Fitch Rates Skagit County Public Hospital District No.2 (WA) $10.5MM LTGOs 'A-'.

SAN FRANCISCO -- Fitch assigns an 'A-' rating to the $10.5 million Public Hospital District No. 2, Skagit County, Washington (Island Hospital) limited tax general obligation bonds (LTGOs), 2005. The Rating Outlook is Stable. Fitch also assigns an 'A-' rating to the district's approximately $3.3 million outstanding series 1996 LTGOs, which will be refunded entirely upon the current issuance. New money bond proceeds will be used to pay for a portion of the costs of a $40.5 million renovation and expansion project of Island Hospital. The bonds will sell the week of Oct. 24th via negotiation by PiperJaffray Inc.

The rating reflects the district's manageable debt burden, good average annual assessed valuation growth, strong voter support, and Island Hospital's stable operations. These strengths are offset somewhat by statutory tax limitations on district property, the district's somewhat limited economy and relatively high taxpayer concentration, slow debt amortization, and Island Hospital's relatively small revenue base.

District debt is manageable. Including the current issuance, the district's direct debt and overlapping debt burdens are a low to moderate 1.4%, and 3.0%, respectively, with overlapping debt stemming primarily from bonds issued by a local school district. In addition, regular tax levy revenue is expected to cover debt service on the LTGOs 1.0 times (x). Of concern, however, is the district's slow debt amortization of its LTGO debt, which will be only 22.6% in the first 10 years. The district currently has no plans to issue additional debt.

The district is located in western Skagit County and encompasses the City of Anacortes, Fidalgo, Guemes, Cypress, and Sinclair Islands. The district economy is influenced heavily by petroleum refining, seafood processing, tourism, and a large retiree population base. The City of Anacortes is the primary retail and population center of the district and serves as a major hub to the San Juan Islands, a popular tourist destination. Voter support of the district hospital has been strong, which is highlighted by the approval by 78% of district voters in a September 2004 election to issue $30.5 million unlimited tax general obligation bonds, the proceeds of which will be used for the current $40.5 million Island Hospital renovation and modernization project. Income levels in Skagit County are slightly below those of the state but Fitch believes this is not representative of the City of Anacortes given its property values and large retiree population base.

Historical district assessed valuation (AV) growth has been good, averaging 6.5% over the last five years. AV increased only 1.1% in 2005; however, Fitch believes the relatively low AV growth in 2005 is reflective of the unusually high 11.5% growth experienced in the prior year. Fitch believes the potential for continued AV growth is good given new building permits and planned retail development. Nevertheless, taxpayer concentration is somewhat high as the top 10 taxpayers accounted for 20.1% of total AV in 2005. Moreover, the top two taxpayers are oil refineries (Shell and Tesoro Corporation), the assessed valuations of which are highly vulnerable to economic fluctuation.

The district's financial profile is highlighted by its recent stable and sound operating performance and good liquidity relative to expenses. District operating performance has improved significantly in recent years largely due to divestitures of underperforming clinics and increased volume of high-margin outpatient services. Income from operations was $3.1 million in 2004 and has been consistently above $2.3 million since 2001, resulting in sound operating margins. Operating income was $1.4 million thru the first eight months ended Aug. 31, 2005. Fitch believes profitability growth could be limited in the medium term due to higher interest expense and inherent construction and ramp-up cost pressures. However, operating profitability has not been dependent on tax revenue in any of the last four years and liquidity relative to expenses is healthy (162.3 days cash on hand at Aug. 31, 2005), which somewhat mitigates this concern.

A primary concern is statewide tax limits. The bonds are limited tax general obligations of the district, secured by a non-voted 'regular' property tax levy of up to $0.75 mills. The district's current levy is only $0.21 mills, although its ability to raise the levy is limited by Initiative 747, which restricts regular levy revenue growth on existing property to 1% per year. The district could, however, bypass Initiative 747 restrictions through a 'levy lid lift' upon approval by a simple majority of district voters. The district and overlapping entities also share an aggregate limit, although this restriction is largely made ineffective by I-747.

Island Hospital is a 43-bed acute care hospital, which is one of three district hospitals in Skagit County. Total revenue was only $45.5 million in 2004, approximately 50% of which was composed of Medicare payments. The hospital's primary service area market share was a dominant 66% in 2004 with the remaining portion lost to other hospitals providing higher acuity services not offered at the hospital. Employees with the Washington State Nurses Association have tentatively agreed on a three-year contract and members of the Service Employees International Union are under contract through 2007.

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