The Daughters of Charity Health System has experienced growing operating losses, weak annual debt service, and revenue declines in the past several years.

LOS ANGELES - Standard & Poor's downgraded Daughters of Charity Health System, Calif. by six notches, moving it to speculative grade.

The downgrade follows the announcement that the struggling six-hospital system, based in Los Altos Hills, would not be merging with another healthcare system, and that it is instead seeking buyers for its hospitals.

Standard & Poor's on Friday dropped the rating to B-minus from BBB-minus on the system's bonds, issued though conduit California Statewide Communities Development Authority.

"The rating action reflects our view of DCHS' escalating operating losses during the past several years and a substantial loss from operations, according to our calculations, through the first half of fiscal 2014," said Standard & Poor's credit analyst Kenneth Gacka. "In addition, we understand that DCHS has begun to solicit proposals from buyers for the acquisition of its individual hospitals or the system as a whole, which creates additional uncertainty as to the future of DCHS."

In January, DCHS announced its decision to solicit proposals from Catholic, public, non-profit, and for-profit organizations to purchase DCHS hospitals individually, or the health system entirely. The system does not yet have any updates on a possible sale.

"We are pleased with the level of interest in DCHS's sale process with many potential buyers considering the system as a whole, individual hospitals or a combination of hospitals," said Elizabeth Nikels, a spokesperson for DCHS. "Respecting the confidentiality necessary for such a process, we are not willing to disclose details of the sale process with S&P, the media or any other third party organizations."

The system's president and chief executive officer, Robert Issai, said during the announcement that the sale of the hospitals would be the most sound and responsible business decision.

"Like other health systems across the country, we recognize that the way health care is provided today — where it is offered, how it is paid for, how it is measured — is changing dramatically, and we believe that new ownership is in the best interest of the communities we serve," Issai said in a statement.

Standard & Poor's said in April 2013 that the BBB-minus rating and developing outlook had reflected the possibility as indicated by DCHS that the system's affiliation with Ascension Health Alliance could potentially evolve into a merger, which could have led to an upgrade.

However, the announcement that the system would not be merging with AHA, along with its growing operating losses, revenue declines, and reserve erosion over the past few years, led to Friday's dramatic downgrade.

"Through discussion with management we understand that the process is progressing; however, we currently have no information about specific acquisition proposals," analysts said. "In addition, the timing of completion of this process is uncertain, as it will likely be dictated by the proposals received and regulatory approvals."

In the meantime, the agency expects that operating losses will continue to mount because of the system's challenging payor mix with a high proportion of uninsured patients or patients with Medi-Cal or Medicare. In addition, analysts expect reimbursement pressures will likely continue to intensify as the health care operating environment evolves under health care reform.

"In fact, we expect DCHS' operating losses to be wider through the second half of fiscal 2014 because of the timing of the approval of the most recent extension of California's provider fee program," analysts said. "Although the provider fee program was approved by the state for a three-year extension through 2016, approval by the Centers for Medicare and Medicaid Services is not expected to occur until later in calendar year 2014."

DCHS has six hospitals throughout California — from the San Francisco Bay Area to Los Angeles. As of Dec. 31, the system had $294.2 million of long-term debt outstanding.

The ratings have been removed from CreditWatch with negative implications, where they had been placed on March 19. The outlook is negative, reflecting the possibility of a further downgrade within the year if the system does not sell its hospitals or if a sale is delayed.

"We believe this could occur because we expect that the system's operations will continue to be pressured and we believe that DCHS' balance sheet offers very limited cushion for further prolonged losses," analysts said.

A higher rating is unlikely during the one-year outlook period, but analysts said a return to a stable outlook would be predicated on sustained, stabilized operations yielding positive cash flow and steady balance sheet metrics.

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