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Providence Health Prices Deal for California Acquisition

LOS ANGELES - Providence Health & Services priced $117.3 million in revenue bonds on Wednesday that helped finance the acquisition of a Santa Monica, Calif. hospital.

The chain's buyout of St. John's Health Center is one of many mergers and acquisitions in a nonprofit healthcare landscape being reshaped as hospitals grapple with financial pressures, including those brought by the federal Affordable Care Act.

This week's deal is the second in a series totaling $392 million Providence sold through conduit issuer California Health Facilities Financing Authority.

The bond sale was take-out financing on commercial notes issued earlier in the year to help pay for its acquisition of St. John's. The purchase price of the hospital has not been disclosed.

Many stand-alone hospitals, like St. John's, have struggled to compete without crucial ties to healthcare providers, which help the hospitals to obtain patient referrals and provide leverage with healthcare insurers.

Dan Wilson, a director at National Public Finance Guarantee, said there are many incremental pressures on the healthcare sector.

"There is declining commercial payor reimbursement and Medicare reimbursement challenges -- hospitals are running into issues of lower volume and lower payments," Wilson said.

Those incremental pressures mean that hospitals are looking at how they can find ways to cut costs and weighing if they can remain a smaller system or if it is better to merge with a larger system to get cost advantages, Wilson said.

The trend has been beneficial to Providence, which has "a track record of being strategic and opportunistic," according to Brad Spielman, a vice president on Moody's Investor Services healthcare team.

The acquisition, finalized in March, brought the number of Providence-owned hospitals in the Los Angeles area to six. The Renton, Wash.-based hospital system owns 30 hospitals in five western states.

Providence earlier issued $275 million Series 2014A revenue bonds on June 11, also through CHFFA.

The bonds received AA, Aa3, and AA-minus ratings from Fitch Ratings, Moody's Investors Service and Standard & Poor's, respectively.

The June Series 2014A bonds with maturities from 2015 to 2034 priced with yields from .18% to 3.76%, according to the official statement.

That deal also included $53.2 million in 2038 term bonds at a 4% coupon priced to yield 4.11% and $53.2 million in 2038 term bonds at a 5% coupon priced to yield 3.83%.

Bank of America Merrill Lynch was the underwriter for both bond series.

This week's Series 2014B deal brought two tranches of 2044 term bonds: those with a 4.25% coupon priced to yield 4.25%, while 5% coupon bonds priced to yield 3.93%, according to Thomson Reuters data.

Providence had to clear the purchase of St. John's through the California attorney general's office and the Vatican before the sale could go through.

Denver, Colo.-based Sisters of Charity of Leavenworth Health System placed St. John's on the market following an extensive management shake-up in November 2012 in which the health system fired most of the local board members and ousted the top two executives.

The Santa Monica-based hospital also wasn't a natural fit for the Denver hospital system as the only hospital it owned in California, in contrast to Providence, which had a large footprint in California, Spielman said.

"Not only is Providence large, but they are contiguous," Spielman said. "They are very geographically-focused."

Providence hospitals are in Montana, Oregon, Washington, California, and Alaska. Its network is also geographically focused within each state. In Alaska, the hospitals it owns are in Anchorage.

Other bidders for St. John's included a foundation affiliated with Los Angeles billionaire Patrick Soon-Shiong, and other Catholic hospital chains.

After final approvals, in March 2014 Providence formally took control in of the 234-bed hospital and the John Wayne Cancer Institute, which has been affiliated with St. John's since 1991.

Renamed Providence St. John's Health Center, the hospital has 1,600 employees and 1,000 physicians.

Providence had $3.78 billion of long and short-term debt as of Dec. 31, 2013, according to the offering documents.

"This bond issuance and an additional debt series expected later in 2014 were incorporated in our rating review in June 2014," Spielman said.

Total pro forma debt is expected to increase by roughly $239 million or 6.5% over what was reported for fiscal year 2013, he said.

Moody's Aa3 rating reflects "strong underlying credit fundamentals, including Providence's large footprint, its good diversification of cash flows, its leadership in most of its markets, its strong management team and its overall commanding revenue base," Spielman said.

Credit challenges include three years of weaker operating performance, balance sheet and debt measures that are notably thinner than medians for the rating category, and high comprehensive debt inclusive of unfunded pension liability and operating leases, according to the Moody's report.

Providence produced relatively poor operating results in fiscal 2013, with the operating cash flow margin dropping to 6.9% from 8.3%. This represents the third year of operating results that are below historical levels.

The operating results compelled Moody's to downgrade Providence from its Aa2 rating in 2013 and assign a negative outlook. The recent report affirmed the Aa3 rating but gave the hospital system a stable outlook.

Providence Health has sizable indirect debt, with an unfunded pension liability of $819 million for fiscal 2013 at 68% pension funded ratio and operating leases with a debt equivalent of $1.09 billion based on six times current lease expense, according to Moody's report.

While holdings of unrestricted cash and investments have improved, liquidity ratios remain relatively modest for the rating category, with 181 days cash on hand at the end of fiscal 2013 compared to the Aa3 median of 239 days, according to the report.

All three major rating agencies assign a negative outlook to the nonprofit healthcare sector.

"The sector as a whole will face weakening business conditions and contracting margins as not-for-profit hospitals adjust to changing dynamics brought on by the Affordable Care Act and insurance companies, employers and other industry participants seek to control healthcare costs," Daniel Steingart, author of the Moody's sector report, said when it was released in November.

But some analysts say the sector offers opportunity for canny investors.

"In our view, the excess yield available on healthcare bonds more than compensates for the higher default risk," Barclays analysts wrote in their Municipal Healthcare Monthly report in May. "We think that the risk premium for hospitals is excessive given the limited default history."

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Realization of efficiencies influenced by economies-of-scale have generally been viewed as a positive and the impetus for M&A activities in the corporate world. Why should the health care sector be exempt from becoming more efficient? While there will be bumps and bruises along the way, they are the realities of changes required to attain longer-term benefits. For example the mega-retailers provide consumers with quality products at prices a local or mom and pop retailer cannot match. While not relishing this fact, it's a harsh reality and has influenced consumer behavior. The health care sector has not been influenced by direct consumer participation because of how hospitals were able to charge costs that were not reflective of a competitive marketplace and the direct payers (health care insurance companies) were usually not the end users. Employers will still represent a significant source to provide health care insurance, but the choices are greater today than before. And, those who are not covered by employee-sponsored programs can purchase health insurance directly, or seek to qualify for governmental programs. Consumers being able to choose an insurance provider based on costs and coverage levels gives them a far closer role to the health care providers than ever before. The health care insurer has to consider market influences when presenting the level and quality of their service coverage. Efficiencies come into play for the insurers and because they are the direct payers, they will require the same the hospitals. Economy-of-scale principles become particularly important and less efficient health care providers will feel the pressure. Consolidations through acquisition to realize efficiencies become the tool of survival.
Posted by Michael.ross1904@yahoo.com | Friday, July 18 2014 at 8:25AM ET
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