Fitch Affirms Nacogdoches County Hospital District, TX Sales Tax Revs at 'A-'; Outlook Negative

AUSTIN, Texas--()--Fitch Ratings affirms its rating of 'A-' on Nacogdoches County Hospital District, Texas' (the district) outstanding bonds:

--$10.5 million sales tax refunding bonds, series 2005;

--$6.8 million sales tax refunding bonds series 2006;

--$43.9 million sales tax improvement and refunding bonds, series 2013.

In addition, Fitch affirms the following:

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

The Rating Outlook is Negative.

SECURITY

The bonds are special limited obligations of the district, payable and secured by a 1% sales and use tax. The bonds are further secured by a standard debt service reserve.

KEY RATING DRIVERS

IMPROVING OPERATIONS; CHALLENGES REMAIN: The Negative Outlook is based on financial stress caused by declining patient volumes and delays in supplemental funding. Preliminary fiscal 2014 financial results reflect progress in management's alignment of spending with lower volumes, although financial performance remains weak. Fitch expects continued improvement in fiscal 2015 based on cost-saving measures underway.

ECONOMIC SENSITIVITY; ADEQUATE COVERAGE: Sales tax revenues exhibit economic sensitivity, with current levels at a seven year low. Overall coverage of the district's maximum annual debt service (MADS) is adequate. Legal provisions include a standard cash-funded debt service reserve fund but a below-average additional bonds test.

ESSENTIAL SERVICE PROVIDER: 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 retains the authority to impose a property tax levy, the rate of which was lowered to zero 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.

RATING SENSITIVITIES

REDUCED COVERAGE; WEAKENED FINANCES: A material decline in sales tax revenues and debt service coverage, no resolution to delayed state supplemental payments, or lack of further notable progress to align expenses with revenue in fiscal 2015 will result in negative rating action at the next review.

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 and gas. Manufacturing represents a large employment sector, behind education and government, because of a sizeable poultry processing plant.

RURAL EAST TEXAS ECONOMY

The county's employment base has been stable with low unemployment rates. The county's 2013 unemployment rate of 6.0% as of July 2014 is above that of the state (5.6%), but below the U.S. average of 6.5% for the same period. Below-average wealth levels partly reflect the influence of the Stephen F. Austin University approximate 13,000 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 commercially insured and managed care patients.

The district has a relatively weak payor mix as a public hospital, with a large percentage of Medicaid (13.2%), Medicare (47.9%) and self-pay (16.5%) 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 make it vulnerable to potential cuts in governmental funding.

ECONOMICALLY SENSITIVE SALES TAX REVENUES

The district's sales tax base increased 36% over the past 15 years, but unevenly, reflecting general economic and oil & gas cyclicality. 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 exploration activity.

Fiscal 2012 collections of $8.5 million reflect a 13-month period, pursuant to a change in accounting methods. Normalizing collections to a 12-month period, fiscal 2012 collections total $7.8 million, representing a 4.6% decline from the prior year. Further declines in fiscal 2013 and 2014 brought the sales tax revenues to a 7-year low of roughly $6 million. The district's budget anticipates a leveling out of collections in the coming year, which appears reasonable given the 5% growth in first quarter collections. Surplus collections from the district's sales and use tax can be used for operations after the payment of debt service.

ADEQUATE DEBT SERVICE COVERAGE

The district's MADS of $3.8 million (2017) is covered adequately at 1.7x based on fiscal 2013 audited revenues of $6.6 million. Debt service is level through 2044. Coverage has declined over the past several years, reflecting both the slide in sales tax revenues and increased debt service due to the district's series 2013 issuance. A stress test indicates collections would need to drop by about 42% below fiscal 2013 levels to reach break-even MADS coverage. The additional bonds test is somewhat below average at 1.35x MADS. A standard debt service reserve fund is in place for each of the outstanding debt series.

WEAK FINANCIAL PERFORMANCE; OPERATIONAL IMPROVEMENTS ONGOING

The district's finances are pressured from several years of reduced patient volumes, a shift from inpatient to outpatient services, lower supplemental payments, and a decline in sales tax revenues. To mitigate the revenue loss, the district cut staff, pared less profitable service lines, froze salaries and cut benefits over the past several years. These cost reductions are reflected in improved fiscal 2014 operating results. The district completed fiscal 2014 with an operating loss of $7 million (unaudited), compared to a loss of $12 million in fiscal 2013.

During fiscal 2013 the district also initiated a comprehensive operational assessment in conjunction with external consultants. Pursuant to board-approved recommendations, officials have implemented a series of improvements including revenue enhancements associated with an updated pricing model, contract renegotiations, and supply chain and staffing efficiencies. Fitch anticipates these changes to further improve fiscal 2015 financial performance.

LIQUIDITY CHALLENGES WORSENED BY DELAYED SUPPLEMENTAL PAYMENTS

The district's supplemental funds include Medicaid disproportionate share (DSH) payments and Texas Delivery System Reform Incentive (DSRIP) payments which combined totaled $7.3 million and $9.9 million for fiscal 2013 and 2014 respectively. A low 19 days of cash on hand as of June 30, 2014 reflects delays in receipt of the district's supplemental payments. Officials are evaluating the need for a line of credit to provide adequate working capital in light of these systemic funding delays. Fitch will continue to monitor this funding issue and its impact on the district's liquidity.

ADDITIONAL FINANCIAL FLEXIBILITY

The district retains authority to levy a property tax of up to $0.75 per $100 taxable assessed value (TAV) without voter approval; the rate was reduced to zero effective with voter approval of the sales tax in January 1992. Based on current TAV, each incremental tax levy of $0.01 per $100 TAV would generate about $320,000 in property tax revenues. Fitch views the ability to levy a property tax as a source of additional financial flexibility.

MODERATE OVERALL DEBT; UNDERFUNDED PENSION

Overall debt is moderate at 3.7% of market value. Amortization is slow at 22% in 10 years. The district's debt includes $45 million issued in fiscal 2013, a portion of which funded the construction of a new surgery unit, labor/delivery floor and renovation of the emergency department. Most of the improvements are operational, with final completion and utilization expected by 2014 year end. Management reports that after completion of these facilities the district anticipates only routine capital needs for the near term.

The funded position of the district's pension plan is well below average at 59.3% as of the most recent valuation date of June 30, 2012, and an estimated 53.4% using Fitch's more conservative 7% investment return assumption. Fitch anticipates some funding improvement based on benefit plan modifications the district enacted effective for fiscal 2014. The district does not have any other post-employment benefit obligations.

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

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 Global Insight, National Association of Realtors.

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=898334

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Contacts

Fitch Ratings
Primary Analyst
Rebecca Meyer
Director
+1 512-215-3733
Fitch Ratings, Inc.
111 Congress, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Dana Ringer
Director
+1 312-368-3215
or
Committee Chairperson
Steve Murray
Senior Director
+1 512-215-3729
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Rebecca Meyer
Director
+1 512-215-3733
Fitch Ratings, Inc.
111 Congress, Suite 2010
Austin, TX 78701
or
Secondary Analyst
Dana Ringer
Director
+1 312-368-3215
or
Committee Chairperson
Steve Murray
Senior Director
+1 512-215-3729
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com