Highmark Inc. wasted no time implementing its takeover of West Penn Allegheny Health System after the Pennsylvania Insurance Department approved the affiliation agreement between the two Pittsburgh organizations.
Blue Cross Blue Shield insurer Highmark closed late Monday on the $604 million deal, in which bondholders took a haircut on all Series A bonds that the Allegheny County Hospital Development Authority issued for West Penn in 2007.
Both parties said in January that the bond haircut arrangement would save West Penn from filing for bankruptcy protection. Holders were offered 87.5 cents per dollar of principal, plus accrued interest through closing date, on the $709.7 million outstanding debt, according to a disclosure document filed on the Municipal Securities Rulemaking Board’s EMMA website.
Highmark on Monday also folded teetering West Penn into a new integrated care delivery system, Allegheny Health Network. The network includes Jefferson Regional Medical Center in South Hills, Pa., which Highmark acquired on March 1.
“This is a new day for health care in western Pennsylvania,” Highmark chief executive William Winkenwerder told reporters. Highmark aims to compete head-on with the region’s dominant provider, University of Pittsburgh Medical Center.
The Insurance Department’s approval, also on Monday, attached conditions designed to preserve competition. They included limits on contracts between Highmark and other hospital networks to five years, with state approval necessary for any going longer; a ban on “most-favored nation” contracts enabling Highmark to treat West Penn more favorably than other area hospitals; and clauses that require state approval for Highmark to spend more than $250 million or if any spending puts Highmark’s “risk-based capital” ratio below 525%.
“Safeguards have been put in place to protect the community and consumers. Highmark will be accountable for policyholder savings and maintaining competition, and has made a long-term commitment to charitable endeavors within the community,” Gov. Tom Corbett said in a statement.
West Penn’s roughly $752 million issue in 2007 made it one of the largest junk-grade issuers in the municipal marketplace - the deal came with across-the-board double-B ratings.
Established in 2000 after the demise of bankrupt predecessor Allegheny Health, Education and Research Foundation, West Penn is western Pennsylvania’s second-largest health care issuer behind UPMC. West Penn sold $430 million of bonds in 2000 to finance its creation. AHERF’s $1.3 billion Chapter 11 case in 1998 was by far the biggest health-care bankruptcy filing at the time.
“They had their ups and downs, but ultimately they never got out from under the debt burden. They were saddled with pension costs and other obligations that were hard to overcome,” Standard & Poor’s health care analyst Martin Arrick said in an interview. “This is a huge boost for them, although we believe the ultimate question over time is what percent of Highmark customers will begin to choose Allegheny Health Network over UPMC.
“Allegheny Health Network has a sizable position in the Pittsburgh health market. They’re a significant player. They have decent market share and we believe it should only grow from here,” Arrick added.
Standard & Poor’s on Monday lowered West Penn’s rating to D from CC, with D an automatic move for any distressed exchange offer involving a bondholder haircut.
Fitch Ratings, which downgraded West Penn to C from CCC in January, put that rating on credit watch evolving.
“Fitch is evaluating the transaction, the merged entity’s development plans, and the terms of the Department of Insurance’s approval, and will also assess whether future disclosure content and practice will be sufficient to maintain a rating. Fitch will update the rating following the conclusion of the review,” it said. Moody’s Investors Service in February revised its outlook to developing from negative, while maintaining its Ca rating.
Monday marked the end of a tumultuous 18 months that began in November 2011, when the organizations first announced their agreement.
The deal appeared headed for quick Insurance Department approval, but the dynamic changed in April 2012 when Highmark fired chief executive Kenneth Melani after he got into a public fistfight with his girlfriend’s husband in suburban Oakmont.
The fight bloodied Melani’s face and left his right eye swollen shut.
Winkenwerder, a former assistant secretary of defense for health affairs in the George W. Bush administration who succeeded Melani, told West Penn late last August that he wanted it to file bankruptcy as a precursor to the transaction.
West Penn balked, but returned to the bargaining table after the Allegheny County Court of Common Pleas ruled that West Penn could not talk with other suitors.