Univ. of Chicago Hospital to Kick Off Big Construction Deal

CHICAGO - The University of Chicago Medical Center on Tuesday will sell the first tranche of a $225 million issue to begin a $500 million borrowing that will help fund a $700 million, 10-story, 240-bed hospital pavilion.

The hospital will enter the market with $50 million of fixed-rate bonds on Tuesday and follow up that sale with another $175 million of variable-rate bonds later in the month. The fixed piece is structured tentatively in 20- and 30-year terms, according to financial adviser Mark Melio.

The Illinois Finance Authority is acting as issuer on behalf of the low-double-A rated hospital. JPMorgan is the senior manager and Barclays Capital is co-senior manager on the fixed bonds. Cabrera Capital Markets LLC and Loop Capital Markets LLC are co-managers. Melio & Co. is financial adviser and Jones Day is bond counsel.

One floating-rate series for $75 million will carry a letter of credit from Bank of America and the other for $100 million will carry a LOC from JPMorgan Chase Bank. Interest rates on both will at least initially be reset daily. Merrill Lynch-Bank of America and Barclays are remarketing agents on the $75 million piece and JPMorgan and Loop are remarketing agents on the other.

Proceeds will go towards the financing for the new tower. Construction began this past spring and the building is slated to open in 2013. The hospital will follow up this year's issue with sales in 2010 and 2011. The hospital is also using cash and donations to pay for the tower.

"This is a project that is central to our core strategy," said Lawrence Furnstahl, the hospital's chief financial and strategy officer. "This will be the new physical home for our strongest programs" like oncology, neurosciences, and advanced surgery.

The hospital project has long been in the works to replace aging buildings that cannot handle new technology. Officials settled on a financing plan three years ago, before the market turmoil of last year that has hit health care borrowers exceptionally hard.

"We put in place several years ago a structure for the financing that anticipates $325 million of synthetic fixed-rate debt and $175 million of fixed-rate debt," he said. "That has not really changed."

Furnstahl said while costs have risen for letters of credit, the hospital benefited from interest from several banks, including JPMorgan, which is counterparty on its forward starting swap tied to all of the hospital's planned floating-rate borrowing for the new hospital.

The hospital entered into a forward starting swap in August 2006 on all of the $325 million. The start date is in 2011 well into the construction process, and it ends in 2044.

Under the swap, the hospital will pay JPMorgan a fixed rate of 3.890% and receive a floating rate of 68% of the London Interbank Offered Rate. The net termination value of the swap was a negative $48.4 million last month, according to Moody's Investors Service. Furnstahl said the swap agreements do not include any collateral posting requirements tied to the swap valuations.

The recession and the hospital's efforts to trim costs amid a drop in revenues prompted the hospital to rebid some contracts, pushing construction that was set to start in January off until May. The delay has proved beneficial in the hospital's market timing.

"The construction has allowed us to enter into a calmer market," Furnstahl said.

Ahead of the sale, Fitch Ratings and Standard & Poor's affirmed the hospital's AA-minus credit although Standard & Poor's revised its outlook to negative. Moody's affirmed its Aa3.

"The negative outlook is based on our view of UCMC's light maximum annual debt service coverage, balance sheet erosion coupled with the new debt issuance, continued funding and construction risk associated with the $700 million pavilion project, and operational challenges in the first half of fiscal 2009," wrote Standard & Poor's analyst Brian Williamson.

The hospital's strengths include its close affiliation with the University of Chicago and the federal government's approval of the state's hospital assessment program that will provide the hospital with an additional $30 million this year.

The hospital also benefits from its status as a nationally recognized academic medical center that provides a broad array of services and a strong and experienced management team with a track record of generating profits, Moody's wrote.

Its challenges include an increased debt load that will lower peak debt service coverage to 3.3 times, construction risks associated with the new pavilion, and a significant decline in unrestricted liquidity due to the market turmoil of the last year.

Unrestricted cash and investments fell to $618 million at the end of April from $842 million at the close of fiscal 2008 on June 30, 2008. The hospital faces a competitive operating environment as one of five academic medical centers in the region and has high exposure to Medicaid, which represents about 23% of its gross revenue.

"Fitch's primary credit concerns are the increased leverage associated with the construction of the new hospital pavilion, funding cuts to community-based providers in UCMC's immediate service area, and the competitive Chicago metropolitan service area," analysts wrote.

The hospital has recorded profits in most recent years except for fiscal 2006. It showed a profit of $41.9 million in fiscal 2008. The hospital's balance sheet did erode, however, in the first half of fiscal 2009 due to the economy's effect on its investments and the decisions by some patients to put off medical treatments.

A decline in cash and investments cut debt service coverage to 2.1 times through May. The hospital undertook cost-cutting measures, including layoffs, to improve operations and expects those measures to improve its year end results although they are expected to lag 2008's results.

The hospital's balance sheet has also benefited from its Urban Health Initiative, in which the hospital partners with nearby community hospitals, steering patients in need of general care to those facilities. The program started as the South Side Health Collaborative, under which the hospital referred the uninsured who were not in need of immediate care from the emergency room to local providers.

It was designed to address the community's health care needs in a more cost-effective and collaborative manner to free up resources for the medical center's educational, research, and patient care missions. Some community activists, doctors, and elected officials, however, have been critical of the program - which First Lady Michelle Obama helped launch during her tenure at the hospital - arguing it provides a means for the hospital to push care of the indigent on to other facilities.

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