CHICAGO -Minnesota's HealthEast Care System will make a rare appearance in the market this week with a debt restructuring aimed at strengthening its balance sheet.
The Twin Cities-area system will issue $150 million of BBB-minus rated tax-exempt, fixed-rate debt Thursday through the St. Paul Housing and Redevelopment Authority. It also plans simultaneously the direct placement of $131 million of taxable, variable-rate paper with three banks.
With the restructuring, HealthEast is "taking a very strategic view of the system's debt," said chief financial officer Doug Davenport, with the aim of improving its position.
JPMorgan is senior manager with Bank of America Merrill Lynch as co-manager. Hammond Hanlon Camp LLC is advising HealthEast and Dorsey & Whitney LLP is bond counsel.
The sales raises about $27 million for projects but the primary motive for the transaction is a refinancing of its existing debt from a 2005 bond issue and a loan from GE Capital.
As part of the restructuring, the system will also assume $34 million of St. Paul Port Authority bonds that it repays through a lease structure that puts the existing bonds at a speculative grade because they are rated one notch lower than the system's general rating.
No new net debt is being added to the system's balance sheet. HealthEast generated $943 million of revenues last year.
A total of $80 million of debt service savings is expected over the next eight years with maximum annual debt service dropping to $22.6 million from $37.4 million annually. The deal also paves the way to update the system's master trust indenture.
Without the new amortization of its debt service schedule, the system was facing the strain of a front-end loaded schedule that ramps up next year.
"We wanted to fix that," Davenport said.
The restructuring allows the system to address the spike and keep more cash reserves on the balance sheet to provide better protection for any unforeseen events and provide stability for the rating and the organization over the long term, said Davenport.
Both Fitch Ratings and Standard & Poor's assigned the publicly offered bonds the lowest investment level rating of BBB-minus, with stable outlooks.
Moody's Investors Service, which rates the system's 2005 bonds at a speculative grade with a positive outlook, was not asked to review the upcoming transaction. The system won back its investment grade level rating from Fitch in 2007 and from Standard & Poor's in 2012.
The bonds are secured by a gross receivables pledge and a mortgage on the system's primary hospital facilities. The deal is not expected to include a debt service reserve fund, which reflects an erosion in bondholder security from current levels, according to Fitch.
The system opted for a taxable structure on the directly placed debt to free itself of Internal Revenue Service rules on amortizing the debt, because the existing GE loan was already in a taxable structure and some of its 2005 bonds included previously advance-refunded paper.
The system liked the pricing on the direct placement.
"It was a pretty efficient way to access the market using a taxable and floating-rate structure," said Rich Bayman, a principal at Hammond Hanlon Camp.
Fitch said the system's debt load is manageable and through February was generating a three times coverage ratio of debt service, with future capital needs limited to about $25 million annually.
Fitch and Standard & Poor's noted the system's weaker liquidity due to expenses tied to its installation of an electronic health record project. With the project's completion late last year and the restructuring's savings, the system's available unrestricted cash and investments of $119 million are expected to improve.
"Failure to demonstrate a sustained trend of improvement in profitability and liquidity metrics would likely prompt negative rating pressure," Fitch said.
"Future rating stability will hinge on HealthEast's ability to improve liquidity metrics to more historical levels and maintain maximum annual debt service coverage at current levels," Standard & Poor's said.
Both rating agencies made note of default covenants tied to days cash on hand levels in the private placement, because they don't allow for a cure period in the event of a default, making the debt immediately due and payable.
"We view this as a concern, and this could trigger a critical event since HealthEast does not currently have unrestricted reserves in excess of acceleratable debt," Standard & Poor's said.
Fitch said the agreements include a semi-annual 40 days cash on hand test that increases to 65 days by fiscal 2018. The system expects to reach 60 days cash on hand in the current fiscal year. Davenport said the hospital expects to remain in compliance and if some unforeseen event triggered a default he believes the system could reach an agreement with the banks to bridge the gap due to their relationships.
HealthEast operates three acute care hospitals: St. Joseph's Hospital, St. John's Hospital, and Woodwinds Hospital.
It also runs Bethesda Hospital, a long-term acute care facility, and 14 outpatient clinics in the St. Paul area.
HealthEast faces stiff competition but has held on to a leading market position in the St. Paul area of 30%, followed by Allina with 28% and HealthPartners with 24%.
The system and its finance team are holding investor meetings in Boston and New York City as well as an internet roadshow ahead of the sale to re-introduce the system to investors, including new management brought in over the last several years.
Kathryn Correia was hired in 2012 to lead the system. Davenport took over the system's finances in March 2014 coming from Navigant Consulting where he served as director of its healthcare practice. He previously had managed finances at several hospital systems.
The extra effort with the buyside provides the system with an "opportunity to get in front of investors and tell their story," Bayman said.
The outreach is important given its absence and the system's low investment grade rating.
"It's become more difficult and more expensive for Baa/BBB acute care hospital systems to issue debt in the current market," says Mark Melio of Melio & Co., Chicago-based financial advisor to health care providers. "On one hand, there has been a relative scarcity of such bonds, on the other hand, investors are increasingly wary of weaker credits."
Melio said that nearly $5 billion of double-A health care deals were issued year to date for acute-care hospital systems. That's in contrast to $1.6 billion of triple-B rated healthcare credits. Senior living contributed another $370 million of A rated credits and another $1.1 billion of triple-B and non-rated credits, he said.
Spreads have widened this year for triple-B rated providers by roughly 20 to 30 basis points, from 145 basis points to 165 to 175. In contrast, yields on double-A providers have widened by only 10 to 15 basis points, or half as much, according to Melio.
The rates remain appealing.
"It's still not a bad time for lower-rated issuers to get to market," said George Huang, director, Wells Fargo Securities, LLC. "The market is still somewhat attractive, though the cost of capital has increased now from earlier this year."
Yields for triple-B credits are up 58 basis points from January 2015, though they remain 20 basis points lower than a year ago.
"With investors still looking for yield, the health care sector continues to be technically driven, despite the sizable increase in issuance this year," said Huang. "Spreads have widened out a little recently, but for hospital issuers that have already made plans, it's still not a bad time."
