[September 12, 2014]

Fitch Rates Karnes County Hospital District's (TX) Revs 'BBB'; Outlook Stable

Fitch Ratings has assigned a 'BBB' rating on the following Karnes County Hospital District (TX) bonds, issued on behalf of Karnes County Hospital District (KCHD, dba Otto Kaiser Memorial Hospital):

--$46 million hospital revenue bonds, series 2014.

The Rating Outlook is Stable.

The bonds are expected to be issued as fixed rate, and used to fund construction of a new hospital and wellness center, and pay costs of issuance. The bonds are expected to price the week of Sept. 29 via negotiation.

SECURITY

A pledge of gross revenues (excluding ad valorem tax revenues) of the hospital district, with additional security provided by a mortgage and a debt service reserve.

KEY RATING DRIVERS

HIGH DEBT BURDEN: With the issuance of $46 million in debt, KCHD will be significantly leveraged, as evidenced by pro forma debt-to-capitalization of 67% and maximum annual debt service (MADS) equal to 19.3% of revenue in fiscal 2014 (unaudited, June 30 year-end). Robust EBITDA supported by over $7 million in tax revenues should allow for steady debt service coverage in line with Fitch's 'BBB' category median going forward. KCHD indicated that it may pay down a portion of its debt as its balance sheet builds from the receipt of increased tax revenues, which would be viewed favorably.

SIGNIFICANT PROPERTY TAX SUPPORT: The 'BBB' rating reflects the significant benefit KCHD receives from its ability to levy property taxes. The district was authorized to levy a maintenance and operations tax (unvoted) in 1970 to support ongoing operations. Productive exploration activity has driven explosive tax base growth with taxable assessed valuation (TAV) rising sharply from $607 million in 2011 to $6.7 billion in 2014, since Karnes County's economy is inextricably linked to the Eagle Ford Shale development. The tax base concentration is viewed as a risk. Based on Fitch's industry research, it is expected that more moderate TAV trends will be sustained over the near- to intermediate-term. KCHD's tax revenue totaled approximately $7 million in fiscal 2013 and 2014, up from $2.4 million in fiscal 2012. Fitch's expectation is that tax revenues will total at least $7 million going forward.

CRITICAL ACCESS DESIGNATION: The rating also reflects KCHD's critical access hospital (CAH) designation, which provides a strong mitigating factor against capital and operating costs given the favorable reimbursement for these small, rural facilities.

BALANCE SHEET STRENGTHENING: KCHD's liquidity has improved significantly as a result of the benefit of increased tax revenues. Unrestricted cash and investments grew from $2.5 million in 2010 to over $13.6 million in 2014. Further incremental improvement is anticipated over the near- to intermediate-term, which is necessary against a sizeable pro forma debt burden and project risk.

RATING SENSITIVITIES

SUSTAINED TAX REVENUE: Over the near- to medium-term, significant volatility or erosion in the amount of tax revenue would likely pressure the rating, as these funds are necessary to provide adequate debt service coverage. Fitch notes that tax revenues are anticipated to remain steady, supported both by an ample margin in the tax levy below the statutory cap, and the significant capacity of TAV to withstand declines before debt service coverage is pressured.

PROJECT EXECUTION: The rating incorporates the risks associated with the construction, completion, and occupancy of the replacement facility in 2016. Fitch expects the project willbe completed on time and within budget, with minimal impact on operating cash flow or liquidity over the near term. Rating pressure is possible over the near term should the replacement project exceed budget or lag behind schedule, affecting operating cash flow or liquidity.

CREDIT PROFILE

Karnes County Hospital District (KCHD) doing business as Otto Kaiser Memorial Hospital currently owns and operates a licensed 25-bed, Critical Access Hospital (CAH) located in Kenedy, Texas approximately 60 miles southeast of San Antonio. KCHD is the only hospital located in Karnes County and provides healthcare services primarily to the residents of Falls City, Karnes City, Kenedy, and Runge. In addition to revenues derived from inpatient, outpatient and emergency services, KCHD receives tax support for operations and management in the form of ad valorem property taxes. Total operating revenues (less $7.2 million in tax support) were $16 million in unaudited fiscal 2014 (June 30 year-end).

SIZEABLE DEBT BURDEN

The $46 million in series 2014 bonds are expected to be issued as fixed rate. MADS is estimated at $3.1 million currently, and debt service is level. Interest will not be capitalized, and KCHD will make its first full debt service payment in 2016. KCHD's balance sheet will be strained, as demonstrated by a weak 4.4x pro forma cushion ratio and 29.6% cash-to-pro forma debt. Both are well below Fitch's 'BBB' category medians of 10.5x and 93.6%, respectively.

KCHD will be very significantly leveraged upon issuance of the series 2014 bonds. Pro forma MADS will equal a high 19.3% of 2014 revenues, and pro forma debt will equal 67% of capitalization at June 30, 2014. The rating incorporates the expectation that KCHD will sustain over 2x debt service coverage by EBITDA (which includes tax revenues) over the near- to medium-term, and continue building its balance sheet to offset the debt burden.

MATERIAL TAX SUPPORT

The fiscal 2014 bonds are secured by KCHD's operating revenues, excluding tax revenues. However, tax revenues provide necessary support of operating performance to generate sufficient cash flow and debt service coverage and are included in KCHD's rate covenant calculation. KCHD received $7.2 million in tax revenue in unaudited fiscal 2014, which Fitch includes in non-operating revenue. This helped produce a robust 34.1% EBITDA margin and 2.7x coverage of pro forma MADS by same. Absent the benefit of tax revenue, KCHD produced a very thin 0.2% operating EBITDA in fiscal 2014.

KCHD's tax rate may not exceed $0.75 per $100 of TAV according to statute, and is set by the board annually. The rate was just under $0.11 in fiscal 2014, well below the threshold. Fitch anticipates KCHD will generate at least $7 million of tax revenue annually going forward due to its ample tax rate flexibility. Further, the likely continuation of production and exploration activity, as well as some accompanying retail/commercial development, should preserve more moderate TAV trends over the near- to intermediate-term. Karnes County is presently the top oil-producing county in the state of Texas.

REPLACEMENT PROJECT

The $46 million in expected debt issuance will be used to fund a $42 million replacement facility, as well as a $4 million wellness center. The facility will be built on land adjacent to the existing facility, and bring KCHD up to contemporary clinical space standards. Fitch expects a higher expense base once the new facility opens in early 2016, which will impact operating profitability. This will be partially offset by the cost-based reimbursement KCHD receives from Medicare.

Disclosure

With the series 2014 issuance, KCHD will covenant to provide annual disclosure within six months of fiscal year end to the MSRB's EMMA system, including financial and operating data. There is no provision for quarterly disclosure, which Fitch views negatively.

Additional information is available at 'www.fitchratings.com'

Applicable Criteria and Related Research:

'U.S. Nonprofit Hospitals and Health Systems Rating Criteria' (May 30, 2014).

Applicable Criteria and Related Research:

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=746860

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=871274

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