[November 29, 2012]

Fitch Rates Nacogdoches County Hospital District, TX Sales Tax Revs 'A-'

Fitch Ratings assigns a rating of 'A-' to the following sales tax bonds of Nacogdoches County Hospital District, Texas (the district):

--$47.44 million sales tax improvement and refunding bonds, series 2013.

The bonds are expected to price via negotiated sale the week of Dec 10, 2012, pending market conditions. Proceeds will be used to fund facility expansion and to refund a portion of the district's outstanding obligations.

In addition, Fitch affirms the following ratings:

--$20.3 million (pre-refunding) in outstanding sales tax bonds at 'A-';

--Implied unlimited tax general obligation rating of the district at 'A'.

The Rating Outlook is revised to Negative from Stable.

SECURITY

The bonds are special limited obligations of the district, payable and secured by the district's 1% sales and use tax.

KEY RATING DRIVERS

FINANCIAL PRESSURES: The Negative Outlook is based on financial stress caused by declining patient volumes and supplemental funding. The district reduced expenses over the past several years to address the trend of thinning margins and reduced liquidity but financial performance remained strained in fiscal 2011 and 2012. Although management presented a balanced 2013 budget, which includes additional cost savings, Fitch notes a continued dependency on uncertain supplemental funding.

ADEQUATE DEBT SERVICE COVERAGE: Overall coverage of the district's maximum annual debt service (MADS) remains solid. Sales taxes exhibit economic sensitivity, but have demonstrated healthy growth over the past 10 years. Legal provisions include a standard cash-funded debt service reserve fund, but a below-average additional bonds test.

ESSENTIAL SERVICE: The district's hospital provides essential safety-net healthcare services to Nacogdoches County area residents. The resulting payor mix is weighted heavily by charity care, Medicaid, and Medicare, making the hospital vulnerable to federal and state budget cuts.

ADDITIONAL FLEXIBILITY: The district still retains the authority to impose a property tax levy, the rate of which was lowered to zero for fiscal 1993 due to approval of the currently active 1% sales and use tax. Reinitiating a property tax levy would be politically difficult, but would substantially increase the district's financial flexibility.

WHAT COULD TRIGGER A RATING ACTION

REDUCED COVERAGE: Reduced debt service coverage of the district's sales tax obligations could put negative downward pressure on the rating.

EROSION OF FINANCIAL CONDITION: Further weakening of the district's operating performance and liquidity could result in negative rating action.

CREDIT PROFILE

The district, created in 1967, is coterminous with Nacogdoches County in east Texas. With the city of Nacogdoches as its primary population center, the service area's economy is based on agriculture, lumber, manufacturing, and oil & gas. Manufacturing represents a large employment sector, behind education and government, due to a sizeable poultry processing plant.

RURAL EAST TEXAS ECONOMY

The county's employment base has been stable, with unemployment rates that consistently trend below state and national averages. The county unemployment rate of 5.9% as of September 2012 is improved from the year prior and compares favorably to the state (6.3%) and national (7.6%) averages for the same period. Below-average wealth levels reflect the influence of the Stephen F. Austin University 12,000-student population.

ESSENTIAL SERVICE PROVIDER

The district owns and operates Memorial Hospital in Nacogdoches, a general acute care facility (Licensed Level III Trauma Center) with 216 licensed beds, 122 of which are in use. The district competes with a for-profit hospital, also located in Nacogdoches, for commercialy insured and managed care patients.

The district has a relatively weak payor mix as a public hospital, with a large percentage of Medicaid (12.6%), Medicare (44.4%) and self-pay (14.2%) patients (measured as a percent of net revenues). While providing essential services to the region, the area's lower-income population and the district's reliance on third-party subsidies, including Medicaid disproportionate share ($4.3 million in fiscal 2011) and upper payment-limit funding ($4.5 million in fiscal 2011), make it vulnerable to potential cuts in governmental funding.

ECONOMICALLY SENSITIVE SALES TAX REVENUES

The district's sales and use tax can be used for both operations and debt service. After posting solid average annual growth of 8.9% from fiscal years 2005-2009, sales and use tax revenues declined by 12.4% in fiscal 2010 due to recessionary pressures, before rebounding nearly 30% in fiscal 2011. The district attributed the fiscal 2011 increase largely to a surge in oil & gas activity.

Fiscal 2012 collections of $8.5 million reflect a 13-month period, pursuant to a change in accounting method; normalizing collections to a 12-month period, fiscal 2012 collections total $7.8 million, representing a 4.6% decline from fiscal 2011. Management projects fairly flat 2013 sales tax revenues at $7.9 million, which Fitch considers prudent based on recent trends and historical volatility. Current sales and use tax revenues provide minimal revenue diversity, comprising only 8.7% of total fiscal 2011 revenues.

SOUND DEBT SERVICE COVERAGE

Coverage of MADS remains solid at 2.2x by audited fiscal 2011 revenues (2.06x based on normalized fiscal 2012 revenues), although down from 3.2x prior to the new issue and by fiscal 2010 revenues. The additional bonds test is below average at 1.35x MADS. A standard debt service reserve fund applies to the new and outstanding series.

MODERATE OVERALL DEBT; UNDERFUNDED PENSION

Overall debt is moderate at $2,468 per capita or 3.2% of market value, after adjusting for state support of local school district debt; amortization is below average at 22% within 10 years. The new issue will fund construction of a new surgery unit, labor/delivery floor and renovation of the emergency department.

The funded position of the district's pension plan is well below average at 55% as of June 30, 2011 (49% using the more conservative 7% investment rate-of-return assumption), although the district has consistently funded the annual required contribution. The low funding levels represent a credit concern. The county does not have any other post-employment benefit obligations.

REDUCED OPERATING MARGINS

Flat patient volumes, growing operating costs, and reduced investment income have thinned operating margins and caused liquidity levels to trend downward from 89 days cash on hand in fiscal 2007 to 34 days in fiscal 2011. The district imposed budget reductions over the past several years including staff reductions (60 full-time equivalents), the closure of its hospice and home health services, sale of its hemodialysis unit, deferment of pay hikes, and various benefit adjustments. A fiscal 2011 operating deficit of $5 million reflects continued pressure on the district's operating margins as the supplemental funding level fell back to normal levels from an abnormally high payment level in the prior year.

Audited fiscal 2012 results reflect an additional deficit of $7.4 million, consistent with recent trends. The district expects break-even fiscal 2013 results based on further cost reductions and increased supplemental funding attributable to a new Medicaid state waiver program. Fitch recognizes the uncertainty of these projected revenues as the Medicaid waiver program has not yet been fully implemented. Fitch also notes that with increased debt service beginning in fiscal 2014, about $1 million less of sales tax revenues will remain to fund the district's operations, placing yet another challenge on strained financial margins.

ADDITIONAL FINANCIAL FLEXIBILITY

The district retains authority to levy a property tax of up to $0.75 per $100 taxable assessed value (TAV) (although the rate was reduced to zero effective with voter approval in January 1992) of the currently enacted 1% sales and use tax for operations, debt service, and economic development. Based on current TAV, each incremental tax levy of $0.01 per $100 TAV would generate about $310,000 in property tax revenues. Fitch views the ability to levy a property tax as a source of additional financial flexibility.

Additional information is available at 'www.fitchratings.com.' The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS (News - Alert) Global Insight, Zillow.com, National Association of Realtors, and the Municipal Advisory Council of Texas.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 14, 2012);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm rpt_id=685314

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