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Rating Action:

MOODY'S ASSIGNS A2 RATING TO ST. JOHN HEALTH SYSTEM'S (OK) $190 MILLION OF SERIES 2012 BONDS; PARITY RATING UPGRADED TO A2 FROM A3; OUTLOOK IS STABLE AT THE HIGHER RATING LEVEL

02 May 2012

SYSTEM WILL HAVE A TOTAL OF $478 MILLION OF RATED DEBT OUTSTANDING

New York, May 02, 2012 -- Moody's Rating

Issue: Series 2012 Fixed Rate Revenue and Refunding Bonds; Rating: A2; Sale Amount: $190,000,000; Expected Sale Date: 05/10/2012; Rating Description: Revenue: Other

Opinion

Moody's Investors Service has assigned an A2 rating to St. John Health System's ("St. John") $190 million of Series 2012 fixed rate revenue and refunding bonds to be issued by Oklahoma Development Finance Authority. Concurrently, we have upgraded to A2 from A3 St. John's parity bonds outstanding. The rating is revised to stable from positive at the higher rating level.

SUMMARY RATING RATIONALE:

The rating upgrade and stable outlook reflect St. John's improving financial performance through six months of FY 2012 with good volume and revenue growth, following softer results in FY 2011 that was expected due in large part to its strategy to move surgical volumes from its flagship facility to the new Broken Arrow Hospital (BAH) that opened southeast of Tulsa in 2010. With the current debt financing plan, St. John will finance the purchases of BAH and an adjacent medical office building. The acquisition of BAH will be accretive to the system, enabling it to further grow, diversify operations and increase market share by entering a new, growing and highly insured market. In anticipation of the acquisition and increase in debt, we note favorably the continued growth in unrestricted cash from improved absolute cash flow generation and the curtailing of capital expenditures over the past three years.

However, these positive credit factors are partially offset by a St. John's increased debt load for the acquisition of BAH , which St. John began servicing in 2010 through its guaranty of the bank loan used to finance the construction of BAH. The increased leverage with the current financing will place some further pressure on an already leveraged balance sheet and stress debt coverage measures. Although, we expect the positive financial momentum to continue as BAH continues to ramp up, due to favorable population growth trends in the region contributing to patient demand, and the system's strong market presence as a large tertiary provider in a highly competitive Tulsa market. Continued improvement in performance will be essential in order to absorb the increased expense base with the acquisition of BAH, support the increased debt, offset any declines in government reimbursement and improve liquidity and leverage measures that are more in line with the A2 rating category.

STRENGTHS

*Strong market presence as a large integrated delivery system serving a broad geographic region in and around Tulsa, Oklahoma (a growing revenue base reaching $947million in FY 2011)

*Continued growth in unrestricted cash and investments to $415.5 million (165 days cash on hand adjusted to include the provision for bad debts as an expense) as of March 31, 2012, up from $398.6 million (165 days cash) at fiscal yearend (FYE) 2011; the increase in cash is largely due to improved cash flow generation since FY 2009, after several years of materially weaker performance and modest capital spending averaging less one times depreciation expense over the past three years

*Favorable and improved operating results through six months of FY 2012 with 3.6% operating margin (adjusted to include the provision for bad debts as an expense and all other measures herein) and 9.9% operating cash flow margin due to in part to good volume growth across facilities and service lines; St. John also received a net $7.1 million of supplemental Medicaid funding under the new hospital provider fee program, Supplemental Hospital Offset Payment Program (SHOPP), implemented in January 2012, (excluding SHOPP the results still exceeded budget and prior year with 2.2% operating margin and 8.8% operating cash flow margin)

*Favorable inpatient and outpatient volume growth through six months of FY 2012; at the flagship hospital combined admissions and observations stays grew 3% and total surgeries were up a strong 9%; combined with BAH, the system's total combined admissions and observations stays grew by 3% and total surgeries grew by a favorable 7%

*Proforma debt structure is largely fixed rate (94% fixed rate debt) with some exposure to short-dated basis swaps; along with the issuance of the Series 2012 bonds, St. John expects to enter into a $30 million 20-year variable rate loan with a Bank, to finance the acquisition of the medical office building constructed adjacent to BAH

*Future capital spending is manageable based on projected cash flow generation (capital spending ratio averages little over one times depreciation expense from FY 2012-FY 2014); St. John is budgeting $55 million of additional capital spending aside from the acquisition of BAH in FY 2012 and projecting $60-$65 million annually in both FY 2013 and FY 2014 which includes routine capital, information technology and strategic spending. No additional debt is expected at this time

CHALLENGES

*Current debt financing and purchase of Broken Arrow Hospital will place some additional stress on an already leveraged balance sheet and weaken debt service coverage; proforma debt will increase by about $67 million (15%) from FYE 2011 (since FY 2010, Moody's has incorporated the $115 bank loan associated with the construction of BAH via a guarantee and also includes the $30 million equity contribution St. John made toward the project in our unrestricted cash calculation); on a proforma basis (based on combined FY 2011 audited St. John Health System results and unaudited FY 2011 Broken Arrow Hospital), cash-to-debt declines to 82%, debt-to-operating revenues rises to 52%, Moody's adjusted maximum annual debt service declines to 3.7 times, and adjusted debt-to-cash flow increases unfavorably to 5.1 times; these ratios are well below the A2 medians of 131.8% cash-to-debt, 35.7% debt-to-operating revenue, 3.3 times debt-to-cash flow, and 4.8 times MADs coverage

*Ability to continue to manage the ramping up of BAH and increase physician referrals to the hospital beyond episodic needs, while backfilling the flagship hospital with new surgical volumes after the planned relocation of one of the largest orthopedic groups to BAH

*Very competitive market with the presence of other large systems and several physician-owned specialty and short-stay surgical hospitals; St. John's inpatient market share was 25.4% in FY 2011 although combined with BAH, market share increases to 26.9%, but still remains behind St. Francis Health System (rated Aa2/stable) with 39% market share

Outlook

The stable outlook at the higher rating level reflects St. John's strong market presence, the positive financial momentum through six months of 2012 expected to continue as BAH ramps up due to favorable population growth trends in the region contributing to patient demand, and continued growth in unrestricted liquidity. The continued improvement in performance will be essential in order to absorb the increased expense base with the acquisition of BAH, support the high debt load, offset any declines in government reimbursement and improve liquidity and leverage measures that are more in line with the A2 rating category.

WHAT COULD MAKE THE RATING GO UP

Sustained strong operating margins; material improvement in financial performance and debt coverage measures; continued growth in unrestricted cash and investments; no loss in market share; financial improvement at BAH and the ability to backfill surgery cases at St. John Medical Center

WHAT COULD MAKE THE RATING GO DOWN

Material downturn in financial performance further weakening balance sheet metrics ; unforeseen challenges with operating BAH once acquired, or the inability to continue to backfill the flagship hospital with new surgical volumes; decline in unrestricted cash and investments; additional increase in debt beyond the current financing; erosion in patient volumes and/or market share

PRINCIPAL RATING METHODOLOGY

The principal methodology used in this rating was Not-For-Profit Healthcare Rating Methodology published in March 2012. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

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Deepa Patel
Analyst
Public Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Mark Pascaris
Vice President - Senior Analyst
Public Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

MOODY'S ASSIGNS A2 RATING TO ST. JOHN HEALTH SYSTEM'S (OK) $190 MILLION OF SERIES 2012 BONDS; PARITY RATING UPGRADED TO A2 FROM A3; OUTLOOK IS STABLE AT THE HIGHER RATING LEVEL
No Related Data.
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