Fitch Downgrades Loma Linda University Medical Center (CA) Rev Bonds to 'BB '; Outlook Negative
The Rating Outlook remains Negative.
SECURITY
The bonds are secured by a gross revenue pledge and mortgage pledge of the obligated group (OG). In addition, there is a debt service reserve fund. The OG accounted for 100% of total assets and 98% of total revenue of the consolidated entity in 2014 (Dec. 31 fiscal year end; audited). Fitch's analysis is based on the consolidated entity, Loma Linda University Medical Center and Affiliates (LLUMC or system).
KEY RATING DRIVERS
STATE MANDATED SESIMIC REQUIREMENTS IMMINENT: The rating downgrade reflects LLUMC's plan to issue approximately \\$816 million of additional debt in the second quarter of 2016 to fund a portion of the cost of its campus transformation project due to state seismic requirements. Although these plans have always been on the horizon, the rating downgrade reflects the magnitude of the expected financing and the increased certainty of the project including the timing and scope.
WEAK LIQUIDITY: LLUMC's liquidity has always been weak. With the expected additional debt, pro forma liquidity metrics are weak even at the 'BB+' rating level. Despite various opportunities for improvement, liquidity growth has historically been a challenge. The most recent issue impacting liquidity is higher than normal accounts receivable and ongoing provider fee receivables; however, the accounts receivable issue has been addressed and should result in better liquidity by year-end 2015.
BETTER OPERATING PERFORMANCE: LLUMC's operating performance has improved since Fitch's last rating review. Improved operating performance has been driven by increased volume and better payor mix as a result of Medi-Cal expansion, the receipt of provider fee funds, and better operating performance at Murrieta (which historically had large losses). Operating and operating EBITDA margins of 4.1% and 10.6%, respectively, in 2014 are strong for the rating level, and are expected to be sustained.
GOOD MARKET POSITION: One of LLUMC's main credit strengths is its position as an academic medical center and its role as a major provider of tertiary and quaternary services in addition to its teaching and research mission. Under leadership from a relatively new team (about one year), the organization is developing various strategies to secure its market position in a growing service area and to prepare for population health management.
CHALLENGING PAYOR MIX: The system has been challenged by its unfavorable payor mix and the system is the second-largest provider of Medi-Cal services in the state. There has been a noticeable shift to more Medi-Cal and less self-pay with implementation of the Patient Protection and Affordable Care Act (PPACA). Given the high Medi-Cal burden, LLUMC's profitability and cash flow have benefited from the state provider fee program, which has been in place since 2010 (payments retroactive to April 2009) and was extended for a three-year period (Jan. 1, 2014 to Dec. 31, 2016), which should net LLUMC \\$282 million over the three years.
RATING SENSITIVITIES
LIMITED FINANCIAL FLEXIBILITY: The maintenance of the Negative Outlook reflects Fitch's ongoing concern about the impact of the campus transformation project on Loma Linda University Medical Center's credit profile. Given the significant size and scope of the project, management's ability to execute will be a key rating determinant. There could be further rating movement if there are material changes in the campus transformation plan and/or if current operating performance is not sustained.
CREDIT PROFILE
Loma Linda Medical Center and Affiliates is part of Loma Linda University Health (LLUH), which also includes Loma Linda University and several other related organizations. A board restructuring in April 2015 resulted in one unified board with additional physician representation. There are no consolidated financials available at LLUH. LLUMC is located in Loma Linda, CA, 60 miles east of Los Angeles and includes 1,076 licensed beds. LLUMC houses the nation's first hospital-based proton treatment center for cancer. The hospitals are University Hospital, Children's Hospital, East Campus Hospital, Surgical Hospital, Behavioral Medicine Center, and Murrieta Hospital. LLUMC had total revenue of \\$1.5 billion in 2014. A new CEO has been in a permanent role since August 2014 (prior General Counsel) and with additional executive management changes, there is a focus on accountability and performance improvement, which will be necessary given the upcoming campus transformation project.
Campus Transformation Project
LLUMC is nearing the deadline to meet state seismic requirements and is proceeding with its campus transformation project, which is expected to begin construction in March 2016 with completion in December 2019. The project cost has increased to \\$1.05 billion due to additions to the project since Fitch's last rating review. The campus transformation project includes two new patient towers (adult and children's), a new emergency room, operating rooms, diagnostic and imaging services, and a birthing center. The project will result in 989,000 square feet of new space with a total capacity of 693 licensed beds (320 adult and 377 children's) including shelled space, new operating rooms, diagnostic and imaging services, cardiovascular labs, birthing center, NICU expansion and two emergency rooms (adult and children's).
The sources of funding are \\$529 million from the series 2016 bonds, \\$160 million from state grants (Proposition 61 and 3 voter-approved ballot initiatives for children's hospital construction), \\$140 million from philanthropy and \\$220 million from cash flow. The increase in the project cost is being funded through operations, which necessitates the maintenance of generating solid cash flow.
Weak Liquidity
Total unrestricted cash and investments at June 30, 2015 was \\$324.4 million, which resulted in 81.8 days cash on hand (DCOH) and 40.1% cash to debt, which is a slight decline from Dec. 31, 2014. Fitch expected liquidity to improve due to the release of swap collateral in conjunction with 2014 debt restructuring as well as a pending provider fee receivable. However, liquidity has been pressured by higher than normal accounts receivable related to the separate licensure of the children's hospital as of November 2014 and the delay in receiving new provider numbers for billing, which resumed in May 2015. This delay resulted in the write down of approximately \\$15 million of net patient revenue, which is viewed negatively. LLUMC has \\$25 million outstanding on a line of credit due to the accounts receivable issue. In addition, the provider fee receivable at June 30, 2015 was \\$68 million from \\$129 million at Dec. 31, 2014.
Assuming the issuance of \\$816 million of additional debt in 2016, LLUMC's weak pro forma liquidity position provides thin financial cushion for any shortfall in the other sources of funding for the project (\\$220 million from operating cash flow and \\$140 million from philanthropy). However, Fitch notes that Loma Linda University has committed a \\$100 million line of credit to LLUMC through construction, which is viewed favorably.
Improved Operating Performance
LLUMC's operating performance in 2014 and through the six months ended June 30, 2015 has improved with operating margins of 4.1% and 5%, respectively and operating EBITDA margins of 10.6% and 11.8%, respectively. LLUMC has benefited significantly from the provider fee, however, the timing of the approval of the various components of the program results in uneven performance.
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. The 2010 provider fee (for the period April 2009 to December 2010) resulted in a net benefit of \\$85 million in 2010. Two subsequent periods were approved with a net benefit of \\$43 million in 2011, \\$63 million in 2012, and \\$87 million in 2013. The provider fee program for the 2014-2016 period is expected to net \\$282 million over three years and only a portion of this program has been approved. LLUMC booked a net benefit of \\$65 million in 2014 and \\$43 million through the six months ended June 30, 2015.
Other factors driving improved performance include strong utilization growth due to Medi-Cal expansion and improved payor mix and better performance at its Murrieta facility. Discharges and emergency room visits have increased 8% and 12%, respectively through the six months ended June 30, 2015 compared to the same prior year period. Although volume growth is favorable, LLUMC has had to use premium labor to meet the demand. Payor mix continues to improve with self pay as a percentage of net revenue declining to 1% in 2014 from 4.7% in 2011. Murrieta has historically been challenged and hampered by high capital costs. Given the refinancing in 2014, improved volume, and other operating improvement initiatives, Murrieta had a negative bottom line of \\$8.8 million in 2014 compared to negative \\$32 million in 2013.
Management has several performance improvement initiatives underway including labor productivity, clinical documentation and operations, and revenue cycle and expects to end 2015 with a \\$100 million bottom line (6% excess margin). It is necessary for LLUMC to sustain strong operations due to its upcoming campus transformation project. Management projects maintaining a \\$100 million bottom line over the next few years.
Solidifying Market Position
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 (San Bernardino and Riverside counties). 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 1.98. LLUMC's market share has increased to 10.5% in 2013 from 9.1% in 2011 compared to the next closest competitor, Kaiser-Fontana, with 6.6% market share. Market share is expected to increase especially with the increased volume at its Murrieta facility.
LLUMC has several strategies underway to solidify and expand its market position in the growing Inland Empire. These include developing a clinically integrated network with the county hospitals in San Bernardino County and a health plan with a large number of Medi-Cal lives, in addition to further growing its facility and physician network for various contracting strategies including narrow networks. These strategies are early in formation and Fitch will monitor the execution of the various strategies.
Debt Profile
Fitch views LLUMC's debt restructuring in 2014 favorably as it eliminated various risks in the debt profile (swap and letter of credit exposure) as well as provided cash flow savings to prepare for the series 2016 issuance.
Total outstanding debt at June 30, 2015 totaled \\$809 million and bonded debt of \\$683 million is 100% fixed rate. Other debt includes \\$54 million of OG notes and capital leases, \\$25 million line of credit, and \\$45 million of non OG debt. Fitch used a consolidated maximum annual debt service (MADS) of \\$56.4 million. Debt service coverage is solid at 3x in 2014 and 3.5x through the six months ended June 30, 2015.
LLUMC has a 60 DCOH covenant and annual debt service coverage covenant of 1.1x.
The series 2016 issuance is expected in the second quarter of 2016 and the \\$816 million of proceeds are expected to fund \\$529 million of project costs, \\$199 million of capitalized interest, \\$76 million for a debt service reserve, and costs of issuance. As provided by management, pro forma MADS (including the series 2016 issuance) increases to approximately \\$115 million which results in weak pro forma debt metrics at the 'BB+' rating level. Pro forma MADS coverage was 1.7x through the six months ended June 30, 2015 and 1.5x in 2014. Pro forma MADS accounted for a high 7.2% of total revenue.
Disclosure
LLUMC covenants to provide annual audited information within 150 days of fiscal year end and quarterly information within 60 days of quarter end to EMMA.
For more information, see Fitch's report 'Loma Linda University Medical Center, CA' dated Dec. 2, 2014.
In addition, Fitch has withdrawn its ratings for the following bond due to prerefunding activity:
--Loma Linda (CA) (Loma Linda University Medical Center Project) hospital revenue bonds series 2008A (prerefunded maturities only);
--Loma Linda (CA) (Loma Linda University Medical Center Project) hospital revenue refunding bonds series 2005A (prerefunded maturities only);
--Loma Linda (CA) (Loma Linda University Medical Center Project) variable rate hospital revenue bonds series 2007B-2 (prerefunded maturities only);
--Loma Linda (CA) (Loma Linda University Medical Center Project) variable rate hospital revenue bonds series 2008B (prerefunded maturities only).
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