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Rating Update:

MOODY'S AFFIRMS SAINT FRANCIS HEALTH SYSTEM'S (OK) Aa2 LONG-TERM BOND RATING; OUTLOOK IS STABLE

16 Dec 2010

SAINT FRANCIS HAS A TOTAL OF $216.2 MILLION OF LONG-TERM BONDS OUTSTANDING

Tulsa County Industrial Authority, OK
Health Care-Hospital
OK

Opinion

NEW YORK, Dec 16, 2010 -- Moody's Investors Service has affirmed the Aa2 long-term bond rating assigned to Saint Francis Health System's ("Saint Francis") $216.2 million of outstanding bonds issued by the Tulsa County Industrial Authority (see RATED DEBT section at end of report). The outlook is stable.

Saint Francis Health System is a regional health system located in Tulsa, Oklahoma. The system is anchored by 918 licensed-bed Saint Francis Hospital in Tulsa which includes the Children's Hospital at Saint Francis and the Saint Francis Heart Hospital. Saint Francis also owns 96 licensed-bed Saint Francis Hospital South and 75 licensed-bed Laureate Psychiatric Clinic and Hospital. The system is also sole corporate member of The Warren Clinic, Inc., which houses the employed physician and provider network and is a joint owner of CommunityCare Managed HealthCare Plans of Oklahoma, Inc.

RATING RATIONALE: The affirmation of the Aa2 rating and stable outlook reflects the exceptional financial performance demonstrated by Saint Francis in FY 2010 which continues a history of strong performance across several years, providing very good coverage of a low debt position. The rating and outlook also reflect the system's large wealth position which should support an increase in capital spending in the near term. Saint Francis maintains the leading market position in the very competitive Tulsa market.

LEGAL SECURITY: First security interest in the gross receipts of the obligated group (Saint Francis Health System and Saint Francis Hospital).

INTEREST RATE DERIVATIVES: The hospital has two fixed-spread basis swaps (notional amounts of $100 million each) which were put in place to lower the cost of the 2006 fixed rate borrowing and expire in November 2026 and September 2027, respectively. Current market-to-market value is a negative $7.9 million. Given the substantial liquidity and operating cash flow of Saint Francis, Moody's believes the risk of the swap transactions are incorporated in the Aa2 rating. Management is considering terminating the swaps when the negative mark-to-market is at a lower level. No collateral is required unless the valuation is greater than $25.0 million on each swap.

STRENGTHS

*Under the direction of seasoned management, Saint Francis continues to post exceptional financial performance with 11.2 percent operating margin and 17.9 percent operating cash flow margin in FY 2010, an improvement over 7.1 percent and 14.5 percent, respectively, in FY 2009; management is projecting some moderation in FY 2011 performance but will likely remain at these solid levels

*Growth in liquidity position with improved market returns and a deliberate reduction in capital spending; management's earlier decision to reduce materially its hedge fund exposure and increase liquidity speaks to Saint Francis' conservative nature and is viewed favorably given the upcoming capital plans

*Very low debt burden with no additional plans for borrowings; strong coverage with over eleven times maximum annual debt service and very low 1.01 times debt to cash flow in FY 2010 (both computations normalize investment returns at 6 percent); all debt is fixed rate; the decision to terminate the defined benefit pension plan in FY 2008 removes risk of future funding liabilities

*Historical market leader by a comfortable margin is viewed favorably given the very competitive climate in Tulsa

*Relationship with The William K. Warren Foundation which has provided significant financial support over several decades, including the construction of certain capital facilities which otherwise would have required funds from Saint Francis

CHALLENGES

*Increase in capital spending over the near term to fund a new patient tower at the flagship facility; to be funded internally with no anticipated contribution from The William K. Warren Foundation at this time

*Location in a very competitive market with the presence of two other large systems as well as a single site hospital owned by a large national for-profit operator; some slow-down in new physician-owned hospitals and surgeries centers has occurred

*Considerable physician employment activity by all providers in Tulsa, although Saint Francis has long demonstrated its ability to respond and proactively manage its physician-related strategies through the well established Warren Clinic

RECENT DEVELOPMENTS/RESULTS

The rating affirmation and stable outlook reflect the continued strong performance demonstrated by Saint Francis Health System ("Saint Francis"). In FY 2010, operating cash flow margin increased to a lofty 17.9 percent, up from a strong 14.5 percent in FY 2009, driven by good volumes, favorable rate structures with payers, continued maturation of the Warren Clinic to minimize subsidies as well as expense reductions incurred during FY 2009. As a result, total operating expenses declined by 1.4 percent in FY 2010 from FY 2009 which helped offset somewhat slower revenue growth of 2.7 percent, down from stronger 6.1 percent revenue growth in FY 2009 over FY 2008. Saint Francis also benefited from UPL funds (approximately $17.7 million in FY 2010, on par with past funding) and Medicaid disproportionate share funds ($4.7 million in FY 2010, up slightly from FY 2009). As a result of these strong levels of performance, debt coverage is very strong with a low 1.01 times debt to cash flow and over eleven times maximum annual debt service coverage (Moody's normalizes investment returns at 6 percent to compute these figures). Management is expecting some moderation in performance in FY 2011 with a more modest although still strong 6.3 percent operating margin, compared to 11.2 percent in FY 2010. First quarter of FY 2011 appears very strong with a 9.8 percent margin through September 30, 2010.

Liquidity increased in FY 2010 by 36 percent to $877.8 million (407 days cash on hand) from $647 million (297 days) in FY 2009, as investment returns were positive, operating cash flow increased 26 percent, capital spending was restrained and days in receivables declined by nearly 4 days to a very low 25.8 (Moody's national median is 45.2 days). In FY 2010 Saint Francis spent $51.3 million in capital expenditures, down from an original plan of $90 million and a reduction from FY 2009 capital spend of $93 million. The average age of plant is very favorably at 8.4 years, compared to the national median of 10.0 years. Management's actions to downsize its investments in hedge funds to 26 percent from 48 percent (for its long-term board designated funds) and increase liquidity are viewed favorably. Saint Francis maintains no exposure to equities; the portfolio is now more heavily weighted to fixed income and cash with no plans to change at this time.

Capital spending will increase over the next two to three years with the construction of a new patient tower and trauma center at the flagship facility at an estimated cost of $200 million. Management reports that the current facility is highly occupied (81 percent for med/surg beds and 91 percent for ICU beds, for example). Inpatient admissions grew 3.5 percent in FY 2010 after two years of decline, in part due to another good year of physician recruitment (36 providers added during the year), the regional draw of a full service children's hospital within the main adult hospital and the recruitment of pediatric specialists, and the completion of the relocation of the Saint Francis Heart Hospital. With its breadth of services, Saint Francis receives 91 percent of its volumes from a 12 county service area, up from 80 percent within a six county service area. The new patient tower will add 150 new beds to the campus. The plan will go to the board this January for approval and will be funded entirely with cash flow ($80 million in year one and $60 million in each of the next two years). Routine capital spending will increase to $90 million in FY 2010 and returns the system to historical levels of approximately $90 million per year before the recession. Given its cash reserves we believe Saint Francis can easily manage the increase in routine spending and the new tower.

Saint Francis's strong liquidity position also reflects its long-standing favorable relationship with The William K. Warren Foundation ("The Foundation"). While The Foundation is not legally related to Saint Francis, we continue to believe that the relationship between The Foundation and Saint Francis is an important credit factor. Substantial direct and indirect (via real estate) donations to SFHS over three decades evidences this relationship. Most recently, The Foundation has funded the construction costs of a new parking garage and medical office building on the Saint Francis Hospital South campus, provided research funding for The Laureate Institute for Brain Research and made a donation to the children's hospital (totaling $50 million). The Warren Foundation holds over $300 million of its own unrestricted net assets as well although we do not include this in our liquidity calculations for Saint Francis.

The Tulsa market is highly competitive and Saint Francis continues to maintain the leading market share position by a comfortable margin. In FY 2010 Saint Francis market share increased to 38.0 percent, up from 37.4 percent in FY 2009, followed by St. John Health System (22.6 percent, on par with FY 2009 levels) and for-profit Ardent Health System (20.7 percent market share, down from 26.3 percent in FY 2009). Tulsa Regional Medical Center, an osteopathic teaching hospital is now a city-owned entity and part of the Oklahoma State University College of Medicine after being divested from Ardent. Finally, Southcrest Hospital, which is owned by for-profit Community Health System, captures about eight percent market share. Southcrest is located very close to Saint Francis Hospital South and provides a similar primary and secondary care service array. Management also reports that the advent of physician-owned hospitals and surgery center facilities has abated but remains a competitive challenge.

The competitive environment is also heightened by the physician employment strategies that all hospitals are actively pursing. Saint Francis has long been in the arena of physician employment via the 290-member Warren Clinic. Further physician employment will likely need to be accomplished by recruitment of physicians outside of Tulsa given that a high 80 percent of the medical staff community is aligned via employment with one of the providers. Saint Francis has been very successful in recruiting physicians with 36 physicians and providers added in 2010.

Outlook

The outlook is stable, reflecting our expectation that Saint Francis will continue to produce strong cash flow and maintain very strong coverage of a low debt burden.

What would change the rating - UP

Unlikely given Saint Francis's single market presence in a highly competitive environment

What could change the rating-DOWN

Material departure from current results that do not appear correctable; unfavorable change in the relationship with The William K. Warren Foundation; significant increase in debt

KEY INDICATORS

Based on audited financial statements for Saint Francis Health System, Inc.

First number reflects audit year ended June 30, 2009

Second number reflects audit year ended June 30, 2010

-Investment return normalized at 6 percent unless otherwise noted

Total system admissions: 44,719; 46,304

Total operating revenue: $919.9 million; $944.9 million

Moody's-adjusted net revenues available for debt service (based on 6 percent investment return): $176.4 million; $223.0 million

Days-cash-on-hand: 296.2 days; 407.6 days

Debt-to-cash flow: 1.31 times; 1.01 times

Maximum annual debt service: $19.9 million; $19.9 million

Moody's adjusted maximum annual debt service coverage (based on 6 percent investment return): 8.86 times; 11.20 times

Maximum annual debt service coverage based on reported investment return: 4.41 times; 11.48 times

Total debt outstanding: $217.3 million; $216.2 million

Operating cash flow margin: 14.5 percent; 17.9 percent

Operating margin: 7.1 percent; 11.2 percent

RATED DEBT

Series 2006: Aa2 ($216.2 million outstanding)

CONTACT

Saint Francis: Mr. Barry Steichen, Executive Vice President, Chief Administrative Officer and Chief Financial Officer, 918-494-1330.

The last rating action with respect to Saint Francis Health System was on November 16, 2009 when the Aa2 and stable outlook were affirmed. That rating was subsequently recalibrated to a global scale rating on May 7, 2010.

The principal methodology used in this rating was Not-for-Profit Hospitals and Health Systems published in January 2008.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Analysts

Lisa Goldstein
Analyst
Public Finance Group
Moody's Investors Service

Lisa Martin
Backup Analyst
Public Finance Group
Moody's Investors Service

Contacts

Journalists: (212) 553-0376
Research Clients: (212) 553-1653


Moody's Investors Service
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USA

MOODY'S AFFIRMS SAINT FRANCIS HEALTH SYSTEM'S (OK) Aa2 LONG-TERM BOND RATING; OUTLOOK IS STABLE
No Related Data.
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