CHICAGO - After years of near financial collapse, Detroit's largest safety-net hospital is enjoying its fourth straight year of operating profitability and now hopes to enter the bond market for the first time in a decade to generate proceeds that would continue to bolster that performance.
Detroit Medical Center's planned $340 million bond sale comes amid intense market turmoil and weakness that has prompted many issuers over the last two weeks to postpone their sales. DMC's finance team is aiming for a mid-October sale, but is willing to delay the sale until it sees attractive interest rates and yield curves as well as sufficient investor interest in below-investment-grade double-B rated bonds, said the center's chief financial officer, Jay Rising.
Proceeds from the bond sale would bolster DMC's continued improvement by addressing two key credit challenges - its thin liquidity position and depressed capital expenditures over the past several years.
Ahead of the sale, Fitch Ratings this week boosted the credit two notches to BB from B-plus and revised its outlook to stable from positive. The upgrade reflects the system's year-over-year improvement in operating performance as well as other factors, said analysts.
Standard & Poor's affirmed its BB-minus rating with a stable outlook, praising the system for recent improvements, but warning it still faces several challenges. Moody's Investors Service has not yet rated the new debt. It currently maintains a Ba3 rating with a stable outlook on its outstanding debt. The credit is still several notches below investment grade.
The largest provider of uncompensated care in the state, DMC operates eight hospitals, five of which are located in downtown Detroit. It's the main safety-net hospital for Detroit, whose economic problems, particularly with unemployed and uninsured residents, present an ongoing burden to the system.
Of the $340 million bond issue, roughly $140 million would refund outstanding fixed-rate debt. Another $85 million would be used to reimburse the center's cash budget and build its liquidity, and another $80 million would finance a series of new capital projects at the system's Detroit campus. Among the new projects is a new pediatric outpatient center at DMC-Children's Hospital of Michigan.
The bonds will be structured as traditional fixed-rate bonds. DMC has a total of roughly $520 million in outstanding debt - all of which is fixed rate. "We just never [issued variable rate] - we're lucky," said Rising, who was Michigan's treasurer before he joined DMC three years ago.
After the upcoming sale, the system will have about $675 million in outstanding debt.
Merrill Lynch & Co. is senior book-runner on the transaction. Kaufman Hall & Associates is DMC's financial adviser, and Miller Canfield Paddock & Stone PLC is bond counsel. The Michigan State Hospital Finance Authority will act as conduit issuer.
For several years prior to 2004, DMC suffered major annual losses, some of which totaled more than $100 million annually. In 2003, the state joined with Wayne County and Detroit and gave an emergency one-time $50 million subsidy to DMC to help with uncompensated care costs.
New management took over about four years ago and implemented a series of changes that helped boost performance across the system. Chief among the shifts was chief executive officer Michael Duggan's role in pushing a new state program that increased Medicaid reimbursement. As part it, DMC in 2007 received more than $50 million in additional payments - key to boosting current and future profitability, according to analysts.
The bond sale would improve the center's chances of an upgrade in the future, according Standard & Poor's. "Completing the transaction would put DMC in a better position to achieve a higher rating in the long term," analyst Liz Sweeney wrote in a report on the upcoming sale.
Last year the system reported its third year in a row of operating profitability, "an impressive achievement given DMC's substantial uncompensated care burden, generally flat volumes, and the size of the losses that had to overcome to reach profitability," Sweeney said.
But DMC's poor liquidity - translating into about 30 days cash on hand - remains a big challenge to its credit, warned analysts. Building that liquidity is system's top priority over the next five years, with a goal of achieving 50 days cash on hand by 2010, said Rising. DMC will use a chunk of proceeds from the upcoming bond issue to boost its liquidity by four days, and the system's five-year capital plan is geared around restoring its liquidity, he said.
Despite its importance to DMC's fiscal situation, Rising said he would be willing to postpone the transaction until the market recovers from its current malaise.
"It's hard to understand what the market is going to do in one day, let alone in two weeks," he said. "We need rates that make our refunding still look reasonable, and we have a fair amount of shortness in our deal, so it's partly the yield curve as well. The long run could be 7.5% to 8% and still not bother us a great deal if the yield curve looks really good. If the curve is flat and my short is nearly the same as my long, then I've got a bigger concern."
On the underwriting side, Rising said he expects no impact from Merrill's planned acquisition by Bank of America Corp. due to close early next year. "They're still expressing their willingness and ability to underwrite the deal and get it sold," he said, adding he chose Merrill in part because of the firm's experience selling double-B rated health care bonds.
Part of the reason for DMC's thin liquidity is that it has spent the last few years making large contributions to its pension plan, said Rising. In both 2006 and 2007, the health care system contributed $96 million to the plan, a move that decreased to 24 the system's days' cash on hand by the end of fiscal 2007.
"That was a real drain on cash, and it came at a time when the system was starting to recover financially, and it got sucked up by pension funding," Rising said. However, as a result of these large recent contributions, the pension plan is now fully funded - as well as frozen, with no new members or benefits - and officials expect future hospital contributions to drop considerably.
The fully funded pension plan now is one of the bright spots in the system's fiscal profile, along with a costly decision a few years ago to invest in a sophisticated medical records system that won DMC national recognition for its information technology.
"Everyone else is going to have to catch up with us on pension and IT," Rising said. "It really drained our cash for the past couple years, but it put us in a great position."
