CHICAGO South Dakota-based regional health care provider Avera Health plans to enter the market tomorrow to sell $140 million of variable-rate demand bonds, one of three transactions that will replace all of its auction-rate securities.
Proceeds also will refund existing insured VRDBs and finance construction of a cancer center.
This week's transaction comes a week after the system sold $51 million in fixed-rate bonds. Avera expects to enter the market with another $61.4 million series of variable-rate demand bonds the week of June 27.
All three series include a mix of refunding and new money. Of the $262.2 million total, roughly $93 million is new money. About $120 million will refund ARS insured by Ambac Assurance Corp. and a line of credit tapped to take out auction-rate securities, and roughly $50 million will refund existing VRDBs insured by MBIA Insurance Corp.
Bond proceeds will also finance a new surgical outpatient center, housed in the same building as the new cancer center, allowing the health care system to vie for more patients in the highly competitive Sioux Falls region.
The South Dakota Health and Educational Facilities Authority will act as issuer for all of the bonds.
Though Avera is a 28-hospital system, the obligated group on the bonds consists of four regional hospitals, including the system's anchor facility, the 533-bed Avera McKennan hospital in Sioux Falls. Avera is one of the top two health care providers in eastern South Dakota, and its service area extends into southwestern Minnesota, northwestern Iowa, northeastern Nebraska, and southern North Dakota.
The 2008 bonds are secured by gross revenue pledge of the obligated group, as well as mortgages on certain properties held by the group.
Thursday's variable-rate demand bonds are supported by a direct-pay letter of credit from U.S. BankNA. The following week Avera will price $61.4 million of VRDBs that will be supported by a direct-pay letter of credit from Allied Irish PLC.
Faced with increased interest rates, the system moved to refund its variable- and auction-rate debt.
"In our wildest thoughts we never thought Ambac and MBIA could possibly start having problems and be downgraded," said Jim Breckenridge, Avera's senior vice president of finance. "When this whole market changed, everyone was looking beyond us and right at the insurance."
The system will end up writing off up to $3 million in insurance premiums when it terminates the policies, Breckenridge said.
"We learned to never pay a one-time premium in advance," he said. "Those days are over. Our system will never see insurance again."
Standard & Poor's and Fitch Ratings have dropped MBIA to AA, and Moody's Investors Service has placed the insurer's Aaa rating on review for possible downgrade.
Ambac has also suffered a round of downgrades lately. However, in Avera's case the loss of confidence in the insurer was secondary to the collapse of the auction-rate market, according to Jack Arnold, senior vice president at Minneapolis-based Dougherty & Co.
"That ARS could have been insured by God and it would still have been getting hammered," he said.
Dougherty and Merrill Lynch & Co. are acting as underwriters on the transactions. Kaufman Hall & Associates Inc. of Skokie, Ill., is acting as financial adviser. Chicago-based Jones Day is bond counsel for the authority.
Avera never saw a failed auction but interest rates rose to 6.4% from around 3% in the last several months as auctions failed across the market.
"My counterparties said about 92% had auctions that failed at one time or another, so we were really lucky," Breckenridge said. The interest rates were set to rise to 15% if auctions had failed. "But still it shattered our nerves. Once we saw what was happening around the country, we got a bridge loan [to refund a portion of the ARS] and we started sleeping better at night."
The new issues will increase Avera's total debt by 37%, to roughly $317 million from $226 million. That could prove to be a challenge to the system, warned Moody's, which assigned an A1 long-term and underlying rating with a stable outlook to Avera's debt.
Moody's also noted that the new letters of credit mean Avera will face $200 million in LOC renewal risk, equal to 64% of its portfolio. However, those risks are offset by the system's "remarkably consistent" and above-average operating income and cash flow performances over the last five years, as well as its large market share in eastern South Dakota, and its strong management team, Moody's analyst Brad E. Spielman in a report on the upcoming issues.
Standard & Poor's assigned its A-plus rating to the debt with a stable outlook, citing the system's stable market share in Sioux Falls and its solid financial profile.
Avera Health will maintain its two outstanding fixed-payer swaps that total $64.2 million. Merrill Lynch acts as counterparty for a $48.5 million swap, and BNP Capital Services Inc., an affiliate of BNP Paribas, is counterparty for a $15.6 million swap.
BNP Paribas only recently stepped in as counterparty on the $15 million swap after the original swap counterparty Dougherty Capital Services LLC, an affiliate of Dougherty & Co. closed its doors about two months ago due to lack of business, according to Arnold.
Roughly 55% of Avera's total debt portfolio is fixed rate and nearly 20% of that is synthetically fixed with the remaining 45% variable rate. "We think that's a perfect mix for us," Breckenridge said.
With the construction of the Avera Cancer Institute, the system hopes to become the dominate provider of oncology services in eastern South Dakota. The cancer center will be housed in a new five-story, 257,000-square-foot building that will also include an outpatient surgical center on the Avera McKennan campus in Sioux Falls.
"We look at our service area and we see a tsunami of cancer in the next five to 10 years out because of the baby boomers," Breckenridge said. "We see that as one area that we want to get ready for. And we have some competition in the outpatient surgical [area] so we wanted to beef those services up."
Avera's chief competitor in the Sioux Falls region is Sanford Health, which has a leading market share of 50% compared to Avera's 42% market share. Avera's three largest regional hospitals Avera St. Luke's in Aberdeen, Avera Sacred Heart in Yankton, and Avera Queen of Peace in Mitchell dominate their markets.
From 2003 to 2006, Avera's annual cash flow was between $60 million and $63 million, and increased to $73 million in 2007, translating into a margin of 10%. Its annual revenues are in excess of $700 million.
Avera Health typically issues debt every two years, and officials expect the upcoming issues to carry the system through the next few years.
