OREANDA-NEWS. Fitch Ratings has affirmed the 'AA-' for St. Joseph Health System's (SJH) outstanding debt. A full list of the outstanding debt rated by Fitch follows at the end of this press release.

The Rating Outlook is Stable.

SECURITY

A gross revenue pledge secures certain outstanding bond issues (series 2007, 2009 and 2011), which benefits all parity bondholders as long as the secured debt remains outstanding. A new master trust indenture (MTI) was introduced as part of the 2013 financing, which includes an unsecured pledge as well as less restrictive covenants. As of SJH's 2014 offering, 36% of bondholders had consented to the new MTI. Bond insurer consent is also needed. The call date on the outstanding insured debt is 2018.

KEY RATING DRIVERS

TRANSFORMATION INITIATIVES DEPRESS PERFORMANCE: SJH is in the third year of its five-year strategic transformation plan to move the organization to population health management. SJH's heavy investment in population health infrastructure (including physician alignment initiatives and information technology) in each of its regions has generated profitability metrics that are weak relative to 'AA' category peer group. However, Fitch believes the return on these investments will be realized over the next few years.

SOLID REGIONAL HEALTH SYSTEM: SJH benefits from its geographic diversity and leading market positions in each of its distinct service areas - Southern California, Northern California and Texas. SJH improved its market position in the Southern California market with the consolidation of Hoag Memorial Hospital Presbyterian (Hoag) as of March 1, 2013. The network in Orange County is now known as St. Joseph Hoag Health and the Southern California region accounted for 59% of total system revenue in fiscal 2014 (June 30 year end).

GOOD LIQUIDITY POSITION: SJH's liquidity position is good for its rating level. At Mar 31, 2015, SJH had \$3.77 billion in unrestricted cash and investments which equated to 241.7 days cash on hand and 154.1% cash to debt and provides a solid cushion as the system implements its transformation initiatives.

HEALTHY CAPITAL SPENDING: Capital spending has been very high reflecting seismic requirements and investment in strategic initiatives. Capital spending equaled 1.8x of depreciation expense through the nine months ended March 31, 2015 compared to 1.5x in fiscal 2014 and 2x in fiscal 2013.

ELEVATED DEBT BURDEN: Maximum annual debt service (MADS) including drawn lines of credit and capital leases is \$178.8 million as of March 31, 2015. This equated to 3.2% of fiscal 2014 total revenues. MADS coverage is weak at 3x for the nine months ended March 31, 2015 and fiscal 2014 on a historical proforma basis compared to the AA category median of 5.4x. Debt service coverage is depressed in the interim period due to lower investment returns. Actual debt service coverage in fiscal 2014 was 4x.

RATING SENSITIVITIES

DEMONSTRATED OPERATING IMPROVEMENT: Although operating performance has declined since 2013, performance through the nine months ended March 31, 2015 indicates improvement and it will be necessary for St. Joseph Health System to demonstrate consistent improvement in operations given its weaker profitability and debt metrics relative to the AA category medians. An erosion in profitability or liquidity levels would likely result in negative rating action.

LIMITED DEBT CAPACITY: Capital spending is projected to remain elevated through fiscal 2017. St. Joseph Health System's evaluates financing options yearly as its debt structure has upcoming put dates. Fitch believes there is limited debt capacity at the current rating level based on year to date performance.

CREDIT PROFILE

SJH has 14 hospitals, 2 affiliated hospitals, 2 home health agencies, physician groups, and a health plan. The system is organized in three regions - Southern California, Northern California, and Texas, which accounted for 59%, 18%, and 23% of system revenue, respectively. Total revenue in fiscal 2014 was approximately \$5.6 billion. The obligated group accounted for 89% of total assets and 76% of total revenue of the consolidated system in fiscal 2014. Fitch's analysis is based on the consolidated entity. The CEO has announced her retirement effective December 2015, but will remain until a successor is in place. The board is in the early stages of the search process.

The 'AA-' rating is affirmed despite weaker operating performance in fiscal 2013 and 2014 due to SJH's strong market position and the expectation that SJH's strategic investments will better position the organization in a value based reimbursement environment. However, SJH will need to sustain the improved operating cash flow trend exhibited through the nine months ended March 31, 2015 and demonstrate continued operating cash flow improvement especially due to its capital needs.

Strategic Investments to Drive Transformational Care

SJH is in the third year of its five year strategic plan that outlined the development of networks of care in each of its regions that encompasses a full continuum of care so that the organization can manage population health. SJH has been building its physician network and has standardized the information technology platform across the system. These investments have pressured operating performance but should position the organization well in a value based reimbursement environment. SJH is proactively entering into alternative payer arrangements with various payers to benefit from its coordinated care and population health management initiatives. Approximately 19% of its total revenue is risk based.

Although each of the regions is fairly competitive, SJH's facilities maintain a leading market share in each service area. The Southern California region benefited from the Hoag affiliation and there are ongoing initiatives to improve operating efficiency in the newly formed system of care.

With the standardized information technology platform (Meditech) across the system complete, information technology investments will be focused on solutions to innovate the delivery and coordination of care and enhance patient engagement.

Other areas of focus include diversifying its revenue stream into non-acute business lines and SJH is pursuing joint venture/partial ownership models in complementary business lines in areas such as wellness, technology, and home care.

Healthy Capital Spending

Capital spending has been high. Capital spending is projected to total \$432 million in fiscal 2015 with master facilities projects at St. Mary Medical Center, Covenant Health, and St. Jude in addition to ongoing strategic initiatives. Approximately 25% of projected spending is on routine capital.

Decline in Operating Performance

SJH's operating performance has historically been solid with a 4.1% operating margin in fiscal 2012 and 4.2% in fiscal 2011. Operating performance declined in fiscal 2013 to a 1% operating margin (4 months of Hoag included) and 0.2% in fiscal 2014. The decline in performance relates mainly to continued investments in information technology and physicians as well as the continued shift of volume to outpatient. In addition, SJH lost the shared service revenue from Children's Hospital of Orange County (CHOC; rated 'A'), which was approximately \$55 million a year when CHOC opened its own facility in March 2013.

Through the nine months ended March 31, 2015, operating margin and operating EBITDA margin were 0.9% and 8.2%, respectively. SJH has benefited from the California provider fee program but the timing of the receipt of funds is volatile due the various program periods and when CMS approves the different portions of the program. Through the nine months ended March 31, 2015, the net impact related to the provider fee was negative \$10.5 million compared to positive \$213,000 in fiscal 2014 and \$66 million in fiscal 2013. SJH still expects to receive over \$200 million on a net basis related to the 2014-2016 provider fee program.

Fitch expects SJH to continue to improve its operating cash flow especially as its strategic investments mature. A failure to realize the benefits of SJH's transformation initiatives through improved operating performance and profitability could pressure the rating over the longer term.

Debt Profile

Total outstanding debt is \$2.3 billion and is 75% fixed rate and 25% variable rate (53% fixed rate bonds, 23% put bonds, 13% variable rate demand bonds, 11% drawn lines of credit). SJH has several lines of credit available (up to \$480 million) for interim financing purposes and \$256 million was outstanding as of March 31, 2015 (included in long term debt).

SJH has seven fixed payer swaps for a notional amount of \$507 million and recently novated the swaps to increase the collateral threshold requirement and the current amount posted as of May 20, 2015 was \$7.2 million.

SJH's aggregate debt service schedule is front loaded. In addition, MADS includes the amortization of the bullet maturities (drawn lines of credit). Currently, MADS of \$178.8 million occurs in fiscal 2017. Bonded MADS is only \$130 million.

The debt structure has annual put maturities in fiscal 2017, 2018, 2020, 2021, and 2023 and SJH will evaluate any new money needs in conjunction with the renewal/refinancing of the puttable debt. Fitch believes there is limited debt capacity at the current rating level unless there is a commensurate improvement in profitability.

Disclosure

SJH covenants to provide annual and quarterly (for first three quarters) disclosure.

Outstanding debt rated by Fitch:
--California Health Facilities Financing Authority (CA) (St. Joseph Health System) variable-rate revenue bonds series 2011D (bank bonds);
--\$100,000,000 California Health Facilities Financing Authority (CA) (St. Joseph Health System) variable-rate revenue bonds series 2011D (LOC: Wells Fargo Bank, N.A.);
--California Health Facilities Financing Authority (CA) (St. Joseph Health System) variable-rate revenue bonds series 2011C (bank bonds);
--\$50,000,000 California Health Facilities Financing Authority (CA) (St. Joseph Health System) variable-rate revenue bonds series 2011C (LOC: Northern Trust Company [The]);
--California Health Facilities Financing Authority (CA) (St. Joseph Health System) variable-rate revenue bonds series 2011B (bank bonds);
--\$100,000,000 California Health Facilities Financing Authority (CA) (St. Joseph Health System) variable-rate revenue bonds series 2011B (LOC: U.S. Bank National Association);
--California Health Facilities Financing Authority (CA) (St. Joseph Health System) variable-rate revenue bonds series 2011A (bank bonds);
--\$52,110,000 California Health Facilities Financing Authority (CA) (St. Joseph Health System) variable-rate revenue bonds series 2011A (LOC: Union Bank, N.A.);
--\$56,150,000 California Health Facilities Financing Authority (CA) (St. Joseph Health System) variable-rate demand refunding revenue bonds series 2009D;
--\$91,460,000 California Health Facilities Financing Authority (CA) (St. Joseph Health System) variable-rate demand refunding revenue bonds series 2009C;
--\$238,015,000 California Health Facilities Financing Authority (CA) (St. Joseph Health System) revenue bonds series 2009A&B;
--\$71,240,000 Lubbock Health Facilities Development Corporation (TX) (St. Joseph Health System) variable-rate revenue bonds series 2008B;
--\$42,375,000 Lubbock Health Facilities Development Corporation (TX) (St. Joseph Health System) variable-rate revenue bonds series 2008A;
--\$460,625,000 California Statewide Communities Development Authority (CA) (St. Joseph Health System) revenue bonds series 2007A-F.