OREANDA-NEWS. Fitch Ratings has assigned a 'BB+' rating to the approximately $883 million California Statewide Communities Development Authority revenue bonds series 2016A issued on behalf of Loma Linda University Medical Center (LLUMC). In addition, Fitch has affirmed the 'BB+' rating on LLUMC's outstanding debt, which is listed at the end of this release.

The Rating Outlook is revised to Stable from Negative.

The series 2016A bonds will be fixed rate and bond proceeds will be used to fund a portion of the cost of LLUMC's campus transformation project ($599 million), fund capitalized interest through December 2019 and a debt service reserve fund ($258 million), refund the series 2014C bonds ($13 million), and pay costs of issuance. The series 2016A bonds are expected to price the week of April 25th.

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 99.9% of the net patient service revenue and 98.3% of the total net assets of the consolidated entity in 2015 (Dec. 31 fiscal year end; audited). Fitch's analysis is based on the consolidated entity, Loma Linda University Medical Center and Affiliates.

KEY RATING DRIVERS

EXPECTATIONS FROM LAST REVIEW MET: The revision in the Outlook to Stable from Negative reflects 2015 performance that exceeded budgeted targets (adjusted for one-time items), as well as project cost and financing plans which were kept in line with what was presented during Fitch's last review in September 2015, when the rating was downgraded to 'BB+' from 'BBB-' and incorporated this sizeable issuance.

CAMPUS TRANSFORMATION PROJECT UNDERWAY: Due to state mandated seismic requirements, LLUMC is embarking on a massive project with the construction of 983,000 square feet of new space, which will include an adult patient tower, children's patient tower, as well as expanded capacity in the emergency room, operating rooms and diagnostic imaging. All of the beds will be private and will include shelled space for 60 beds. The total project cost is $1.084 billion, and $1.022 billion is remaining to be spent. The sources of funding include $599 million from the series 2016A bonds, $165 million from state grant funding, $120 million from philanthropy, and $138 million from operating cash flow.

BETTER OPERATING PERFORMANCE: LLUMC engaged a consultant and started to implement a performance improvement plan in the latter part of 2015 focused on clinical operations, revenue cycle, non-labor and supplies cost, labor productivity, and clinical documentation. Initiatives implemented to date are yielding a $90 million annual impact. There is a continued focus on reducing length of stay and reaching the 50th percentile on CMI adjusted length of stay as well as improving labor productivity. Adjusted for one-time items in 2015 ($21 million consulting expense and $26 million of provider fee funds related to the period but not recorded due to a delay in CMS approval) resulted in $99.6 million of operating income (6.2% operating margin and 13% operating EBITDA margin) and this level of performance is expected to be sustained.

HIGH DEBT BURDEN: With this issuance, MADS accounted for a very high 6.8% of total revenue in 2015 and results in weak pro forma debt service coverage of 1.6x in 2015 (2x adjusted for one-time items). Fitch believes there are opportunities with the new project including improved operational efficiencies and capacity for additional volume, which should assist in moderating the debt burden over time as additional revenue and benefits from the new facility are achieved.

WEAK LIQUIDITY: LLUMC's liquidity has historically been weak, but improved in 2015 with 112.7 days cash on hand and 53.9% cash to debt at Dec. 31, 2015. Cash to debt on a pro forma basis is a very weak 26.5%, but is in line with what was presented during the Sept. 2015 review.

KEY PLAYER IN MARKET: 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 two years), the organization is developing various strategies to secure its market position in a growing service area and to prepare for population health management. These include physician alignment initiatives, affiliations with other providers, and partnerships with payers. LLUMC is in the early stages of developing a clinically integrated network.

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. Given the high Medi-Cal burden, LLUMC's profitability and cash flow have benefited from the state provider fee program, which started in 2010 (payments retroactive to April 2009) and is in place through Dec. 31, 2016. There is a ballot initiative in November 2016 to make the program permanent and it is management's expectation that it will pass.

RATING SENSITIVITIES
MANAGEMENT EXECUTION IS CRUCIAL: Management's ability to complete the project on time and within budget while sustaining the improved operating performance will be crucial to maintaining the current rating, as LLUMC has limited financial flexibility. An unfavorable deviation from plan would likely result in negative rating action.

CREDIT PROFILE
Loma Linda Medical Center and Affiliates is part of Loma Linda University Health (LLUH), which also includes Loma Linda University, the Faculty Medical Group 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, with a total of 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 $1.6 billion in 2015. A new CEO has been in a permanent role since August 2014 (prior counsel), and with additional executive management changes, there is a focus on accountability and performance improvement, which will need to be sustained given the campus transformation project.

Campus Transformation Project
University Hospital is required to meet seismic compliance by Jan. 1, 2020 and a campus transformation project has been in the planning stages for many years. The final project cost and scope is in line with what was presented during Fitch's review in Sept. 2015 with a small increase ($36 million) related to the potential addition of a vertical ground motion isolation system since a new fault line was discovered under the site. However, this is new technology and LLUMC may not move forward with this addition if it is not approved. Regardless, the building can receive final sign-off by the engineers without this addition.

The campus transformation project includes two new patient towers (adult and children's) with all private rooms, expanded and separate emergency rooms (adult and children's), expanded neonatal intensive care unit and birthing center, 16 new operating rooms (five additional), enhanced diagnostic imaging services and cardiovascular labs. The project will result in 983,000 square feet of new space with a total capacity of 693 licensed beds (320 adult and 377 children's) once the shelled space is built out for the additional 60 beds. The project cost is $1.084 billion ($1.05 billion at time of last review in Sept. 2015) with $1.022 billion remaining to be spent. Total construction cost is $771 million and a guaranteed maximum price contract is secured for $727 million. Other costs relate to design, equipment, information technology, and contingency.

The sources of funding are $599 million from the series 2016A bonds, $165 million from state grants (Proposition 61 and 3 voter-approved ballot initiatives for children's hospital construction), $120 million from philanthropy and $138 million from cash flow. This is in line with what was presented during Fitch's last review and is slightly better with more funds being generated through bond proceeds and less reliance on funding from operating cash flow.

The project is expected to start construction in May 2016, be complete by December 2019 and open by June 2020. This is a tight timeframe to meet the regulatory deadline related to seismic requirements; however, Fitch believes LLUMC would have other options if there were a delay in the construction schedule, such as requesting an extension in the deadline. Fitch would view unfavorably any shortfalls in the planned funding sources or project cost overruns.

Improved Operating Performance
LLUMC's operating performance in 2015 (adjusted for one-time items) sustained its improved profitability with a 6.2% operating margin ($99.6 million operating income) compared to 4.1% in 2014, and performance has exceeded budget. One-time items in 2015 included $21 million of consulting fees and $26 million of provider fee funds related to 2015 that could not be recorded due to the delay in CMS approval related to the managed care portion of the program. Actual 2015 operating margin was 3.3%.

Factors driving improved performance include strong utilization growth due to Medi-Cal expansion, improved payor mix and implementation of performance improvement initiatives. Discharges and emergency room visits have increased 5.8% and 11.3%, respectively, in 2015 from the prior year. Payor mix continues to improve with self-pay as a percentage of net revenue declining to 1% in 2015 from 4.5% in 2013. Management implemented several performance improvement initiatives in the latter part of 2015, which have an annual impact of $90 million. This has led to continued strong operating performance through February 2016. There continues to be additional opportunity and management is focused on reducing length of stay, cost per adjusted discharge, and improving clinical documentation and labor productivity. Management budgeted a bottom line of approximately $100 million in 2016 (includes transfers to affiliates as an operating expense).

There have been ongoing transfers to affiliates, which are below the line but management views as an operating expense. These transfers to affiliates are generally for the support of the School of Medicine and are projected to be around $26 million-$28 million a year.

Murrieta has historically been challenged and hampered by high capital costs. Given the refinancing in 2014, improved volumes, and other operating improvement initiatives, Murrieta had a bottom line loss of $7.7 million in 2015 compared to negative $32 million in 2013. Murrieta's performance would be closer to breakeven in 2015 excluding a $7 million prior period Medi-Cal adjustment that management is currently appealing.

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, however, the timing of the approval of the various components of the program results in variability of when funds are recorded. LLUMC booked a net benefit of $43 million in 2011, $63 million in 2012, $87 million in 2013, $65 million in 2014, and $61 million in 2015. The current provider fee program is in place through Dec. 31, 2016 and there is a ballot initiative in November 2016 to make the program permanent.

Weak Liquidity
Total unrestricted cash and investments at Dec. 31, 2015 was $448.6 million, which resulted in 112.7 days cash on hand (DCOH) and 53.9% cash to debt, which improved from 96.4 days and 44.7% cash to debt at Dec. 31, 2014 due mainly to the receipt of provider fee receivables (declined to $40 million at Dec. 31, 2015 from $129 million at Dec. 31, 2014).

Given LLUMC's weak liquidity position, there is minimal cushion for a deviation in planned funding sources of the project. A lower than expected amount from philanthropy ($120 million) would be viewed negatively and to date, $142.3 million has been raised with $48.9 million received in cash. The availability of the state grant funding had conditions (meeting certain financial targets), which have been met, and this funding source will be used first to fund the children's hospital portion of the project.

Financial Projections Attainable
LLUMC's financial projections for 2016-2023 assume continued performance improvement initiatives and modest volume growth. The provider fee is included at $89 million a year and annual operating EBITDA margin is maintained at 13%-14%, which was LLUMC's performance in 2015 adjusted for one-time items (13%). There is capitalized interest through Dec. 2019 and annual debt service coverage is projected above 3x in the forecast period, while MADS coverage is around 2.5x.

In addition to the campus transformation project, the projections include approximately $764 million of other capital spending that could be flexed according to management.

Solidifying Market Position

LLUMC's market share has increased in its service area, which is defined as the Inland Empire (San Bernardino and Riverside counties). It offers quaternary and tertiary services and has the only level-I trauma center and level-IV neonatal intensive care unit in the service area. LLUMC's Medicare case mix index is very high at 2.04. LLUMC's market share has increased to 10.58% in 2014 compared to 10% in 2012 and the next closest competitor, Kaiser-Fontana, had 6.7% market share. However, Kaiser has several facilities in the area and Kaiser's combined market share in the region was 11.8%.

LLUMC has several strategies underway to solidify and expand its market position in the growing Inland Empire. LLUMC is in the early stages of developing a clinically integrated network (University Preferred Health Partners) with other providers (hospitals and physician groups) in the service area as well as partnering with payers to better manage the care and cost especially of the Medi-Cal population. These strategies are still early in formation and Fitch will monitor the execution of the various strategies.

Debt Profile

Total outstanding debt after the series 2016A bonds is projected to be approximately $1.7 billion and will be 100% fixed rate. Debt includes $1.6 billion of bonds (series 2016 and 2014A&B), $80 million of note payables and capital leases, and $31 million of non-obligated group guarantees. MADS is approximately $107 million and debt service is back-loaded with MADS occurring in 2025.

LLUMC's $122.8 million of series 2014B bonds was structured as a 10-year bullet and is due on Dec. 1, 2024. Under the master trust indenture, this is amortized over 30 years based on the definition for debt service requirements. An inability to refinance this debt would be viewed negatively.

LLUMC has a 60 DCOH covenant and annual debt service coverage covenant of 1.1x.

Disclosure

LLUMC covenants to provide annual audited information to EMMA within 150 days of fiscal year end and quarterly information within 60 days of quarter end for the first three quarters and within 90 days of the fourth quarter. LLUMC will also be hosting investor calls twice a year beginning in June 2016.

Fitch has affirmed the following outstanding debt at 'BB+':

$12,890,000 California Statewide Communities Development Authority (Loma Linda University Medical Center) revenue bonds (taxable) series 2014C
$122,840,000 California Statewide Communities Development Authority (Loma Linda University Medical Center) revenue bonds (taxable) series 2014B
$573,295,000 California Statewide Communities Development Authority (Loma Linda University Medical Center) revenue bonds series 2014A