 million of variable rate debt outstanding due to the fixed rate refunding of some of its previous variable rate debt. CHOC is required to post collateral on a mark to market valuation (MTM) in excess of $15 million. As of Oct. 13, 2010 the MTM was negative $51 million and $36 million of collateral was posted. In addition, the unhedged portion of the swaps cost CHOC $3.6 million in interest expense in fiscal 2010 (classified as non-operating expense). Management stated that it will monitor the MTM levels for an appropriate time to exit the agreements.
The Stable Outlook reflects CHOC's stable financial performance and expectation that the project will be completed on time, within budget, and without a significant amount of additional debt. If there is a shortfall in any of the funding sources for the project, it could place pressure on the need for additional debt. Fitch will evaluate the impact of any additional debt to CHOC's profile, if and when issued.
CHOC consists of a 238 staffed-bed pediatric hospital and other affiliates located in Orange County, CA and had total revenue of $455 million in fiscal 2010. CHOC covenants to provide annual audited financial statements within 150 days of fiscal year end and unaudited quarterly statements (for the first three quarters) within 60 days of quarter end.
Additional information is available at www.fitchratings.com.
In addition to the sources of information identified in Fitch's report 'Revenue-Supported Rating Criteria', this action was additionally informed by information from the Underwriter.
Applicable Criteria and Related Research:
'Revenue-Supported Rating Criteria', dated Oct. 8, 2010.
'Nonprofit Hospitals and Health Systems Rating Criteria', dated Dec. 29, 2009.
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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