Fitch Affirms Palomar Health, California GOs at 'A+'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has affirmed the following Palomar Health (the district), California, bonds:

--$486 million general obligation (GO) bonds (election of 2004), series 2005, 2007A, 2009A, and 2010A at 'A+'.

The Rating Outlook is Stable.

SECURITY

The bonds are repayable from an unlimited, voter-approved, ad valorem tax levied on all taxable property within the district boundaries. The district is required to pay the GO bond debt in the unlikely event that the ad valorem property tax revenues are insufficient.

KEY RATING DRIVERS

GOOD TAX BASE AND ECONOMIC GROWTH PROSPECTS: The district retains good potential for long-term growth due to its location, availability of relatively affordable land for development, and a growing labor force. Socio-economic characteristics are mixed but property values have more than recovered from recent recessionary losses.

IMPROVING FINANCIAL PERFORMANCE: The district's financial performance continues to recover from opening its major new hospital, although weak liquidity, high debt burden, and high accounts receivable persist. Recently announced campus rationalization is expected to facilitate improved financial results.

LEADING MARKET SHARE: The district is the local market leader with 51% market share. Fitch has some concern as to current and projected tax rates well in excess of those originally presented at the last bond election. Some relief might be provided by future bond refundings.

CASH-FUNDED DEBT SERVICE CUSHION: The GO property tax rate covers 18 months of debt service, building in a six-month cushion to protect the district's non-tax revenues.

MIXED DEBT PROFILE: Overall debt remains high and amortization slow. However, the district's debt, pension, and other post-employment benefit (OPEB) carrying costs remain very manageable.

RATING SENSITIVITIES

The rating is sensitive to shifts in fundamental credit characteristics including the district's debt profile and financial management, including the maintenance of a six-month cash-funded GO debt payment cushion. The Stable Outlook reflects Fitch's expectation that such shifts are unlikely.

CREDIT PROFILE

The district is California's largest local health care district serving approximately 18% of the county's population (an estimated 507,000 residents) over 850 square miles of northeast inland San Diego County. The service area is primarily residential, with some light industrial and commercial activity. The district opened its $956 million, 288-bed Palomar Medical Center (PMC) on a 56-acre campus in Escondido in August 2012 with considerable future expansion capacity. The district also operates a 107-bed general acute care hospital in Poway. Its Palomar Health Downtown Campus (PHDC) is scheduled for closure by year end, with services consolidated at PMC and the Poway hospital.

GOOD TAX BASE AND ECONOMIC GROWTH PROSPECTS

Wealth levels within the district vary considerably but county per capita money income and median household income are above-average. After robust average annual taxable assessed value (TAV) growth of 9.2% in fiscal years 2000-2009, the district experienced TAV volatility through fiscal 2013 which resulted in a cumulative TAV decline of 5.5%. This loss has been more than recovered by the district's tax base rebound of 3.8% and 7.5% in fiscals 2014 and 2015, respectively. District expectations for further TAV growth appear reasonable given new construction currently underway and planned, and the county assessor's reversal of Proposition 8 valuation reductions. Property taxpayer concentration remains very low.

The district retains good potential for long-term growth due to its location near the San Diego and southern Orange County economies. Even as the county's labor force continues to grow, the unemployment rate declined considerably to 4.8% in April 2015, compared to 6.1% a year prior, and is better than the state (6.1%) and the nation (5.1%).

IMPROVING FINANCIAL PERFORMANCE

The district's financial performance continues to improve, although weak liquidity, high debt burden (with some interest rate swap exposure), and high accounts receivable persist. Nevertheless, the district expects to meet all of its fiscal 2015 liquidity covenants for its outstanding certificates of participation (COPs) and new revenue oversight should improve cash collections. (Fitch rates the COPs 'BB+'.) Volume under a bed-capacity agreement with Kaiser Permanente has been consistently below budget, although it has recently increased and the Kaiser contract is profitable. Consolidation of services at two campuses and closure of PHDC is expected to save approximately $20 million per year going forward. However, there could be pressure on near-term capital spending. Fitch views this campus rationalization favorably despite potential implementation costs.

The district's overall profitability is aided by its status as a California Hospital District, a political subdivision of the State of California. The district receives unrestricted property tax revenues from a fixed share of the 1% property tax levied by the County of San Diego on all taxable real property within the district's boundaries.

The district received $13.5 million in unrestricted property tax revenues in fiscal 2014 (2% of total revenues, net transfers, and other uses). These revenues are in addition to the $16.4 million in fiscal 2014 ad valorem tax revenues generated by the separate voter-approved tax levy pledged solely for the repayment of the district's GO bonds.

There is almost no correlation between the district's business operations and revenue generation for GO debt service. Legally the district must repay its GO debt from other sources in the event that ad valorem property tax revenues prove insufficient. The need to access other monies is unlikely because the GO property tax rate covers 18 months of debt service to build in a six-month cushion to protect the district's non-tax revenues.

LEADING MARKET POSITION

The district has a strong 51% market share in its primary service area. The district benefits from its position as the only major inpatient hospital provider in north San Diego County. The district continues to work with other health systems and providers in an effort to grow patient volume. A strategic planning process is underway. The district continues to make strategic investments, particularly in its medical foundation (the primary care base for integrated health care), which will likely hinder near-term liquidity growth.

Strong voter support for the district was demonstrated when 68.9% voted in favor of the 2004 bond election. There is a risk that voter support has subsequently moderated given tax rates in excess of those originally presented at the bond election. This could hinder the district's ability to issue future debt. However, Fitch notes that the current $23.50 per $100,000 TAV tax levy has remained constant for the past four years and that the district currently has no plans to issue further debt. Potential GO bond refundings could lower future debt service costs.

MIXED DEBT PROFILE

Overall debt including the outstanding COPs is high at $5,578 per capita and 4.5% of TAV, driven by the district's construction of a new hospital. The district's slow debt amortization (approximately 32% in 10 years) and escalating debt schedule have the potential to diminish the district's debt management flexibility. The district maintains marginal exposure to interest rate swaps with a negative value of $26.5 million approximating 4% of spending.

The district has manageable pension costs and only a small liability associated with its OPEBs which are funded on a pay-as-you-go basis. The district's fiscal 2014 debt repayments, pension costs, and OPEB pay-as-you-go contributions cumulatively totaled an affordable 11.4% of total governmental spending.

For further information on the COPs, please see Fitch's press release dated July 14, 2015, 'Fitch Affirms Palomar Health, CA's Revenue Bonds at 'BB+'; Outlook Stable' at www.fitchratings.com.

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, and National Association of Realtors.

Applicable Criteria

Tax-Supported Rating Criteria (pub. 14 Aug 2012)

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

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

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

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=987899

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=987899

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Alan Gibson
Director
+1-415-732-7577
Fitch Ratings, Inc.
650 California Street, 4th Floor, San Francisco, CA 94108
or
Secondary Analyst
Yueping Liu
Analyst
+1-415-732-5629
or
Tertiary Analyst
Emily Wong
Senior Director
+1-415-732-5620
or
Committee Chairperson
Douglas Offerman
Senior Director
+1-212-908-0889
or
Media Relations:
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Alan Gibson
Director
+1-415-732-7577
Fitch Ratings, Inc.
650 California Street, 4th Floor, San Francisco, CA 94108
or
Secondary Analyst
Yueping Liu
Analyst
+1-415-732-5629
or
Tertiary Analyst
Emily Wong
Senior Director
+1-415-732-5620
or
Committee Chairperson
Douglas Offerman
Senior Director
+1-212-908-0889
or
Media Relations:
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com