CHICAGO - Joining the parade of borrowers moving to restructure their auction-rate securities, St. Louis-based Ascension Health beginning tomorrow will make three trips to market in coming weeks to convert $1.4 billion of debt with the hope that its improved credit will give the system's financings an edge.
Ascension - the largest not-for-profit health care system in the county and one of the top rated - received a one-notch upgrade from Moody's Investors Servicelast year to Aa1 on its senior-lien debt and Aa2 on its subordinated debt. Standard & Poor's rates the system's senior and subordinate bonds AA/A-minus with an outlook that was revised to positive earlier this year, and Fitch Ratings has the credit at AA-plus/AA.
All three rating agencies affirmed the credit and assigned top short-term marks.
"We think the upgrade is a big deal. There is a lot of supply coming and we think that will draw attention," said Ascension assistant treasurer Steve Gilmore. "It's a good time for us to stand on our own."
The system carries $4.3 billion of debt on its books with about 45% structured as fixed-rate and 55% with floating rates, including the auction-rate securities. Ascension's London Interbank Offered Rate index-based swaps that synthetically fix its rates on various tranches of its auction-rate securities at 3.28%, 3.99% or 4.09%, depending on the maturity of the swap, will remain in place on the restructured debt.
Citiand Morgan Stanley are the co-senior managers on the transactions. Kaufman, Hall & Associates Inc. is the financial adviser and Orrick, Herrington, & Sutcliffe LLP is bond counsel.
Various parts of the deal will be sold through a handful of conduits used by the multi-state health system. They include tax-exempt series through the Indiana Health Facilities Financing Authority, the Michigan State Hospital Finance Authority, the Missouri Health and Educational Facilities Authority, the Idaho Health Facilities Authority, and the Wisconsin Health & Educational Facilities Authority.
About half of the auction-rate securities are being converted to variable-rate demand bonds with a weekly remarketing cycle with the system providing its own liquidity in the event of a failed remarketing. The other half are being structured as serial mode put bonds. The system's finance team will decide at pricing the initial term of the serial bonds.
"We will see what the yield curve offers," Gilmore said.
Officials opted to use the dual structure given the size of its auction-rate portfolio. "We didn't want to get heavily into one bucket and wanted some diversity," Gilmore said. The amortization structure will mirror the original issues.
The first wave of borrowing will come tomorrow with about $326 million of the serial bonds, with one piece selling through the Indiana authority and another through the Missouri authority. Ascension will follow up that sale next week with another $354 million of serial bonds through the Indiana, Michigan, and Wisconsin authorities. The remainder will sell as variable-rate demand bonds with the conversion taking place as the auctions come up in April through the Idaho, Indiana, and Michigan authorities. The overall deal also includes a small $39 million taxable commercial paper component.
About $700 million of the ARS carried insurance from MBIA Insurance Corp., which retains its triple-A from all three rating agencies but carries negative outlooks. Another $350 million was insured by Ambac Assurance Corp., rated triple-A by two agencies and double-A by another, but with a negative outlook. The remaining $350 million was uninsured.
Like most other holders of auction-rate debt, Ascension saw its rates rise to a maximum level spelled out in bond documents and experienced a wave of auction failures. While rates had been on the rise late last year for some borrowers, it was not until earlier this year that rates skyrocketed and auctions failed as investors began to shun the products amid credit concerns and investment banks withdrew their support as they too worried about liquidity amid massive losses over exposure to subprime securities. Ascension's ARS are auctioned every 35 days. Once the restructuring is completed, only a small piece of the system's overall debt will carry insurance.
While others saw their rates move into the double digits, Ascension benefited from a limit built into the original deal documents tying the maximum rate to a formula based on Libor that held the increased rate to a ceiling between 4.5% and 5.5%. Though the impact was not a dramatic one, the increase still caused a spike in costs as the average rates previously were in the range of 2.5%, Gilmore said.
The system also experienced some added costs due the swaps tied to its ARS, although the system has yet to put a dollar amount on the added costs due to the collapse of the auction-rate market.
Overall nearly $3 billion of Ascension's debt portfolio is tied to swaps, with the current mark-to-market valuations mixed, with some favoring the counterparties and others favoring Ascension. In addition to the ARS swap contracts, the system has swaps under which it pays the Securities Industry and Financial Markets Association Municipal Swap Index rate on $514 million of variable debt and receives fixed rates ranging from 2.78% to 3.28%.
Ascension has $135 million of fixed-spread basis swaps on existing fixed-rate bonds under which Ascension pays the SIFMA index and receives 68% of one-month Libor plus 43 basis points. On another $631 million, Ascension pays the SIFMA rate and receives an average of 4.12%, according to Moody's.
"Given Ascension Health's strong credit position, significant investment portfolio and sophisticated treasury management we believe any risks associated with the swap transactions, including potential termination payments, do not detract from the system's overall credit position," Moody's wrote.
The system's central strength is its size and geographic diversity with facilities that generate more than $12 billion in operating revenue annually. Ascension operates 73 hospitals in 20 states and the District of Columbia.
Once the refinancing and conversions are completed, the system will hold about $1.4 billion in variable-rate demand bonds remarketed weekly and backed by self-liquidity. Another $1.2 billion will be structured in the serial mode form with staggered put dates limiting the amount that can be tendered in any week to about $700 million.
The system's liquidity position is strong with more than $6 billion in unrestricted investments that equal 205 days cash on hand. About $3.6 billion is available in total daily and weekly liquidity to cover any potential tender of bonds.
The system has seen nine consecutive years of operating cash flow growth, providing a six times debt service coverage ratio. The potential use of about $1.5 billion in annual cash flow gives the system flexibility in financing its large capital program that calls for annual spending of between $1.2 billion and $1.3 billion over the next five years. Gilmore said no new debt is planned in the near-term.
The system's challenges include managing such a significant capital program, a slightly higher than average leverage and competition posed by other prominent facilities in some of Ascension's largest markets. One specific potential trouble spot is Michigan, which is susceptible to economic and payer difficulties. Ascension's 16 facilities in the state generate about 26% of the system's operating revenues.