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Fitch Rates Loma Linda University Med Center's (CA) Series 2014 Revs 'BBB-'; Outlook to Negative
[November 21, 2014]

Fitch Rates Loma Linda University Med Center's (CA) Series 2014 Revs 'BBB-'; Outlook to Negative


SAN FRANCISCO --(Business Wire)--

Fitch Ratings has assigned a 'BBB-' rating to the following bonds issued on behalf of Loma Linda University Medical Center (LLUMC):

--$543,370,000 California Statewide Communities Development Authority revenue bonds, series 2014A;

--$106,670,000 California Statewide Communities Development Authority revenue bonds, federally taxable revenue bonds, series 2014B.

In addition, Fitch affirms the 'BBB-' rating on LLUMC's outstanding debt, which is listed at the end of this press release.

The series 2014A and B bonds will be used to refund approximately $560 million of LLUMC's outstanding bonds, notes payable, and a taxable bridge loan, provide funds for capital expenditures, fund a debt service reserve fund (DSRF), pay swap termination costs, and costs of issuance. Total pro forma debt outstanding after the series 2014 transaction is $785 million, which will be 100% fixed rate. The series 2014A and B bonds are expected to price the week of Dec. 8, 2014.

The Rating Outlook is revised to Negative from Stable.

SECURITY

With this issuance, there will be an amended and restated master trust indenture and the obligated group (OG) will include the medical center, the children's hospital, and Murrieta Hospital (Murrieta). The bonds are secured by a gross revenue pledge and mortgage pledge of the OG. In addition, there is a DSRF. The OG accounted for 94% of total assets and 97% of total revenue of the consolidated entity in 2013 (Dec. 31 fiscal year end; audited). Fitch's analysis is based on the consolidated entity, Loma Linda University Medical Center and Affiliates (the system).

KEY RATING DRIVERS

PRESSURED FINANCIAL PROFILE: The revision in the Outlook to Negative from Stable reflects a higher debt burden than expected at the time of Fitch's last review (August 2014) and a more pressured financial profile. LLUMC has been a major beneficiary of the provider fee program; however, the most recent program (2014-2016) is still awaiting approval by CMS so LLUMC has not been able to recognize the funds in fiscal 2014, which has resulted in weaker profitability. Although Fitch does expect this revenue stream to be realized in the near term, LLUMC has limited financial cushion to handle a longer delay in timing of the receipt of the net benefit from the program.

FRONT-LOADED DEBT SERVICE STRAINS COVERAGE: Although LLUMC is completing a significant debt restructuring, the continued use of notes payable and leases creates a front-loaded debt service schedule that results in thin debt service coverage. Maximum annual debt service (MADS) of $62.1 million for the system was covered by EBITDA by 1.9x in fiscal 2013 and 1.7x through the eight months ended Aug. 31, 2014. However, if the net benefit from the provider fee was recognized in 2014, coverage through the eight months would have been 2.7x compared to the 'BBB' category median of 2.6x.

WEAK LIQUIDITY: LLUMC's liquidity is weak with $337 million of unrestricted cash and investments at Aug. 31, 2014 that translated to 91.2 days cash on hand and pro forma cash-to-debt of 42.9% compared to the 'BBB' category medians of 145 and 93.6%, respectively. In August 2014, LLUMC converted an off-balance-sheet transaction (operating lease for Murrieta) to a debt obligation, with an approximately $200 million taxable bridge loan which will be refinanced with this issuance. Liquidity measures have always been light for the rating level and the revision in the Outlook also reflects Fitch's concern about LLUMC's ability to fund its upcoming capital needs.

LOOMING CAPITAL NEEDS: LLUMC has significant capital needs that need to be addressed due to state seismic requirements. 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 for a total cost of $926 million. Sources of funding include a mix of debt, cash flow, philanthropy and state funding. Philanthropy has been successful and between state funding and philanthropy, the funding for the children's hospital portion has been raised. A debt issuance of approximately $514 million is expected in 2016 and this rating does not incorporate that issuance.

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.

ROOM FOR IMPROVEMENT: LLUMC has several performance improvement initiatives in place in addition to a continued positive trajectory at Murrieta, which should result in improved profitability. Murrieta has historically had significant operating losses but is on track to break even for fiscal 2014.

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 Medicaid 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 $259 million over the three years.

RATING SENSITIVITIES

ADDITIONAL DEBT PLANS: Fitch does not believe LLUMC has capacity at an investment-grade rating level to fund the expected additional debt issuance in 2016 on its own credit.

EXPECTED PROVIDER FEE FUNDING: The 2014-2016 provider fee program is still awaiting CMS approval and there is an expectation that a portion of te program will be approved by the end of the year. It is Fitch's expectation that these funds will be realized in the near term and that a longer delay in funds or further pressure on LLUMC's financial profile could result in negative rating action.



CREDIT PROFILE

LLUMC is an 881-licensed bed academic medical center located in Loma Linda, CA (News - Alert), 60 miles east of Los Angeles. LLUMC houses the nation's first hospital-based proton treatment center for cancer. LLUMC includes four hospitals - University Hospital, Children's Hospital, East Campus Hospital, and the Heart and Surgical Hospital. Other affiliates include Loma Linda University Behavioral Medicine Center, Loma Linda University Children's Hospital Foundation, Loma Linda Healthcare Properties, LLUMC - Murrieta, and Loma Linda University - Urgent Care. The total system has 1,076 licensed beds. Total revenue in fiscal 2013 was $1.5 billion.


Plan of Finance

The series 2014A tax-exempt fixed rate and series 2014B taxable fixed rate bond proceeds total $650 million and, in conjunction with the release of existing debt service reserve funds ($23 million) will refund the majority of LLUMC's outstanding bonds and refinance the taxable bridge loan ($501 million), fund $66 million of capital expenditures, refund various loans ($56 million), fund a DSRF ($39 million), pay swap termination costs ($25 million) and pay costs of issuance. The series 2014B is expected to be issued as a 10-year bullet maturity, which would also be of concern if LLUMC could not access the capital markets to refinance the debt. Total pro forma debt after this financing is $785 million with $738 million in debt for the OG and $47 million debt related to non-obligated affiliates. The swaps will be terminated and approximately $26.4 million of collateral will be released. The debt profile will be 100% fixed rate and LLUMC has reduced its capital structure risks, which Fitch views favorably. Fitch used a MADS of $62.1 million for the consolidated system and debt service drops fairly significantly to approximately $47 million by 2028.

This financing will be issued under a new amended and restated master trust indenture with a new OG that includes Murrieta. The security remains the same with a gross revenue pledge and mortgage pledge by the OG in addition to a DSRF. LLUMC has a 60 days cash on hand covenant and annual debt service coverage covenant of 1.1x.

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 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 $259 million over three years. For the eight months ended Aug. 31, 2014, the net benefit from the portion of the provider fee that is expected to be approved by December 2014 would have been $41 million. Profitability is solid for the rating level due to this funding stream, although core operations were pressured in 2013.

Weaker Fiscal 2013 Results

The system's profitability declined to 1.7% ($25.2 million operating income) in 2013 from 4.3% in 2012 and 6% in 2011, and dropped to 0.6% through the eight months ended Aug. 31, 2014. Performance in 2013 was affected by Epic implementation costs over budget, higher supplies expense from the noncompliance in the 340b drug program, as well as flat volume. Murrieta's performance also continues to be a drag on the overall performance with a negative $31.6 million bottom line in 2013, but has improved from negative $51 million in 2012 and negative $61 million in 2011. Murrieta is on track to be breakeven in 2014 and projected to be profitable in 2015, which Fitch believes is attainable with the reduction in capital costs as well as several operational improvement initiatives implemented with the assistance of HFS Consultants.

If the net benefit of the provider fee program was recognized through the eight months ended Aug. 31, 2014, operating margin would improve to 4.7%. The system has a $100 million of performance improvement initiatives underway and expects to identify another $100 million of opportunity over the next few years.

Significant Opportunity with Regional Growth Strategy

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 should continue to increase especially as LLUMC continues to capture outmigration from the Murrieta market.

Fitch believes LLUMC has a major area of opportunity with its investment in the Murrieta market. LLUMC opened the 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 and there is significant population growth of a favorable payor mix in this region. LLUMC's ability to capitalize on this investment will be key to an improved overall financial profile of the system.

When the hospital was planned, it was initially intended to be a joint venture with physicians and the construction was financed through a 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 was being leased under a 15-year term that expired in March 2026 but a buyout of the lease occurred in August 2014 and should result in positive cash flow of approximately $10 million a year.

LLUMC is also in discussions with other providers in the area to develop a regional accountable care network to collectively leverage the strengths of the individual providers to better provide care for the population it serves. These affiliations are expected to have minimal capital investment as the system has no debt capacity to take on additional capital requirements given its own upcoming capital needs.

Large Capital Needs

LLUMC's capital needs total approximately $1.6 billion over the next 10 years and are mainly driven by the state seismic compliance requirements. The campus transformation project is now estimated at $926 million and the expected funding sources are $514 million from a debt issuance in 2016, $160 million from state grants (Proposition 61 and 3 voter-approved ballot initiatives for children's hospital construction), $140 million from philanthropy and $112 million from cash flow. LLUMC expects the construction on the patient towers to begin in first quarter 2016 and complete by the fourth quarter 2019. Philanthropy has been successful and LLUMC recently received its largest gift in its history - a $100 million donation. LLUMC has raised $155 million to date with $10.1 million received in cash.

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.

Outstanding Debt

--$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;

--$80,000,000 Loma Linda (CA) (Loma Linda University Medical Center Project) variable rate hospital revenue bonds, series 2007B-1 and B-2;

--$142,089,000 Loma Linda (CA) (Loma Linda University Medical Center Project) hospital revenue refunding bonds, series 2005A;

--$11,640,000 Loma Linda (CA) (Loma Linda University Medical Center Project) hospital revenue refunding bonds, series 1999A.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'U.S. Nonprofit Hospitals and Health Systems Rating Criteria', dated May 20, 2014

Applicable Criteria and Related Research:

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=746860

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=931595

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