Fitch Downgrades Saint Barnabas (NJ) $893MM Bonds to 'BBB'; Outlook Stable.

NEW YORK -- Fitch Ratings has downgraded the underlying rating on approximately $893 million New Jersey Health Care Facilities Financing Authority and New Jersey Economic Development Authority bonds issued on behalf of Saint Barnabas Health Care System (SBHCS) to 'BBB' from 'BBB+' and has removed the bonds from Rating Watch Negative. All outstanding bonds are listed below. The Rating Outlook is Stable.

The rating downgrade to 'BBB' reflects the impact of the six-year $265 million settlement with the U.S. Department of Justice (DOJ) in conjunction with the lack of historical profitability. Given SBHCS' lack of operating profitability over the last four years, the system will be challenged over the medium term to generate sufficient cash flow to cover settlement payments and other fixed costs without impairing the system's balance sheet. Under the settlement, SBHCS will be required to pay $45 million in 2006 (paid July 1, 2006), $80 million in 2007, and $24 million-$32 million annually from 2008-2012 for overpayments by Medicare for outlier reimbursement.

Operating performance remains challenged as four of the system's seven hospitals are unprofitable due primarily to insufficient Medicare reimbursement. In addition, the integration of the system's medical staff and clinical service lines has been slow to result in cost savings and revenue enhancement. SBHCS' profitability over the last four years has been negative to breakeven, affected significantly by the elimination of $321 million of Medicare outlier payments from 2001-2004. SBHCS posted breakeven operating results in 2005, which included several positive one-time items related to a Medicare change in ownership (CHOW) settlement ($29.3 million) and prior year settlements ($27.1 million). The present value of future DOJ settlement payments is reflected as a non-operating expense in 2005 of $204.5 million, and excluding the charge would result in maximum annual debt service (MADS) coverage of 2.0 times (x) for 2005. Through the four months ended April 30, 2006, SBHCS had a negative operating margin of 0.5%, which is relatively unchanged from the prior year period, resulting in a 2.3x MADS coverage.

The lack of cash flow generation, which has been limited over the last four years, will pressure current liquidity indicators given the size of future settlement payments, especially in 2007, and spending for future capital needs. Unrestricted cash and investments declined to $674 million at April 30, 2006 from $783 million at Dec. 31, 2003, which translated into 121 days cash on hand and 78% cash to debt.

In addition, SBHCS' high age of plant of 13.3 years indicates the need for future capital spending. While management expects to invest close to depreciation expense over the next five years, limited capital reinvestment could weaken SBHCS' competitive position in the market.

Despite the impact of the settlement, the current rating is supported by SBHCS' business improvement plan, a management team that has aggressively responded to cuts in Medicare outlier payments in the past, and its position as the largest health care system in NJ. In September 2005, SBHCS engaged Deloitte Consulting to assist in the development and implementation of a business improvement plan to significantly grow revenues by primarily focusing on revenue cycle initiatives related to denial management, strategic pricing, and charge capture. The plan is projected to result in breakeven operating results in 2006. Operating margins are projected to increase to around 2% in the following years, which Fitch views as aggressive given SBHCS' lack of historical profitability. Days cash on hand and cash to debt are projected to be 109 days and 76% at year-end 2006 and gradually increase the following years.

Fitch views management as capable of implementing some, if not most, of the improvement plan given its previous track record of aggressive cost cutting, managed care renegotiations, length of stay reductions, and centralizing billing and supply management systems. In addition to the business improvement plan, management is performing a strategic assessment of current hospital facilities and implementing initiatives to further integrate the system. SBHCS has demonstrated its past willingness to close and divest unprofitable hospital facilities with the most recent closures of West Hudson Hospital in 2004 and Irvington General Hospital in 2006. Currently, management is evaluating the divestiture or closure of two other financial drains to the system, Union Hospital and Kimball Medical Center (posted operating losses of $8.0 million and $12.7 million in 2005, respectively), with a decision likely to be made later in the year. Despite these potential divestitures, SBHCS should continue to benefit from its status as the largest health care system in the state, providing it economies of scale and leverage over managed care payors.

Separate from the settlement with the DOJ, SBHCS is currently defending itself from a lawsuit from a group of hospitals that allege to have claims on SBHCS' receipt of Medicare outlier payments. SBHCS plans to vigorously defend itself against any claims; however, the potential outcome of this lawsuit is unknown at this time and has not been factored into the rating.

The Rating Outlook is Stable, reflecting SBHCS' implementation of a business improvement plan, strategic assessment of facilities, and initiatives to increase clinical integration, planning and quality. While Fitch believes these initiatives are aggressive, they should result in positive operating margins and improved cash flow. Weaker than expected performance, a material decline in liquidity, and an unanticipated outcome of the currently outstanding lawsuit could result in additional rating pressure.

SBHCS consists of seven free-standing acute care hospitals, a children's hospital, a free-standing psychiatric hospital, 10 long-term care facilities, and other various health care entities operating in northeastern and coastal NJ, with corporate headquarters located in West Orange, NJ. SBHCS had total revenues of $2.2 billion in 2005. SBHCS covenants to disclose to bondholders on a quarterly basis.

Outstanding Issues:

--$36,900,000 New Jersey Health Care Facilities Financing Authority revenue and bonds (Saint Barnabas Health Care System Issue), series 2001A (secured by an irrevocable direct pay letter of credit provided by the JP Morgan Chase Bank);

--$76,750,000 New Jersey Health Care Facilities Financing Authority insured revenue and bonds (Saint Barnabas Health Care System Issue), series 2001B; Insured by FSA;

--$470,876,000 New Jersey Health Care Facilities Financing Authority revenue and refunding bonds (Saint Barnabas Health Care System Issue), series 1998B; Insured by MBIA Corp.;

--$12,075,000 New Jersey Health Care Facilities Financing Authority revenue and refunding bonds (Kensington Manor Issue), series 1998C. Insured by MBIA Corp.;

--$119,781,000 New Jersey Economic Development Authority revenue bonds (Saint Barnabas Realty Development Corporation Project), series 1997A. Insured by MBIA Corp.;

--$70,640,000 New Jersey Health Care Facilities Financing Authority revenue and refunding bonds (Community Medical Center/Kimball Medical Center/Kensington Manor Care Center), series 1998. Insured by FSA;

--$59,715,000 New Jersey Health Care Facilities Financing Authority revenue and refunding bonds (Saint Barnabas Medical Center/West Hudson Hospital), series 1998A. Insured by MBIA Corp.;

--$61,265,000 New Jersey Economic Development Authority revenue bonds (Clara Maass Health System Obligated Group Project), series 1996. Insured by FSA;

--$13,590,000 New Jersey Health Care Facilities Financing Authority revenue bonds (Shoreline Behavioral Health Center), series 1997. Insured by MBIA Corp.

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