Minnesota health system readies deal for Duluth 'transformation'

Register now

CHICAGO – Minnesota-based Essentia Health Obligated Group will bring $708 million of mostly new money to finance a makeover of its Duluth campus that cost the system a one-notch hit.

The system operates 15 hospitals that serve Idaho, Minnesota, North Dakota, and Wisconsin will sell $667 million through the Duluth Economic Development Authority and $40 million through Cass County, North Dakota. The deal is slated for Tuesday.

The bulk of the proceeds will fund the medical campus project in Duluth with $95 million going to capitalize interest related to the campus project through the construction period through 2021.

Ahead of the sale, S&P lowered its rating to A-minus from A and assigned a stable outlook. The downgrade is due to “Essentia's large capital transformation project, associated project risk, and weaker financial metrics,” S&P said.

Fitch Ratings also lowered its rating one notch to A-minus and assigned a stable outlook to reflect “a sizable increase in Essentia's leverage to fund with the issuance of the series 2018 bonds to fund its Vision Northland hospital replacement project in Duluth.”

Officials of the system said they aren't bothered by the downgrade, citing the long-term benefits of the project.

“We feel these ratings reflect our confidence in the forecast and the project itself,” said chief financial officer Traci Morris in a recorded investor presentation.

Proceeds will also refund about $70 million of outstanding debt.

The bonds mature from 2033 through 2058. The 40-year maturity allows the system to keep maximum annual debt service at $72 million.

The bonds are secured by an unrestricted receivables pledge from the obligated group that includes facilities that generate about 88% of the system’s unrestricted revenues. The system generated more than $2 billion of revenues in fiscal 2018.

Bank of America Merrill Lynch, Citi and Piper Jaffray are the underwriters with BAML running the books and Raymond James is financial advisor.

The system has been readying its balance sheet as it prepared for the new debt load by increasing its liquidity with its unrestricted cash and investments rising to $1 billion and holding the line on capital spending to reduce leverage. Unrestricted reserves cover 189 days of operations.

Operating margins in fiscal 2018 suffered as it recorded several one-time adjustments as it works to establish a “clean slate,” Morris.

The overhauled campus carries a price tag of $675 million and facilities would be built on the existing campus, reducing its size to streamline access among facilities on the campus. It will house 340 private rooms and 37 surgical suites, an out-patient facility, and accommodate level one trauma services. Planning and design began last January and the facility is expected to open in mid 2022. The system will use $110 million of cash to also fund the project.

“The Duluth Medical Campus practice represents a major investment not only in our mission but our commitment to our patients, to the economic vitality of the community and the work environment of our staff,” Chief Operating Officer Jodi Mansfield said in a recorded investor presentation.

The system is hoping that the new facility helps stem patient losses to the nearby Twin Cities.

Other capital projects in the works include $84 million to fund the continued expansion at its hospital in Fargo, investments in various clinical spaces, and routine capital spending.

While the added debt drove the downgrade, S&P said the damage is limited and the project has longer term benefits. The system will have about $1.2 billion debt after the issuance.

“While the new debt will pressure the balance sheet, unrestricted reserves remain stable. In addition, we believe the overall credit profile benefits from Essentia's fairly consistent historical operating performance,” S&P said. “Despite the weaker financial profile, in our view, the overall credit profile benefits from Essentia's good business position in a geographically broad service area with an integrated physician model.”

“Furthermore, we believe the campus transformation project in the east market (Duluth) will further support Essentia's strategy and expansion plans,” S&P added.

Fitch said it “expects that Essentia's leverage position will stabilize at a level consistent with a low 'A' category rating in light of Essentia's leading system-wide market position and its high degree of integration supporting enhanced cost flexibility and stable cash flow.”

Essentia holds a leading market position in two of its three markets that is supported by a “well-integrated clinical platform and medical staff,” Fitch said. While inpatient volumes have seen modest growth in aggregate, outpatient care now accounts for mroe than 70% of gross revenue reflecting continued growth due to expansion in some markets and Essentia's efforts to shift care to lower cost settings.

For reprint and licensing requests for this article, click here.
Not-for-profit healthcare Primary bond market Minnesota North Dakota Wisconsin Idaho