Fitch Ratings Downgrades Tulare Local Health Care District

Fitch Ratings, which has provided independent and prospective credit ratings for 100 years, has downgraded to ‘B’ from ‘B+’ the rating on $15,230,000 series 2007 fixed rate bonds issued by the Tulare Local Health Care District, doing business as Tulare Regional Medical Center (TRMC). The bonds have been placed on Rating Watch Negative.

Tulare Regional Medical Center owns and operates a 112-bed hospital in the city of Tulare.

The downgrade to ‘B’ reflects a continued trend of operating losses driven by declining revenues from “persisting challenges in patient utilization.” Operating losses were sustained in the fiscal year ended June 30, 2013, and through the interim period ended December 31, though somewhat improved from 2012 levels. Due to negative cash flow, TRMC violated its debt service covenant in fiscal 2012, and a “going concern” was expressed in the last two audited financial statements.

TRMC’s liquidity position is very weak, resulting from negative cash flow and complications with its ongoing construction project, according to Fitch Ratings. Unrestricted cash and investments were $6.3 million on December 31, compared to $10.5 million at the end of 2012, and $24.4 million in 2010. Management indicated that a large part of the decline through the interim period was due to timing of intergovernmental transfers, and reported an unrestricted cash balance of $9.8 million at the end of February.

Turnaround Expected

In January, TRMC entered into a management agreement with HealthCare Conglomerate Associates (HCCA), an organization that was formed specifically to address operational and construction challenges at TRMC. HCCA recruited a number of industry experts in operational, financial, clinical and construction efforts, and began operating TRMC on January 13 under a short-term management contract. HCCA is projecting TRMC to break even by the end of 2014, which Fitch believes is relatively attainable.

The completion of the new bed tower that was initially scheduled for October 2012 has yet to be accomplished. The remaining cost and sources of funding for the project is unknown at this time but will likely pose a significant demand on already weak liquidity. TRMC is leveraging HCCA’s expertise to renegotiate contracts and develop a recovery schedule.

The Negative Watch reflects the uncertainty around the timing and funding sources of the construction project. Management expects to have a construction completion plan in the next 60 days, which is expected to provide greater clarity on TRMC’s ability to meet all its financial commitments.

TRMC posted operating losses for the second year in 2013 with an operating loss of $2.3 million, which includes annual district tax revenues of approximately $1.5 million that can be used to support operations and debt service requirements. This is significantly improved from a loss of $9.9 million in fiscal 2012, from significant expense reductions in areas such as labor and supply costs. As a result, operating margin improved to a negative 3.1% in fiscal 2013 compared to a negative 13% in fiscal 2012.

Agreement with HealthCare Conglomerate Associates

In December, the board of TRMC selected HCCA as an affiliation partner. HCCA is a management organization formed with the purpose of addressing the issues at TRMC, including financial and operational turnaround, improving physician relationships, and completing its construction project. Under a 12-month management contract, HCCA began managing TRMC in January with the goal of entering into a long-term lease within this calendar year. As the potential transaction is in its early stages and no details were provided, Fitch’s analysis assumes the bonds will remain outstanding in its current form.

Under the management contract, HCCA has several executives on-site that will manage the day-to-day operations. The turnaround plan focuses on three key areas – operational/financial, clinical and construction. A chief restructuring officer from HCCA is at TRMC full-time, assuming the responsibilities of CEO, as well as several other professionals focusing on physician integration and construction management.

A thorough review of revenues and expenditures began once HCCA came onsite in January, and several initiatives are being executed to improve operating profitability. Projected growth in revenue is estimated at 5% for this calendar year, with a focus on recovering patient volumes and improving clinical documentation and revenue cycle. Targeted expense reductions total 8%, which is distributed across most expense items including labor, supplies and maintenance. Management believes these targets are achievable, and should bring TRMC back to near breakeven operations in the next 12 months.

Ongoing Construction Delays

The district has a major construction project in progress, which plans to feature a 24-bed emergency department, a new diagnostic department, a 16-bed obstetric unit, four surgery suites, and 27 new private patient rooms meeting seismic requirements. This new expansion tower was initially slated to open October 2012, but suffered disruptions due to delamination issues. Renegotiating with contractors and putting a makeup schedule in place is one of HCCA’s priorities, and is expected to be complete in the next two months.

As of December 31, there was approximately $6.8 million of restricted funds remaining for the construction project, which Fitch believes is insufficient to complete the project. TRMC will likely need to procure additional funding to attain completion. The Negative Watch reflects the uncertainties around construction completion and funding, and the impact on TRMC’s solvency. Fitch will evaluate the impact of the new construction plan and new debt, if any, after plans are finalized in the next two months.

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