A $681 million bond deal sold in late April to fund the merger of Mt. Sinai and New York University Medical Center was clearly a test of the municipal market's ability to digest borrowings in a troubled sector. But it was not only the huge size of the issue -- the largest so far in the health care sector this year -- that caught investors' attention. Buyers were also intrigued by its lack of bond insurance and the use of a new Internet-based marketing system to sell the debt.
Cheryl Ishmael, managing director for public finance at the New York State Dormitory Authority, the issuing agency through which the bonds were sold, said the size raised capacity problems for the insurance companies, preventing them from participating.
"Retail tends to buy higher-rated, insured bonds, so this is a test, being sub-A-rated," said Richard Kolman, co-manager of underwriting at Goldman, Sachs & Co., senior manager on the issue.
HELP FROM THE INTERNET
But Kolman also said that a new electronic platflorm that Goldman used to sell the deal over the the Internet was a big help. The underwriter had used the system once before for a deal sold in mid-March for the Commonwealth of Puerto Rico.
''This was Goldman's second e-bond offering in the marketplace and I don't think there's any question the e-process widened the overall investor base,'' he said. ''By having information out there for two solid weeks, combining the e-process with the road show allowed us to reach out to many more investors and develop a good support based despite what's beeen going on in the market.''
Goldman officials said that by giving investors access to the electronic road show on Goldman's secure site, they will get automated answers for all the most frequently asked questions, while the firm's sales staff will be able to concentrate on addressing other, more complicated concerns.
The deal ended up including both new-money and refunding debt sold on both a tax-exempt and a taxable basis. The $499.94 million of tax-exempt fixed-rate bonds were sold first. The remaining variable-rate taxable and tax-exempt debt were sold a bit later. This included $95.1 million in taxable variable-rate debt, which defeased a 1992 Mount Sinai refunding.
Under IRS rules this piece cannot be advance refunded on a tax-exempt basis, but can be current refunded tax-free when the underlying bonds are callable in 2002. Moody's Investors Service rates the bonds Baa1, Standard & Poor's BBB-plus, while Fitch IBCA Inc. rates them A-minus.
Despite the lack of insurance, the Dormitory Authority thinks it has offered a very tight security. Borrowing an idea from New York's school debt guaranty program, the agency has created a direct intercept "lockbox" account that will capture Medicaid payments to the system to make debt service payments, Ishmael said. The hospitals will then receive what is left over in the account after debt service has been paid. In addition, the issue features pledged mortgages on the core facilities of Mount Sinai, NYU, and the Hospital for Joint Diseases, debt service coverage and a cushion ratio of 1.25 times, as well as 45 days cash on hand.
RENOVATIONS FUNDED
New money proceeds will be used to finance a wide range of renovations at Mount Sinai Hospital, New York University, and the Hospital for Joint Disease. Much of funding will be used to upgrade clinical equipment and information systems at the hospitals.
While the lockbox feature is a structural strength, the deal contains a "significant structural weakness," said Howard Manning, director of health care at Raymond James & Associates Inc. in Boston. In this case, the mortgages are pledged to the authority, depriving the bondholders of true first mortgage rights. The authority can -- without investors' consent -- release the mortgage, should the hospital system enjoy strong financial health during the life of the loan, and that leaves investors unprotected, Manning said. "I find that unacceptable," he continued. "I, as a bondholder, would want to have a first mortgage."
Others, meanwhile, said the added allure of attractive yields helped them swallow the risks. This is even more true in a sector "that has been looked at fairly skeptically by some investors," said Bob Lindberg, a portfolio manager at Fortis Inc. in New York. "People who are at all hesitant about health care will have to make a credit decision."
Portfolio managers said the improving financial performance of the hospitals in the obligated group, however, was a strong selling point on the deal. Officials at the system expect that over time, the hospitals -- which agreed to merge in 1998 -- will continue to see the benefits of consolidation and demonstrate that the strength of the system is at the A-rated level.
"The insurance question aside, Mt. Sinai is a high-level tertiary system and academic medical center with a strong market share in top specialties,'' said Gene Caponi, senior credit analyst with the Scudder Group, which approved the bonds for purchase. "We think it has some fundamental strengths long-term within the triple-B rating category.''
The system's liquidity, cash-on-hand, and other measures reflect financial strength in the high triple-B range, said Fitch director Craig Kornett. But, he added, the Mount Sinai-NYU affiliated system has a strong management team that should be able to produce improved bottom-line performance over the next three to five years, bringing their ratios in line with the A-minus rating.
STRENGTHS AND WEAKNESSES
The Mount Sinai-NYU affiliated system showcases many of the strengths and weaknesses of the New York City market. Mount Sinai and NYU both have world-class reputations and prestigious teaching facilities and draw many patients from outside the New York area. But the affiliated system -- though not the obligated group on the bond sale -- includes the financially troubled New York Downtown Hospital, also known as Beekman Hospital.
New York Downtown, which was a member of the expired state-backed "secured hospitals" program for financially troubled facilities, has a track record for losing money, with an operating margin of -8.9% for 1998. Unaudited results for the first six months of 1999 show "a slight improvement" with a -6.7% margin, according to Kornett. System management is not likely to let New York Downtown remain a drain on the bottom line, he said. But that does not mean New York Downtown's performance has no bearing on the long-term health of the system, he added.
If financial performance at New York Downtown does not improve, Mount Sinai-NYU may want to consider altering Downtown's mission, perhaps more toward ambulatory care, Kornett said. But New York Downtown also serves an otherwise underserved part of the city -- Manhattan's Chinatown and Lower East Side -- and it may be politically difficult for management to win approval to significantly alter the hospital's role in the community, Kornett noted. However, even with a static role, New York Downtown has other assets that may contribute to the bottom line of the system, he said.
The hospital owns an approximately one-million-square-foot parking garage. Located in lower Manhattan between the heart of the financial district and the South Street Seaport, the garage -- which may be one of the largest sites available for development in the city -- could be a very valuable asset should the system seek to sell it, sources note. However, a Goldman Sachs official said a sale of the garage is not part of the financing plan for this deal.
ROAD TO MARKET
The deal almost didn't get done through the Dormitory Authority. While ratings for the transaction are investment-grade, they do not meet the usual credit standards of the agency for issuing unenhanced debt. Traditionally, the agency has required bond insurance for issuers whose ratings do not equal or surpass the single-A general obligation level of the state's rating.
But the Goldman official said that under rules the Dormitory Authority revised last summer, the agency has the discretion to approve financings with lower ratings that do not have insurance. However, it would not make a decision on approving a financing under the revised rules until all the details of the transaction were settled.
Additional reporting by: Christine Albano, Sean Montsarrat
