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Baylor Med School Treats Rate Risk With Refinancing

DALLAS — Baylor College of Medicine, the largest private medical school in the Southwest, plans to issue about $475 million of bonds next month to refinance fixed- and variable-rate debt and stabilize its financial structure, officials said.

The issues for the Houston-based medical school will come in two segments, including fixed-rate and variable rate bonds.

The bonds will bear the name of conduit issuer Harris County Cultural Education Finance Corp. Barclays and Bank of America Merrill Lynch are senior managers, with Cain Bros. as financial advisor and Fulbright & Jaworski as bond counsel.

BCM chief financial officer Kim David said the issue should appeal to institutional investors, as well as individuals. “We’re optimistic,” she said.

After the August issue, BCM will have $500 million of outstanding fixed-rate debt and $150 million of variable rate, according to David.

“We are seeking to fix rates on as much of our variable-rate debt as we can, take advantage of low rates, and to make the long-term finance as stable as possible,” David said.

Standard & Poor’s assigned an A-minus rating with stable outlook to the upcoming Baylor College of Medicine issue. “With these issuances, as well as an anticipated $150 million of variable-rate refunding debt, Baylor will streamline and somewhat reduce the risk of its debt portfolio by increasing the fixed-rate percentage, leveling debt service, revising covenants, and terminating some swaps,” wrote analyst Carlotta R. Mills.

The upcoming deals will reduce Baylor’s swap exposure to $150 million from about $200 million, including $25 million in mark-to-market losses on $79 million of collateral, according to David. The swap termination fee is negligible by comparison, she said.

“Post-issuance maximum annual debt service, although slightly higher at $38.1 million, is manageable, in our opinion, at less than 3% of 2011 operating expenses,” Mills wrote. “We understand that the college has no plans to issue additional new debt.”

Baylor’s two floating-to-fixed rate swap contracts with a current notional amount of $201.4 million used Barclays and Bank of America as counterparties. The medical school was not required to post collateral on its swaps until August 2008.

The tax-exempt series 2012A fixed-rate issue will refund a portion of the Series 2007A-1, 2007A-2, 2007B, 2008A, 2008B, 2008C and 2008E bonds, and all of the Series 1999A bonds. The taxable fixed-rate Series 2012B bonds will refund a portion of the 2008E bonds, fund the termination of about $27 million in swaps, and repay around $49 million of a line of credit. 

While the new issue will increase long-term debt by about $72 million, the two liabilities related to the line of credit and the swap will be reduced on the balance sheet, analysts noted.

The Baylor College of Medicine has made several changes in strategic direction in recent years, ultimately emerging about where it started.

After a proposed merger with operating partner St. Luke’s Hospital failed to come about, BCM announced in September 2006 a plan to build its own 256-bed, fully integrated adult clinic and hospital, Baylor Clinic and Hospital, on a 33-acre site adjacent to Michael E. DeBakey Veterans Affairs Medical Center. The college planned to combine donations and $600 million of 2007 bond proceeds, including auction-rate securities, to fund construction.

The issue came just as the auction-rate market was freezing up. In 2009, construction of the hospital was postponed for lack of funds.

Last March, Baylor decided not to finish the hospital but to convert the building to outpatient clinics. The college will rely on private philanthropy to complete construction in stages by 2015, according to officials.

The new clinic will begin seeing patients next year, plans indicate. Amid the economic upheaval, the medical school considered a merger with Rice University in 2009, but the proposal was ultimately abandoned by the boards at both Houston institutions.

Then, Baylor University, which had operated the medical school until the facility became an independent entity in 1969, began considering stronger ties to the medical school after the merger with RIce failed. However, the board of Baylor Medical College decided to retain its independent status.

Located in Houston’s Texas Medical Center, among the largest concentrations of medical facilities in the world, BCM works with several nearby hospitals. They include Texas Children’s Hospital, the University of Texas System’s MD Anderson Cancer Hospital, the VA Hospital, the Harris County Hospital District, St. Luke’s Episcopal Hospital, and Methodist Hospital.

This year’s refinancing deals come amid heated political rhetoric and varying opinions about the impact of the federal Affordable Care Act that was narrowly affirmed last month by the U.S. Supreme Court. However the court allowed states to opt out of the expanded Medicaid program that would provide health insurance to more Americans.

Texas Gov. Rick Perry announced that that his state would reject an estimated $62 billion in federal funds for Medicaid expansion and not participate in subsidized health care exchanges to lower the cost of insurance.

“We were doing this refinance regardless of what was happening with the health care act,” David said. “From a business standpoint, more people will be insured, so for us, that’s a good thing.”

Moody’s Investors Service declared the Supreme Court’s endorsement of the Affordable Care Act in itself as credit neutral, while noting that the act itself is a negative for the nonprofit hospital sector because Medicaid payments to such hospitals will be reduced.

Standard & Poor’s and Fitch Ratings viewed the action more positively, though S&P warned that very few states may actually participate.

“How successful hospitals and health systems are in managing this transition and its related risks will be an important credit consideration for several years,” Standard & Poor’s analysts wrote after the 5-4 Supreme Court ruling in favor of the new health insurance law.

“This risk will worsen in the years ahead, but to date, the sector has managed transition risk well, although it has not been without challenges,” they wrote.

“For example, the higher capital and operating costs required to implement transformational strategies have strained income statements and balance sheets in some cases and caused some providers to join with stronger partners to better position themselves for the future,” the S&P analysts noted.

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