Cyber event cited in Palomar Health ratings falling further into junk territory

The ratings of troubled Palomar Health, an Escondido-based two-hospital system, took another hit this week, falling further down the Fitch Ratings junk scale as its financial situation worsened.

In a Wednesday report, Fitch cited a “significant cyber event that lasted several months, severely disrupted operations and key billing functions,” in explaining why it downgraded Palomar’s issuer default rating to B from BB-plus. 

The hospital system was the subject of a cyber attack on May 5, during which the hospital system took its systems offline including a patient portal, phones and faxes, according to Becker Hospital Review.

But, the San Diego-based healthcare system also has violated its debt service coverage and days’ cash on hand covenants; and Fitch’s “forward-looking analysis indicates the district’s financial profile metrics will remain challenged in the medium term.”

Management has a financial turnaround plan and Fitch said it expects potential improvements to eventually rebuild the organization’s liquidity.

The healthcare district “also anticipates signing a forbearance agreement with bondholders,” which Fitch said it will review once available.

Fitch also lowered the ratings on the system’s general obligation bonds to BBB-minus from A and placed it on negative rating watch.

The San Diego County not-for-profit’s financial woes were dire enough to earn junk ratings from Fitch, Moody’s Ratings and S&P Global Ratings earlier this year. 

Palomar Health is the largest public health care district in California, with over $1 billion of revenues reported for fiscal 2023, and over 24,000 admissions, according to Moody’s October ratings report.

Palomar’s operational loss for 2024 of $184 million is significantly worse than the $44.5 million in operating losses reported for year-end 2023, according to Fitch.

The system’s financial performance has been challenged over the past 18 months.

In addition to the cyber event, it has experienced declining volumes, higher labor and supply expenses, programmatic delays, a substantial and rapid decline in reserves and days’ cash on hand, and has a high debt burden and leverage, according to Fitch analysts.

Fitch said its Wednesday downgrade reflects Palomar’s worsened and still-pressured financial performance since it’s last review on April 29, when it downgraded the ratings to BB-plus from BBB-minus.

Palomar has approximately $711 million of revenue bonds outstanding; GOs total $621.6 million, inclusive of $240.6 million in accrued interest on the capital appreciation bonds, according to Moody’s.

When Moody’s downgraded the revenue ratings to B2 from Baa3 and its general obligation unlimited tax ratings to Baa3 from Baa1 on Oct. 22, analysts noted, the ratings are under review for further downgrade “as we assess risks related to breaching financial covenants which, absent lender cooperation, could lead to acceleration of all of Palomar’s outstanding revenue debt,” adding unrestricted cash to debt was only 11% on March 31.

The downgrade of Palomar’s ULTGO bonds to A “reflects Fitch’s assessment that the pledged revenues for repayment of these bonds meet the definition of ‘pledged special revenues’ under the U.S. Bankruptcy Code,” Fitch analysts wrote. “As such, the bond’s security protections warrant a rating of up to five notches higher than the district’s IDR.”

The negative outlook “incorporates the persistent operational challenges Palomar confronts as management navigates through a period of financial uncertainty,” Fitch analysts wrote. “If management is able to succeed on a number of strategic and operational priorities, which would result in improved operating performance and improvements to unrestricted balance sheet resources, a return to a stable outlook would be considered.”

Credit strengths include the district’s sizable market position, historical track-record of good cash-flow generation, and diverse tax base, Fitch analysts said, adding the unlimited nature of the tax levy offsets potential risk regarding tax base volatility.

Fitch said it views Palomar’s healthcare services as essential to North San Diego County as the district maintains the only trauma center, NICU and inpatient behavioral health unit within the county boundaries.

The rating agency said it “will continue to monitor the trajectory of the organization’s market presence and volume trends, as well as the subsequent impact upon performance.”

The healthcare system’s bonds could be further downgraded “if Palomar is unable to sign an anticipated forbearance agreement and come to a successful resolution with bondholders after violating its days’ cash-on-hand and debt service coverage financial covenants,” Fitch said.

“The structure of the forbearance agreement could also trigger negative rating action, should it result in material changes to the initial repayment schedule or amount,” Fitch wrote. Or, “if capital-related metrics (unrestricted cash to adjusted debt and debt to capitalization) continue to decline from current levels.”

If the operating performance improves significantly, and Palomar can demonstrate some level of operating stability to support unrestricted balance sheet stabilization and material growth, the ratings could be upgraded, Fitch wrote.