|[July 31, 2014]
Fitch Affirms Cottage Health System's (CA) Rev Bonds AA-; Outlook Stable
SAN FRANCISCO --(Business Wire)--
Fitch Ratings has affirmed the 'AA-' rating on the following revenue
bonds issued on behalf of Cottage Health System (Cottage):
--$280,230,000 California Statewide Communities Development Authority
fixed-rate revenue bonds series 2010;
--$47,980,000 California Health Facilities Financing Authority fixed
rate revenue bonds series 2003B.
The Rating Outlook is Stable.
The bonds are secured by a pledge of gross revenues of the obligated
group. The obligated group accounted for 95% of total revenue and 80% of
total assets of the consolidated entity in fiscal 2013 (Dec. 31 year
end). Fitch's analysis is based on the consolidated entity.
KEY RATING DRIVERS
SOLID FINANCIAL PROFILE: Cottage's financial profile is solid with
strong profitability, good debt service coverage and a rebound in
liquidity after heavy capital spending. The majority of Cottage's
financial metrics exceed Fitch's AA category medians.
DOMINANT MARKET POSITION: Fitch believes that Cottage's dominant market
position is a key credit strength. As the only major provider of acute
health care services in the Santa Barbara region, Cottage maintains a
strong market position of over 80% in its primary service area.
MAJOR CAPITAL INVESTMENT UNDERWAY: Cottage is nearing the completion of
its master facilities plan, which included a significant rebuilding of
its Santa Barbara Cottage Hospital and the replacement of its Goleta
Valley Hospital. The remaining spend totals approximately $246 million
of which more than half will be funded by its related foundations.
Cottage recently decided to invest in Epic, which will be an additional
capital outlay mainly in 2015 and 2016.
RELATED FOUNDATIONS: Cottage is affiliated with four separately
incorporated charitable foundations, Santa Barbara Cottage Foundation,
Goleta Valley Cottage Hospital Foundation, Santa Ynez Valley Hospital
Foundation, and Rehabilitation Hospital Foundation. The sole purpose of
the foundations is to provide support to the respective hospitals and
the foundations provided funding for $291 million of Cottage's $925
million master facilities plan.
AFFILIATION WITH LARGE PHYSICIAN GROUP: Cottage has been in the process
of further integrating with the largest multispecialty physician group
in town, Sansum Clinic. The transaction is currently under review by the
FTC (News - Alert) and could close by the end of the year. Cottage may issue additional
debt if the affiliation occurs. Fitch will evaluate the impact of this
transaction on Cottage's rating when details are finalized.
Cottage consists of Santa Barbara Cottage Hospital (SBCH; 450 licensed
beds), Goleta Valley Cottage Hospital (GVCH; 122 licensed beds) and
Santa Ynez Valley Cottage Hospital (11 licensed beds) all located in
southern Santa Barbara County, California. Total revenue in 2013 was
CREATING AN INTEGRATED DELIVERY SYSTEM
Cottage enjoys a dominant market position as the only major provider of
acute health care services in the desirable and affluent Santa Barbara
region with 88.2% market share in its primary service area. Cottage has
had a close working relationship with Sansum Clinic, the large
multispecialty physician group (160 physicians), in town and the two
organizations have been working toward a closer alignment strategy over
the last several years. The contemplated structure would result in the
creation of a medical foundation and common governance and management.
Fitch views this affiliation favorably as it better positions the
organizatin to coordinate care and manage population health.
Operating cash flow has been consistently strong due to good revenue
growth from increased volume, favorable contracting, and continued cost
management. Operating EBITDA margin was 17.1% in 2013 compared to 12.6%
in 2012 and 11.4% in 2011. There was a significant increase in
depreciation and interest expense in 2012 as the majority of its master
facilities plan at SBCH came on line. Operating margin was 8.1% in 2013
compared to 3.3% in 2012 and 6.9% in 2011. Through the three months
ended March 31, 2014, operating margin and operating EBITDA margin were
9.9% and 18.3%, respectively and performance is ahead of budget.
Fitch notes that Cottage's profitability is impacted by the timing of
the California provider fee program. The various components of the
program get approved at different times and the revenue from the fee
lags the expense. Although Cottage is a net beneficiary from the
program, the impact on the financials was negative $7 million in 2012
and positive $13 million in 2013. It is expected that 2014 will also
exhibit a lag effect and portray a loss on the provider fee program.
REBOUND IN LIQUIDITY
Cottage's balance sheet has rebounded after spending on its master
facilities plan and metrics are now back in line for a AA category
credit. Unrestricted cash and investments at March 31, 2014 was $528.9
million and translated to 360.4 days cash on hand and 161.2% cash to
debt compared to the AA category median of 254.3 and 173.6%. Liquidity
growth has been driven by strong operating cash flow and good investment
returns. Cottage is currently analyzing its investment policy and may
make minor changes to its investment strategy as the organization is
nearing the completion of its master facilities plan.
MAJOR CAPITAL SPENDING UNDERWAY
Cottage is nearing the end of its extensive master facilities plan,
which has a total cost of $925 million and includes rebuilding SBCH
($811 million) and GVCH ($114 million) to modernize the facilities and
meet seismic requirements.
The sources of funding include $325 million of series 2003 and 2010
bonds, $309 million from cash and cash flow and $291 million from the
Foundations. Major elements of these projects include the construction
of three 100-bed patient pavilions at SBCH and a replacement facility at
GVCH. SBCH brought two new inpatient pavilions online in February 2012
and the third pavilion and an expanded emergency room is currently being
constructed and is expected to be completed at the end of 2018 and open
in early 2019. The remaining spend totals $246 million from 2014 - 2018
for the project. Other capital needs include routine capital
expenditures that total $123 million from 2014 -2018 as well as its
investment in Epic. The cost of Epic is yet to be finalized as Cottage
is still in contract negotiations. Fitch views the investment in Epic
favorably as Sansum Clinic is already on Epic and Cottage plans to offer
the same platform to independent physicians. Capital spending is
expected to impact liquidity; however, Fitch expects this to be
CONSERVATIVE DEBT PROFILE
Cottage has $328 million of total debt outstanding, which is 100% fixed
rate. Cottage retained three fixed payer swaps after the refinancing of
its variable rate debt to fixed rate debt in 2010. In addition, Cottage
has one fixed receiver swap. The swaps have a notional amount of $227
million and no collateral is being posted at this time.
Cottage's debt burden is moderately high with MADS accounting for 3.2%
of total revenue in 2013, but has declined from 3.9% in 2010. MADS is
$22 million and debt service is level. Debt service coverage is solid
due to strong profitability and debt service coverage by EBITDA was 6.4x
in 2013 compared to 4x in 2012 and 5.3x through the three months ended
March 31, 2014 and the AA category median of 5x.
Cottage covenants to provide annual audits within 150 days of fiscal
year end and quarterly disclosure within 75 days of quarter end for the
first three quarters.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Nonprofit Hospitals and Health Systems Rating Criteria' (May 20,
Applicable Criteria and Related Research:
U.S. Nonprofit Hospitals and Health Systems Rating Criteria
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