Struggles of two California hospitals reflect industry’s challenges

The struggles of two public hospital districts in central California are emblematic of financial pressures facing the healthcare industry.

Kaweah Delta Health Care District in Visalia violated a debt service ratio covenant in its master bond indenture, forcing it to put $18.1 million into a debt service reserve fund two weeks ago; 150 miles west in Hollister, the board of the San Benito Healthcare District voted in November to declare a fiscal emergency, clearing the way for it to file Chapter 9 bankruptcy.

The San Benito district, which operates Hazel Hawkins Memorial Hospital, has since courted strategic partners and received a loan from the state increasing the likelihood it can avert a bankruptcy filing.

The hospital industry around the country is under strain, according to a report healthcare consulting firm Kaufman Hall released Tuesday.

“While we have seen a stabilization in operating margins over the past several months, the trendline continues to show that hospitals will be in a tough spot financially for the foreseeable future,” Erik Swanson, senior vice president of data and analytics at Kaufman Hall, said in a release. “With future COVID-19 surges possible and challenging financial months ahead for hospitals, managing cash on hand will be critical to weathering the storm.”

The failure of Kaweah Delta Health Care District to maintain cash reserves through the last six months violated its bond indenture, triggering a technical default that requires it to deposit around $18.1 million within 30 days to protect investors, according to a Feb. 13 filing by Malinda Tupper, the healthcare district’s chief financial officer, to the Municipal Securities Rulemaking Board’s EMMA bond disclosure website.

In the letter to trustee U.S. National Bank Association, Tupper also reported that the hospital suffered a net income loss of $36.9 million from July 1 to December 31, the first half of fiscal year 2023.

Kaweah Health was founded in 1963, and Kaweah Health Medical Center is the largest hospital in Tulare County and the only hospital in 140,000-population Visalia, according to its website.

“All required principal and interest payments have continued to be made in full and on time for all five bond issues,” said Gary Herbst, Kaweah Health’s chief executive officer. “Because of the significant financial challenges we and most other hospitals across the country continue to face as a result of the pandemic, we did not generate enough net income in the six-month period July 1, 2022 through Dec. 31, 2022 to meet the minimum debt service coverage ratio, a financial covenant required by the bond indenture.”

The $18.1 million of the hospital’s cash reserve will be transferred into a trustee-controlled debt service reserve fund, Herbst said, adding the amount is equal to the maximum amount of principal and interest payments that will come due in any one year between now and the last maturity date of June 30, 2045.

“The reserve account is still owned by Kaweah Health and will appear as an asset on our balance sheet, but it cannot be used for any operating or capital purpose,” he said.

The outstanding debt includes the $32 million 2022 Series revenue bonds, $13.3 million 2020 Series A and B revenue bonds, $53.4 million 2017 Series C revenue bonds, $13.4 million 2015 Series A revenue bonds and $98.4 million 2015 Series B revenue bonds. All of the revenue bonds are controlled by a single, master bond indenture first issued back in 1999 and amended with each subsequent revenue bond issue.

Kaweah Health’s current year-to-date operating loss, revenues minus expenses, stands at $39.4 million for the seven months ended Jan. 31, Herbst said. A recent forecast shared with the district board of directors projects an additional operating loss for February, but then anticipates it will begin generating modest to break-even operating margins over the balance of the year, ending the fiscal year on June 30 with a cumulative operating loss of $35.8 million.

“We are currently experiencing unprecedented financial losses, as is the entire healthcare industry,” Herbst said. “When our fiscal year ends on June 30, it is going to be a record loss for that year.”

The losses have been driven primarily by labor costs, including contract labor, inflationary operating costs and reduced revenue due to the suspension of elective surgeries by state mandate at the height of the pandemic, Herbst said.

“Since the beginning of the pandemic, Kaweah Health has spent more than $95 million in contract labor and tens of millions of dollars in extra-shift bonuses and overtime to meet its clinical staffing needs,” he said.

The hospital suffered cumulative operating loss from March 2022 through December 2022, but that was offset in part by $61 million in federal provider relief funds, he said.

Moody’s Investors Service downgraded the district’s revenue backed debt to Ba1 from A3 on Dec. 7.

The four-notch cut to speculative grade “reflects a sudden and precipitous decline in operating performance in the quarter ending September 30, 2022, which has resulted in material cash burn to levels well in excess of expectations,” Moody’s said. A review for further downgrade was resolved Friday with a negative outlook.

The downgrade affected the district’s ability to secure loans to cover the shortfall, Herbst said.

“While we currently have no plans or needs to access the tax-exempt, municipal bond market at this time, it has affected our ability to secure a line of credit or letter of credit with commercial banks,” he said. “While a couple of banks have recently approached us with an expression of interest, the interest rate and the other terms of the borrowing are cost prohibitive and will not be pursued.”

The stakes for hospitals are high and the risks are real, as shown in January when the 106-bed Madera Community Hospital shut down after efforts to affiliate with a larger health system fell apart. Would-be partner Trinity Health cited onerous conditions set by Attorney General Rob Bonta.

The county of 159,000, roughly midway between Hollister and Visalia, is now without a hospital.

In Hollister, Hazel Hopkins avoided an immediate cash crunch by obtaining a $3 million loan from the California Health Facilities Financing Authority in January. When the board voted to declare a fiscal emergency, it was expected that the hospital would run out of funds on Feb. 18. A spokesman said the hospital has enough cash to get it through April.

The healthcare district still needs additional funding to cover expenses until it can close a deal with a strategic partner, which could take until September, Mary Casillas, the hospital’s interim chief executive officer, said in an opinion piece posted on the hospital’s website. “Some feel that we should pursue drastic layoffs or immediately file for bankruptcy to save the organization – after detailed analysis with our consultants, we simply disagree,” she wrote.

“We have retained an investment banking firm, B. Riley, to represent and market the healthcare district with potential partners,” Casillas said in emailed responses to questions.

The hospital has already signed non-disclosure agreements with 10 potential partners and has completed five site visits, she said.

“We continue to meet with local elected officials and state legislators to request emergency funding,” Casillas said. “We also continue to try to find private funding. We have been successful at reducing operating expenditures by $5.1 million since November, and continue to look for opportunities for efficiencies and savings in all operations of the healthcare district. We also have several initiatives to increase revenue including an audit of our revenue cycle.”

Hazel Hawkins closed its Home Health Department at the end of January, Casillas said. Hazel Hawkins, the only acute-care hospital serving the 62,000 residents of San Benito County, is in Hollister, about 48 miles southeast of San Jose.

“At this time, we are trying to preserve all other services and do not have immediate plans to close any other services,” she said.

The district had $38 million in outstanding bond debt, according to its audited financial statement for the fiscal year ending June 30, 2021. That includes $25.17 million of general obligation refunding bonds approved by voters in 2005 and repaid through a dedicated tax levy.

The 2014 GO refunding was placed directly with TPB Investments, a wholly owned subsidiary of Western Alliance Bank, according to documents filed with the California Debt and Investment Advisory Commission.

The remaining $12.75 million of insured refunding revenue bonds were issued in January 2021 to refund 2013 bonds.

S&P Global Ratings rated the revenue bonds AA-minus — on par with the state of California — because they’re insured by the California Office of Statewide Health Planning and Development.

The revenue bond debt is “fully and unconditionally guaranteed by the State of California,” the official statement says.

Hospital rating trends have skewed negative going back to 2019, largely driven by the COVID-19 pandemic, according to S&P rating activity data evaluated in the BofA Global Research weekly municipal market report published Friday. For the 2019-22 period, only 2021 resulted in a net positive rating year and just barely with an upgrades to downgrades ratio of 1.05. That number worsened to 0.61 by the end of 2022 with only 20 upgrades compared to 33 downgrades within the year.