CHICAGO - Seeking to stem the drain on their balance sheets from the dramatic spike in interest rates on their outstanding auction-rate securities, a pair of Midwestern health care systems have turned to a new strategy designed to give them more flexibility to wait out the faltering market.
The systems - Trinity Health Credit Group and Premier Health Partners - recently revised some terms associated with their auctions, attaching more liquidity to their offerings in hopes of reassuring nervous investors and in turn capturing lower interest rates.
As an auction approached, the systems opted to lengthen the auction term to up to nine months in some cases from the traditional seven to 35 days with an unconditional tender offer provided to investors at the end of the new cycle. The new terms are aimed at lowering interest rates in the near term and then providing the systems with time to gauge whether the auction market will stabilize. If not, the longer-term offers time for the systems to consider converting to another mode.
Michigan-based Trinity, one of the top health care systems in the nation, and Ohio-based Premier Health Partners had seen interest rates spike as high as 12% in auctions held last month as investor interest dried up amid a credit crunch and broker-dealers failed to step up.
With nearly $600 million of auction-rate debt, Trinity needed to figure out a solution to lower its costs, said Jim Bosscher, the system's vice president of finance. "We challenged our bankers to come up with creative ideas to help us deal with the problems in the auction-rate market. This product now allows us to maintain ARS but in terms where the rate is much lower."
In response, bankers at Merrill Lynch & Co. suggested the new strategy.
It worked, Bosscher said. On Feb. 12, the system saw its interest rates spike to 12% after two auctions failed. Using the revised terms, Trinity saw its interest rates drop to 2.95% earlier this week.
Premier Health Partners, which has sold about $140 million of auction-rate debt, has seen similar results, according to chief financial officer Tom Duncan.
Though Premier did not experience any failed auctions, its interest rates on auctions held throughout February rose as high as 11%. Working with Merrill Lynch, bond counsel Jones Day, and financial adviser Kaufman, Hall & Associates Inc., Premier extended both its seven- and its 35-day auction tranches to nine months, and issued a notice of unconditional tender offers for the day after the auction is to be held in November. The system also obtained a short-term rating of F1-plus from Fitch Ratings based on its self-liquidity. Interest rates dropped to 3% with the revised structure, said Duncan.
"The theory was to buy some time, let the auction-rate market calm down, and give us some time to think about how to fix the auction problem," Duncan said. "In order to make it work, we put an unconditional tender offer on those bonds so when the auction period expired in November, it gives the bondholders some comfort that there is liquidity at the end of the rainbow."
In both cases, the term extensions were permitted in the original bond documents.
Having enough cash on hand to offer the tender option is key to the strategy, analysts said. Though both Bosscher and Duncan said they believe it is unlikely they will end up buying back all their outstanding auction-rate bonds, the systems' short-term ratings are based in part on their ability to do so.
"I think it may be somewhat unique but we're going to be seeing more of it," said Fitch analyst James LeBuhn. "Many of these credits have the liquidity to do it; they're very strong credits."
He added that the restructured debt may be particularly attractive to money market buyers who hold the bonds but will now have the "security of knowing they have the ability to liquidate those bonds date specific."
Rated in the double-A category by all three rating agencies, Trinity's $600 million of outstanding auction-rate debt represents about 28% of its overall $2.7 billion portfolio. The system carried unrestricted cash and short-term investments of about $956 million as of January 2008, according to Fitch, which assigned a short-term grade of F1-plus based on the system's liquidity.
Also rated in the double-A category, Premier holds roughly $140 million of outstanding auction-rate debt - all of which is insured by Ambac Assurance Corp., which lost its AAA from Fitch and is under review by Moody's Investors Service and Standard & Poor's. Duncan said the new structure gives him time to wait out turmoil in the municipal bond insurance market.
"I don't know what's going to happen out there," he said. "Is Ambac going to get its triple-A back? There's a lot of irrationality in the market right now, and it may take some time for logic to get back into the market."
"There's no reason for these bonds to be of any concern from my perspective," Duncan added. "We've got tons of liquidity to handle our obligations. It's a nice little marriage that allows us all to get a little bit closer to what these bonds should be trading at."