County steps in to buy two of bankrupt California chain's six hospitals

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A bankrupt California hospital system has agreed to sell two of its six hospitals to Santa Clara County.

Verity Health System filed for Chapter 11 bankruptcy on Aug. 31 just three years after a deal put the troubled nonprofit under a hedge fund's management.

The health system had $459.2 million in long term debt outstanding and $254 million of pension liabilities as of June 30, 2017, according to its comprehensive annual financial report posted on the Municipal Rulemaking Securities Board’s EMMA website.

Verity held an auction Monday to sell O’Connor Hospital in San Jose and Saint Louise Regional Hospital in Gilroy, and the county was the only bidder.

“O’Connor and Saint Louise are two critically important institutions in the communities they serve, and the county has shown great leadership to ensure both can continue their mission of providing high-quality care to patients well into the future,” said Rich Adcock, CEO of Verity Health, in a prepared statement.

The county had offered to buy the local facilities in October as part of the bankruptcy process. Verity had been in discussions with more than 100 organizations looking at various parts of the hospital system, but none put in a bid.

The two hospitals and DePaul Center, an urgent care clinic in Gilroy, sold for $235 million, the price set when the county entered into an agreement to acquire the hospitals on Oct. 5. The sale still has to be approved by the bankruptcy court. The final sale order hearing with the U.S. Bankruptcy Court for the Central District of California in Los Angeles is slated for Dec. 19.

The chain has two Los Angeles-area hospitals, St. Francis Medical Center and St. Vincent Medical Center, and four northern California hospitals; O’Connor, St. Louise, Seton Medical Center in Daly City and Seton Coastside in Moss Beach.

Verity Health continues to seek buyers for the other hospitals.

“At this stage, we have no official buyer to announce for the other hospitals, but our every hope is that prospective buyers maintain our core objectives: quality healthcare and employment for all,” Verity told The Bond Buyer. “We remain focused on finding such a buyer for the remaining hospitals and throughout this time, they remain open.”

The company’s board of directors has said previously they prefer to sell some or all of the hospitals to buyers who would continue to provide health care, rather than convert the property to housing, offices or shops.

Verity, formerly Daughters of Charity Health System, has been struggling financially for several years, but the move by current owner Nantworks to file for bankruptcy protection took hospital employees by surprise, said David Miller, director of research for SEIU-UHW, a union that represents nearly 2,000 workers at four Verity hospitals.

The hospital system was renamed Verity after Integrity Healthcare, a company created by New York hedge fund BlueMountain Capital Management, took over management of the hospitals in July 2015. Last summer, Nantworks, a Culver-City company controlled by billionaire Patrick Soon-Shiong, who owns the Los Angeles Times, purchased Integrity.

“We were at a loss,” said Miller of the union’s reaction to the bankruptcy filing.

Soon-Shiong is worth $8 billion, Miller said. “We assumed he knew it would be a slow turn-around. We don’t know why he took over Blue Mountain and then tossed it into bankruptcy so quickly.”

Ultimately, the decision to file for Chapter 11 bankruptcy was not up to Soon-Shiong, whose firm owns Integrity, the company that managed the hospital system. In the end, the decision to restructure the hospital system under bankruptcy protection was made by the board of the non-profit Verity.

The Verity board made the decision “after a diligent process of assessing all possible options with Verity’s financial and legal advisors,” Verity officials said. “It was the best strategic decision for all of our patients, employees and other stakeholders.”

“The financial and operational issues facing Verity are born out of a myriad of inherited, historical challenges,” Verity said. “Operating losses had plagued the system’s predecessor for some time due to, among other things, challenging cost structure, low reimbursement rates and the ever-changing healthcare landscape.”

Daughters of Charity unsuccessfully explored a merger with Dignity Health and Providence in 2014. Prime Healthcare Services then pulled out of a proposed purchase agreement when then-California Attorney General Kamala Harris added conditions Prime found to onerous. Daughters of Charity finally reached a purchase agreement with Integrity.

Not long after Soon-Shiong purchased the company last year, he “got in front of union members and said he would be the last employer they would ever know," Miller said. “He took a senior debt position on the 2015 bonds, so he’s trying to get paid 100%, which would cut some worker’s pensions in half."

Verity said at the time of the bankruptcy filing that it has secured $185 million of debtor-in-possession financing.

The bankruptcy affects Daughters of Charity Health System Series 2005A and Daughters of Charity Health System-St. Francis Medical Centers Series 2005G and 2005H bonds issued through the California Statewide Communities Development Authority, a conduit issuer. It also affects 2015 notes issued for Verity Health through the California Public Finance Authority, a conduit issuer.

In addition to the $459.2 million in long-term debt, in May 2017 Verity also closed on a Commercial Property Assessed Clean Energy funding of $40 million to finance seismic upgrades to the Seton Medical Center campus to comply with California's earthquake safety laws.

Verity has $167.6 million in principal payments due on its debt in 2019.

The original filing includes a 2,781-page list of creditors.

The workers had an unregulated pension plan like other Catholic hospitals, but the pension was shifted to ERISA coverage when Blue Mountain purchased the hospital chain. The pensions were on a five-year course to become fully insured and funded. Since the company was placed in bankruptcy protection two years later, the pensions are only about two-fifths funded, Miller said.

Prime, Good Samaritan and Tustin, California-based KPC Healthcare have been floated as potential buyers of the three Southern California hospitals, Miller said. The most troubled hospital in the chain is Seton in Daly City because it needs earthquake safety improvements.

The Lynwood City Council voted in September to launch a bid to buy St. Francis in September. Lynwood city officials didn’t return calls about the status of that effort.

St. Francis, as a trauma center, is not only the most important safety net hospital in the system, meaning there aren't other options in the area, but, according to Miller, it's probably the one that will draw the most interest, because it is relatively profitable.

When Blue Mountain purchased the hospital, the hedge fund had to agree to a slew of requirements from the state attorney general’s office. But now that the hospital system is in bankruptcy, it’s not clear how much power the AG has to preserve the hospitals, some of which serve low-income communities.

The AG's conditions also don't come into play for Santa Clara County, because it's a public entity. The office just guides the sale of non-profit hospitals to private entities.

“I think we will see a negotiated settlement, rather than have either side brook a confrontation with the attorney general,” Miller said.

Whether the remaining hospitals provide the same services they do today remains to be seen. Long-term acute care facilities, outpatient or a rehabilitation facility are all possibilities, Miller said.

“There are a lot of other unmet medical needs in California, the facilities could provide,” he said.

Verity Health System's long-term rating lowered to CC from CCC by S&P Global Ratings on Sept. 17. The ratings agency gave the health system a negative outlook when it announced the downgrade.

The lowered rating reflects S&P's “view that the issuer is currently highly vulnerable to nonpayment over the next 12 months,” according to the report.

Management indicates that the system intends to continue to make its interest payments to the trustee during the proceedings, analysts wrote. The negative outlook reflects the inherent risk of missing a debt service payment over the next 12 months, analysts wrote.

S&P defines a CC rating as an obligation currently highly vulnerable to nonpayment. The CC rating is used when a default has not yet occurred but S&P expects default to be a virtual certainty, regardless of the anticipated time to default.

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