CHICAGO — Michigan’s largest charity-care provider, already junk-rated, saw its outlook revised to negative by Moody’s Investors Service Monday.
The rating action comes as the state still needs to give final approval for the Detroit Medical Center to be sold to a for-profit health care company for $1.5 billion.
Moody’s assigned the negative outlook to $500 million of bonds issued by Ba3-rated Detroit Medical Center. Analysts warned that the system faces a difficult operating environment and fresh pressure from looming pension contributions and capital needs.
The rating action comes as DMC and Tennessee-based Vanguard Health Systems Inc. await word from the Michigan attorney general on whether the proposal can go forward.
A high-profile transaction that has attracted national attention, the acquisition would mean an $800 million investment in Detroit — the single largest in the troubled city’s history.
Attorney General Mike Cox, who is embroiled in a re-election campaign, is expected to rule in October. If approved, the transaction would likely close by Nov. 1.
Moody’s said the pending acquisition has no impact on its current Ba3 rating for the center.
DMC owns eight hospitals, five of which are located in downtown Detroit. It’s a rare debt issuer, having last sold bonds in 1998. Management had planned to issue $340 million of new-money and refunding bonds in October 2008, but pulled out as the market crashed. The lack of capital spending has led to pent-up demand for improvements, which is part of the pressure facing the system, Moody’s said.
As of fiscal 2009, DMC reported three straight years of declining admissions. Operating income fell to $8.8 million in fiscal 2009 from $45.1 million in fiscal 2008. Part of the decline was due to a $20 million increase in pension expenses.
The health care system is likely to face liquidity pressure as it begins to contribute to its highly underfunded — and frozen — defined-benefit pension plan, according to analyst Kay Sifferman.
“DMC continues to manage through a difficult operating environment, but we have concerns on a go-forward basis as the organization faces increased demands on an already weak liquidity balance to fund its pension obligations, operates in a service area with high unemployment and declining inpatient utilization that is contributing to low revenue growth, and addresses low capital spending over the past several years,” Sifferman wrote in a release on the outlook revision.
If the deal is closed, DMC is expected to call and defease all of its bonds within 90 days, with Vanguard financing the transaction. Vanguard also agreed to fund $278 million in pension obligations.
The price of DMC’s bonds has risen since the Vanguard deal was announced in March. As of last week, bonds with a 2028 maturity had a yield of 5.9% compared to 7.9% in April.
The Michigan State Hospital Finance Authority has issued all of DMC’s debt. Standard & Poor’s assigns a BB-minus with a stable outlook to the credit. Fitch Ratings rates it BB, and put it on positive watch in March after DMC announced the proposed acquisition.
Under the deal, Vanguard would pay $417 million for DMC and pay to defease all its debt.
Vanguard also agreed to spend $850 million on capital improvements, including $800 million in Detroit. The city would need to set up a tax-free renaissance zone on DMC’s central campus. The zone would allow Vanguard to avoid local property taxes for 15 years.
As part of the deal Vanguard has agreed to spend $800 million on DMC’s Detroit facilities. Vanguard, which owns 15 hospitals in large cities across the country, promised it would keep open all of DMC’s hospitals and follow its charity-care guidelines for the next 10 years. The system is the largest provider of uncompensated care in the state.
