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New Issue:

MOODY'S ASSIGNS A3 RATING TO ST. JOHN HEALTH SYSTEM'S (OK) SERIES 2011 BONDS ($155 MILLION); OUTLOOK IS REVISED TO POSITIVE FROM STABLE

24 Mar 2011

ST. JOHN HEALTH SYSTEM WILL HAVE A TOTAL OF $482 MILLION OF A3 AND A3/VMIG2 DEBT OUTSTANDING

Oklahoma Development Finance Authority
Health Care-Hospital
OK

Moody's Rating

ISSUE

RATING

Hospital Revenue Bonds, Series 2011

A3

  Sale Amount

$155,000,000

  Expected Sale Date

04/20/11

  Rating Description

Hospital Revenue Bonds

 

 
Moody's Outlook   Positive
 

Opinion

NEW YORK, Mar 24, 2011 -- Moody's Investors Service has assigned an A3 rating to St. John Health System's ("St. John") estimated $155.0 million (not to exceed $200 million, including a potential refunding of 1999 bonds) of Series 2011 fixed rate bonds to be issued by Oklahoma Development Finance Authority. The rating outlook has been revised to positive from stable. At this time, we are affirming the A3 and A3/VMIG2 ratings assigned to St. John's outstanding debt (see RATED DEBT below).

SUMMARY RATING RATIONALE The A3 rating reflects St. John's improved financial performance in FY 2010 following more challenging years of operations and growth in absolute liquidity. The rating also reflects the recent completion and opening of the new 68 bed (with capacity to grow to 96 beds) Broken Arrow Hospital (BAH) in south Tulsa, which adds a significant new St. John presence in an important service area for the system. St. John will acquire BAH with the proceeds of this financing and will now be charged with ensuring its long-term financial success as a full service hospital while backfilling relocated surgical volumes at St. John Medical Center, the flagship campus of the system. Management for St. John believes that the acquisition of BAH will add significant new volumes and revenues to the St. John system. These attributes are offset by the higher debt burden that St. John began servicing last year through its guaranty of the bank loan used to finance Broken Arrow's construction. Likewise, days cash on hand may decline as St. John's expense base increases with the purchase of BAH without a commensurate increase in absolute cash. The revision of the outlook to positive from stable reflects our view that financial performance should show improvement and result in better debt service coverage after BAH gains traction and the system shows improved results. The A3/VMIG2 rating on St. John's variable rate debt reflects adequate coverage of the system's $3.1 million of variable rate debt supported by self-liquidity.

STRENGTHS

*Much improved financial performance in FY 2010 with a 9.6% operating cash flow margin, up from 6.7% in FY 2009, resulting in better debt service coverage of 3.8 times maximum annual debt service coverage and 4.6 times debt to cash flow, compared to 3.7 times and 5.4 times, respectively, in FY 2009 (Moody's FY 2010 coverage ratios incorporate $115 million of a guaranteed bank loan)

*Improved liquidity through cash flow growth and improved receivables management as unrestricted cash and investments reached $356 million or 153 days at fiscal year end 2010, up from $306 million or 135 days in FY 2009; cash to debt declined to 78% due the $115 million bank guaranty and remains below the A3 median of 129%

*Growth in volumes at St. John Medical Center (admissions up a material 7% in FY 2010) after two years of decline; St. John Health System is a sizable full service provider ($919 million in revenues) in the competitive Tulsa market

*Nearly all debt is fixed rate with some exposure to short-dated basis swaps

*Sufficient liquidity to meet any unremarketed tenders on the remaining $3.1 million of variable rate debt (see Short-Term Rating Rationale section below)

CHALLENGES

*Ability to navigate through the early opening phase of BAH and increase physician use for the hospital beyond episodic needs, while backfilling St. John Medical Center with new surgical volumes as one of the largest orthopedic groups relocated to BAH in a planned transfer of volumes from St. John Medical Center 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 market share increased in 2010 to 27.0% from 25.1% although remains behind St. Francis Health System with 37.6% market share

*While improved, financial measures and balance sheet metrics remain shy of A2 medians

DETAILED CREDIT DISCUSSION

USE OF PROCEEDS: The bond proceeds will be used to purchase the assets that comprise the Broken Arrow hospital totaling approx. $130 million, to reimburse St. John and certain of its subsidiaries for previous capital expenditures totaling up to $20 million and to pay the costs of issuance. St. John will also purchase the adjacent Broken Arrow Medical office building for approximately $20 million, but will not use bond proceeds for this purchase. The current owners of Broken Arrow will use the funds paid for the hospital assets and medical office building to repay the $115 million bank loan that St. John is currently guarantying; and repay approx. $30 million of additional debt outstanding that was used to finance construction and start up costs. Previously, St. John had invested $30 million of private, non-voting preferred equity in a company that used those proceeds to make the additional $30 million loan to the owners of Broken Arrow and this St. John investment will be redeemed when the loan is paid off. In addition, St. John is evaluating refunding approximately $33 million of the outstanding Series 1999 Bonds

LEGAL SECURITY: With this issuance, management reports that St. John will be strengthening the security on all outstanding bonds to a revenue pledge of the obligated group from a general obligation pledge. The obligated group will include the parent St. John Health System, St. John Medical Center, (which is the system's flagship and main cash flow generator), Jane Phillips Medical Center, and the companies that own and operate the Owasso, Broken Arrow and Sapulpa hospitals. St. John Medical Center cannot exit the obligated group. Prior to this issuance, St. John utilized a weaker restricted affiliate structure. Moody's has not received the draft documents evidencing this change at the time of publication.

INTEREST RATE DERIVATIVES: St. John has several swap agreements whereby St. John is required to pay variable interest payments based on the SIFMA index. One swap ($100 million notional amount) matures in 2021 and is a basis rate swap under which St. John pays a variable rate based on SIFMA but receives a rate of 73.875% of one month LIBOR. There are three additional swaps that are all fixed to floating swaps with a total $100 million notional amount. Under each of these swaps, St. John pays a variable rate based on SIFMA in exchange for a fixed rate. The first swap has a notional amount of $25 million and matures in December 17, 2013. St. John receives 1.19% fixed interest on this swap. The second swap has a notional amount of $25 million and matures in December 13, 2012. St. John receives 1.57% fixed interest on this swap. The third swap has a notional amount of $50 million and matures in December 21, 2012. St. John receives 1.28% fixed interest on this swap. The counterparty on all swaps is Citigroup Global Markets Holding Inc. At the A3 rating level, St. John does not have to post collateral unless the loss exceeds $10 million and no collateral has been required or is currently posted.

MARKET POSITION/COMPETITIVE STRATEGY: OPENING OF THE NEW BROKEN ARROW HOSPITAL VIEWED FAVORABLY AS CONSTRUCTION IS COMPLETE; NOW MUST INTEGRATE INTO THE SYSTEM, GAIN PHYSICIAN ACCEPTANCE AND BACKFILL VOLUMES AT ST. JOHN MEDICAL CENTER

We view favorably the successful opening of the new 68-bed Broken Arrow Hospital (BAH), which opened at the end of 2010. The construction was largely funded with a $115 million bank consortium loan which St. John guarantees. Proceeds from this financing will fund St. John's purchase of the facility from the current owners. St. John will wholly own the facility. The communities served by BAH constitute a largely new adjacent service area for St. John and this expands the System's presence to the favorable payor mix in south Tulsa. The hospital will provide primary and secondary care services.

Prior to BAH's opening, management entered into a co-management agreement with a large independent orthopedic group practicing at St. John Medical Center (the flagship) to manage the orthopedic service at BAH and at St. John Medical Center and the Owasso hospital as well. The group relocated much of its surgical orthopedic business to BAH and the group is located in a medical office building that the group owns that is roughly half way between St. John Medical Center and BAH. Management will now be challenged to increase daily census and expand the use of the facility by physicians for acute care rather than episodic care while concomitantly backfilling surgeries at St. John Medical Center. To date management reports that some of the backfill has been with more medical cases than surgical, typically at lower reimbursement rates than surgery.

The Tulsa market is very competitive and BAH should provide a vehicle for St. John to increase its market share by growing incremental volumes. St. John materially increased its inpatient market share to 27.0% in 2010 from 25.1% in 2009 as admissions increased over 7% at St. John Medical Center in FY 2010. St. John is second in the market behind St. Francis Health System with 37.6% market share (stable trend). Other large providers include for-profit Ardent Health System with 23.1% market share (down from 23.6%) and OSU Medical Center with 5.9% market share (stable trend). OSU Medical Center is owned by the City of Tulsa through a public trust. For-profit Community Health Systems owns one facility in this market, Southcrest Medical Center, which captures 6.4% market share, down notably from 7.5%.

Beyond these providers, there are several physician owned specialty and short-stay surgical hospitals in Tulsa that have increased the competitive climate over the years. These hospitals are reportedly very profitable due to favorable out of network payment schedules and minimal uncompensated care. Most of the physicians in Tulsa are either employed by one of the systems or invest in or participate at the specialty hospitals, creating another level of competition for physician loyalty and employment. We note that St. John and St. Francis co-own one of the largest managed care companies in Oklahoma, CommunityCare. The two systems also have several smaller joint ventures together as well.

St. John Health System is wholly-owned by Marian Health System, a confederation of three health systems which include St. John, Via Christi Health System in Kansas (which is 50% cosponsored by Ascension), and Ministry Health Care System in Wisconsin. No funds are transferred to Marian. Marian is sponsored by the Sisters of Sorrowful Mother congregation with nine Sisters and several lay members serving as board members. Any mergers must be approved by Marian, which is headquartered in Tulsa. The CEO of Marian is the former CEO of St. John Health System who recently retired from her CEO position at St. John. St. John's former COO was selected as system CEO effective January 1, 2011 following a national search.

OPERATING PERFORMANCE: NOTED IMPROVEMENT IN FY 2010 PERFORMANCE; SOME DILUTION EXPECTED IN FY 2011 AS BROKEN ARROW GAINS ITS FINANCIAL FOOTING

As budgeted, St. John showed favorable improvement in FY 2010, continuing the turnaround that began gaining traction in FY 2009. Operating margin improved to 2.0%, up from a deficit margin of 1.9% in FY 2009, while the operating cash flow margin improved to 9.6%, up from 6.7%, respectively. Debt service coverage improved to 4.62 times debt to cash flow, from 5.49 in FY 2009, while Moody's-adjusted maximum annual debt service coverage improved to 3.8 times from 3.7 times, respectively. Moody's FY 2010 coverage computations include the $115 million bank loan guaranty.

The improvement in operations reflects admissions growth at each inpatient facility, with St. John Medical Center's admissions increasing a strong 7.2% in FY 2010 over FY 2009. The addition of new beds, new physician recruits (both employed and independent), new urgent care centers and a well-run transfer center to intake transfers from the rural parts of the 4-state region (as well as from other St. John hospitals) are contributing to these increased volumes. As a result, system revenues increased 5.6% in FY 2010 over the prior year, while total operating expense growth was limited to 1.5% due to a continued focus on cost controls. FY 2010 exceeded budgeted expectations which forecasted an operating margin of 1.2% and an operating cash flow margin of 9.7%, lending credibility when analyzing future projections.

Through four months ending January 31, 2011, however, performance has slightly eroded with a 1.4% operating margin and 8.6% operating cash flow margin, due to some challenging weather trends and a higher mix of medical cases than more favorable surgical cases. While performance does not include current operating losses of BAH, the decline in performance is related to the planned movement of profitable, insured orthopedic cases from St. John Medical Center to BAH (as discussed above). Management is projecting a softer year of performance in FY 2011 (1.2% operating margin; 9.2% operating cash flow margin) due to the absorption of the costs of BAH (once purchased) and its continued ramp up period. After FY 2011, St. John is expecting to show improvement with the operating cash flow margin exceeding 10% in both FY 2012 and FY 2013.

BALANCE SHEET POSITION: FAVORABLE GROWTH IN LIQUIDITY; ADDITIONAL DEBT IS MANAGEABLE AT THE A3 RATING

St. John reported growth in unrestricted cash and investments, reaching $356.2 million or 153 days at the end of FY 2010, up from $306 million or 135 days at the end of FY 2009. Cash-to-debt declined to 78% due to the new $115 million guarantee St. John currently provides to a consortium of banks that funded the cost of BAH's construction. St. John also made a $30 million equity contribution (described above) toward the project that Moody's includes in our total unrestricted cash computation. Since Moody's has already incorporated the debt associated with BAH via the guarantee, the Series 2011 bonds will only add a manageable $45 million of new debt to the balance sheet or 9% increase. $15 - $20 million of the new debt will for reimbursement of prior capital spending.

Capital spending is manageable with $40 million per annum which includes routine and IT needs and another $40 million in strategic capital over the next three years. No additional debt is expected.

St. John participates in the Marian Health System defined benefit plan which is a Church Plan and therefore not subject to ERISA funding requirements. St. John contributed and expensed $15.8 million in FY 2009 and $14.4 million in FY 2010. Management reports that the plan was 89% funded on a PBO basis at October 1, 2010, based on a $45.2 million underfunded status. Management reports that the ABO funding level exceeded 100% at October 1, 2010. St. John makes up 45% of the plan, so it would be responsible for funding nearly half of the shortfall (approximately $20.3 million) which we view as a manageable level relative to about $482 million of pro forma debt to be outstanding.

SHORT-TERM RATING RATIONALE

The Aa3/VMIG2 rating on the Series 1984 variable rate bonds ($3.1 million outstanding) reflects the satisfactory liquidity mechanism to meet the demand feature by St. John.

Outlook

The revision of the outlook to positive from stable reflects our belief that financial performance and liquidity should continue to improve, positioning the system for a rating upgrade over the next two years. However, challenges of bringing BAH on line and backfilling the flagship with surgical cases could present a hurdle to a rating upgrade.

What could change the rating--UP

Improved financial performance with margins and debt coverage that are more in line with A2 medians; no dilution 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 change the rating--DOWN

Departure from current results; unforeseen challenges with operating BAH once acquired, or the inability to backfill St. John Medical Center with new surgical volumes; decline in unrestricted cash and investments

KEY INDICATORS

Based on audited financial statements for St. John Health System, Inc. and Subsidiaries

-First number reflects audit year ended September 30, 2009

-Second number reflects audit year ended September 30, 2010 with the $45 million of additional debt added; Moody's already incorporates the $115 million of debt associated with BAH in FY 2010 results

-Investment return normalized at 6%

Total hospital admissions: 36,440; 38,887

Total operating revenue: $871.1 million; $919.6 million

Moody's-adjusted net revenues available for debt service: $80.1 million; $115.5 million

Days-cash-on-hand: 135 days; 153 days

Debt-to-cash flow: 5.49 times; 4.62 times

Maximum annual debt service: $21.2 million; $31.3 million

Moody's adjusted maximum annual debt service coverage based on 6% investment return: 3.7 times; 3.7 times

Maximum annual debt service coverage based on reported investment return: 3.26 times; 4.81 times

Total debt outstanding: $344.1 million; $452.6 million

Operating cash flow margin: 6.7%; 9.6%

Operating margin: -1.9%; 2.0%

RATED DEBT (debt outstanding as of September 30, 2010)

Series 1984: $3.1 million; A3/VMIG2 (short term portion of the rating based on internal liquidity of St. John's; semi-annual interest rate mode)

Series 1999: fixed rate ($33.5 million); A3

Series 2004: fixed rate ($48.5 million); A3

Series 2007: fixed rate ($242.3 million); A3

CONTACTS

Obligor: Mr. Lex Anderson, Executive Vice President and Chief Financial Officer, 918-744-2740

Underwriters: Mr. Michael Marcus, Goldman Sachs & Co., 212-902-6531; Mr. Andrew Pines, Citi, 415-951-1729

The last action taken with respect to St. John Health System's ratings was on March 22, 2010 when the A3 and A3/VMIG2 ratings were affirmed and the outlook was revised to stable from negative.

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

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, confidential and proprietary Moody's Investors Service information, and confidential and proprietary Moody's Analytics information.

Moody's Investors Service considers the quality of information available on the credit satisfactory for the purposes of assigning a credit rating.

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
250 Greenwich Street
New York, NY 10007
USA

MOODY'S ASSIGNS A3 RATING TO ST. JOHN HEALTH SYSTEM'S (OK) SERIES 2011 BONDS ($155 MILLION); OUTLOOK IS REVISED TO POSITIVE FROM STABLE
No Related Data.
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