Fitch Ratings has affirmed the following Palomar Pomerado Health System (the district), California, bonds:

--$489.5 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 secured by 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 are rebounding following recent tax base declines.

WEAKENED FINANCIAL PERFORMANCE: Opening the district's new hospital and preparing for health care reform have pressured the district's financial operations, particularly in terms of its liquidity. Fitch expects strategies undertaken by management to result in stabilized performance.

LEADING MARKET SHARE: The district is the local market leader with 49% market share. Fitch expresses some concern over current and projected tax rates well in excess of those originally presented at the last bond election. Future debt issuance may be consequently constrained.

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

SHIFT IN FUNDAMENTALS: 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 operates other inpatient and outpatient facilities, including a 107-bed hospital in Poway and the Palomar Health Downtown Campus (PHDC).

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%. A considerable portion of this loss was recovered as the district's tax base rebounded by 3.8% in fiscal 2014. District expectations for 1%-2% annual TAV growth appear reasonable. 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, as well as relatively affordable and available land for development. Even as the county's labor force continues to grow, the unemployment rate declined considerably to 7.4% in August 2013, compared to 9.2% a year prior, and is now in line with the nation as a whole (7.3%).

DISTRICT FINANCIAL PERFORMANCE HAS DETERIORATED

Fitch rates the district's revenue bonds 'BB+'. The district has suffered significant losses in fiscal 2013 due to lower volume than expected as well as higher expenses from the transition to the new facility. Liquidity has also been drained due to the completion of its master facility plan as well as the investment in several initiatives to position itself for healthcare reform. Management implemented a turnaround plan, and most of the expense savings are from a reduction in force that happened in July and August 2013. Budgeted fiscal 2014 performance is still weak for the rating level but much improved from the prior year.

There is practically almost no correlation between the district's business operations and revenue generation for GO debt service. Legally the district must repay its debt from other sources in the event that ad valorem property tax revenues provide 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.

The district's overall profitability is slightly 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 $12.9 million in unrestricted property tax revenues in fiscal 2013 (2% of total revenues, net transfers, and other uses). These revenues are in addition to the $15.8 million in fiscal 2013 ad valorem tax revenues generated by a separate voter-approved tax levy pledged solely for the repayment of the district's GO bonds.

LEADING MARKET POSITION

The district has 49.2% market share in its primary service area. The district benefits from its position as the only major provider in north San Diego County. The district continues to work with other health systems and providers in an effort to grow volume. These include an agreement with Kaiser for a certain amount of bed usage and an affiliation with Rady Children's Hospital that operates a pediatric facility within PHDC.

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 TAV declines and 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 three years and that the district currently has no plans to issue further debt.

MIXED DEBT PROFILE

Overall debt is high at $5,614 per capita and 4.7% of TAV, driven by the district's construction of a new hospital. The district's slow debt amortization (approximately 30% 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 $26.3 million approximating 3% 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 2013 debt repayments, pension costs, and OPEB pay-as-you-go contributions cumulatively totaled an affordable 9.9% of total governmental spending, less capital.

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 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=811862

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