Jan 10 - Fitch Ratings has affirmed the following bonds of the Martin County Hospital District (MCHD), Texas at 'BBB': --$17.8 million combination limited tax and revenue bonds, series 2011A; --$3.9 million combination limited tax and revenue bonds, taxable series 2011B. The Rating Outlook is Stable. SECURITY The bonds are secured by a limited ad valorem tax and pledge of net revenues of the hospital. KEY RATING DRIVERS BUSINESS OPERATIONS RISK: The district's business operations operate at a deficit and receive considerable support from local property tax revenue. LIMITED AND CONCENTRATED LOCAL ECONOMY: The service area is a small rural community, and the tax base and local economy has a significant concentration in oil and gas exploration. EXCESS TAX REVENUE SUPPORT: Operations are aided by property tax revenues beyond what is pledged to the bonds, and the district maintains sizeable taxing capacity for operations under its statutory limits. HIGH PER CAPITA DEBT: While low as a percentage of assessed value, the tax-supported debt level is high on a per capita basis. Amortization of principal is slow. COMPETITION AN ISSUE: The hospital is the only one in Martin County and is designated as a Critical Access Hospital (CAH). However, patient volume has been very low historically as many district residents utilize hospital facilities in nearby Midland/Odessa. NEW HOSPITAL BUILDING OPENED: Proceeds from the bonds were used to finance the construction of a replacement hospital and adjacent medical office building, which opened on May 1, 2012. Outpatient volume has increased at the new facility; however, inpatient volume is still flat due to physician recruitment challenges. WHAT COULD TRIGGER A RATING ACTION FAILURE TO IMPROVE FINANCIAL PERFORMANCE: Fitch expects MCHD to reduce its operating losses due to physician recruitment plans that are expected to enhance services and drive revenue growth. The failure to improve financial performance will likely put downward pressure on the rating. CREDIT PROFILE Located in central west Texas in the Permian Basin, which holds a significant portion of the nation's proven, accessible oil and natural gas reserves, Martin County is approximately 20 miles east of Midland. The hospital district was established in 1967 to serve county residents (presently estimated at about 5,000) and its taxing jurisdiction is coterminous with county boundaries. The 25-licensed bed, acute care facility operated by MCHD in the city of Stanton is the only hospital in the county and is designated as a CAH. MINERALS BASED ECONOMY Activity in mineral extraction drives much of the local economy, which has reportedly gained additional momentum in light of recent rises in oil prices. In addition, the large and broader Midland-Odessa employment base is easily accessible. County unemployment levels have improved over the past year, dropping from 5% in October 2010 to 3.9% in October 2012; the county rate remains well below the state (6.2%) and national (7.5%) averages for the month. Area wealth levels are slightly below the state and U.S. averages. The district's tax base totals nearly $4.6 billion for fiscal 2013 or close to an astounding $960,000 per capita. More than 85% of the tax base is comprised of oil and gas reserves susceptible to fluctuations in mineral values. Top taxpayer concentration in this sector is high at around 46%. The top taxpayer is Endeavor Energy Resources at 17%. Taxable assessed valuation (TAV) experienced strong annual gains of 30% on average since fiscal 2008, including a very large 58% gain for fiscal 2013. LOW TAX RATE RELATIVE TO STATUTORY CAP Fitch views positively the significant taxing margin currently available under the statutory cap of $0.75 per $100 of TAV; the fiscal 2013 total tax rate of $0.14 provides MCHD with ample financial flexibility in the event of large TAV declines. However, Fitch tempers this currently large taxing margin with the highly volatile and correlated nature of the district's tax base. The operating component of the tax rate is limited to $0.30, and the fiscal 2013 operating rate is $0.0937. PROPERTY TAXES SUPPORT OPERATIONS MCHD's operating performance historically has been hampered by a small rural service area and aging hospital, and results have been aided materially by property tax revenues; operating results excluding tax revenues have typically shown losses. Tax revenues in recent years had provided roughly 25% of total operating revenues, but that amount increased to more than 35% beginning in fiscal 2011 with a property tax rate increase. Although patient revenue was down in fiscal 2011 and again in 2012, the boost in tax revenues generated net income of more than $2 million and $1 million, respectively, and an increase in liquidity and operating margin. The district's operating margin was a healthy 18% in fiscal 2011 but dropped to 9% in fiscal 2012 due to decreased patient revenue while still operating at the old facility. Liquidity levels, as measured by days cash on hand, improved to 184 days from 171 days in fiscal 2011. For fiscal 2013 management anticipates a bottom line gain of $1 million for the year and generated $513 thousand through the six months ended Oct. 31, 2012. The hospital benefits from its CAH status as it is reimbursed by Medicare at cost plus 1%. Also, CAHs are reimbursed for capital costs (depreciation and interest) of construction based on their Medicare payor mix. Medicare patients comprised nearly 36% of the payor mix in fiscal 2012, which is somewhat below average for a CAH. INDEPENDENT BOARD APPROVES TAX RATE The district is governed by an independent six member board appointed by the county commissioners. Members serve staggered two-year terms, meet monthly for policy oversight and to approve the annual operating and debt service levies as proposed by the county assessor and by district management. DEBT PROFILE Overall debt levels are low at 0.9% of market value but very high on a per capita basis at almost $8,800 given the county's small population base and relatively high mineral property wealth. The outstanding $21.7 million in limited tax debt was sold in 2011 to finance the construction of a replacement hospital and adjacent medical office building. The $22.8 million authorization received strong voter approval at more than 80% in May 2010. Principal amortization is very slow (but not atypical for hospitals) with approximately 27% retired in 10 years. The district's debt service tax rate was projected to increase to the $0.11--$0.13 range to service this debt, but rapid TAV growth in recent years has kept the rate to under $.05. Management reports no additional borrowing plans. EXPECTED IMPROVEMENT WITH NEW FACILITY Fitch expects MCHD's financial performance to improve as benefits from the move to the new facility are realized. Management has several physician recruitment plans that should enhance inpatient volume and services at the facility. The failure to realize these benefits could result in negative rating pressure.