Muni market expected to easily absorb enormous healthcare deal
The municipal bond market's supply-demand imbalance and thirst for high-yield paper means it should easily absorb the $5.8 billion in healthcare bonds CommonSpirit Health plans to bring to market Aug. 8.
The new entity created by the merger of Dignity Health and Catholic Health Initiatives landed ratings of BBB-plus from S&P Global Ratings and Fitch Ratings and Baa1 from Moody’s Investors Service. Peter Delahunt, head of trading at Raymond James, said the incremental yield means the deal will garner interest more like a non-investment grade high-yield deal.
“There is a big appetite for yield,” Delahunt said. “We are in a low-rate environment.”
CommonSpirit will issue $2.7 billion of taxable series 2019 bonds directly and the $2.4 billion series 2019A tax-exempt fixed rate bonds and $665 million series 2019B tax-exempt put bonds will be issued by conduits in Colorado, Kentucky, Tennessee and Washington.
“On the taxable side, it’s important that they maintain enough size per CUSIP,” Delahunt said. “As long as it’s not heavily serialized and there are enough bonds for liquidity purposes, they should do well.”
The finance team for both the taxable and tax-exempt debt is the same. Citi, JPMorgan and Morgan Stanley are lead managers. Polsinelli is bond counsel. Kaufman Hall & Associates is the municipal advisor.
Chicago-based CommonSpirit was created by the Feb. 1 merger of Dignity and CHI to form the largest not-for-profit and largest Catholic healthcare system in the country. The new group has 142 hospitals and more than 700 clinical sites across 21 states.
The lion's share of the bonds, $5.2 billion, on both the taxable and tax-exempt sides will refinance pre-existing debt from the separate entities under the new banner. Roughly $600 million will be used to reimburse Common Spirit for capital expenditures and $314 million will refinance commercial paper.
“During the past few years as the merger has been pending, neither entity has been able to access the market,” said Kenneth Gacka, senior director with S&P Global Ratings. “They relied on short-term debt and bank debt. As part of this financing, they are taking out a considerable amount of short-term debt they had outstanding."
The deal “creates one unified credit group that will secure both the new bonds as well as legacy bonds previously issued by Dignity Health and CHI,” according to Fitch.
The BBB-plus-level ratings were within the healthcare system’s range of expectations, Dan Morissette, the company’s chief financial officer, said in a statement.
The ratings align with CHI’s ratings, but are lower than Dignity Health's. Fitch and S&P had rated Dignity A-minus and A, respectively. Moody's rated Dignity A3 stable and CHI Baa1. All three rating agencies assign stable outlooks.
“This restructuring accelerates the alignment of the organization, achieves significant cash flow relief and capitalizes on savings opportunities in this rate environment,” Morissette said.
It “also mitigates risk and creates a stable capital structure for future growth,” he said.
“We are confident that our bond offering will be highly successful and support our plan of finance and long-term strategy,” Morissette said.
The refunding adds another component to demand, because the investors who own the existing bonds will seek to put that money back to work, Delahunt said.
“You have a number of investors who will be taken out with the refunding,” said Lisa Washburn, a managing director at Municipal Market Analytics. “They already have exposure to a portion of the credit. I imagine they would be interested parties in participating in the deal. You have built-in demand, because of the bonds coming out of the market.”
The extensive pre-marketing of the deal and the fact CommonSpirit has been priming the market for this merger and debt consolidation should also give the deal life, Washburn said.
“I would be surprised if the deal weren’t well received, so they will probably get favorable financing,” Washburn said. “Issuers with a lot more challenges have found a receptive market.”
Two-thirds of the volume that has hit the market this year has been higher-rated, said George Huang, director and senior municipal research analyst at Wells Fargo covering the healthcare industry. The dearth of paper in the triple-B part of the market means that there is more demand for it when it appears, Huang said.
Based on Wells Fargo’s projections, there won’t be a lot of paper to compete with CommonSpirit the week it brings its bonds.
“We downgraded our overall market projection a week ago, down from 5%,” Huang said.
Wells Fargo is anticipating $355 billion to $400 billion in volume for the year, which would be flat from last year, he said.
In keeping with trends for the past few years in hospital debt, Wells Fargo anticipates a volume decrease in the sector.
He couldn’t speak specifically to the CommonSpirit deal, but Huang said he thinks triple-B debt in general would be absorbed well by the market.
“I think the inflows have been about 10% of net asset value for high-yield, referring to not just true high-yield, which is non-investment grade, but triple-B,” Huang said.
S&P's Gacka cited weak financial performance based on the latest financials, partly from industry headwinds and challenges in key Catholic Healthcare Initiatives markets that continued to weigh on the combined entity's financial performance.
S&P's report says the BBB-plus rating reflects execution risks during the initial integration of the system particularly because CommonSpirit is not starting from a position of financial strength because of common industry pressures and some underperforming markets.
In general, the healthcare industry is facing challenges from declining volumes, rising costs, decreased reimbursement rates from the federal government, all as hospitals try to reinvent themselves and invest in different payment strategies, Gacka said.
Gacka ticked off several reasons that S&P views the finance plan favorably.
It replaces short-date debt with committed capital largely through fixed-rate offerings, which de-risks the debt portfolio; and provides short-term cash-flow savings at a time where cash flow is at a low point.
“This is a good step toward optimizing their capital structure,” he said.
Though CommonSpirit’s decision to name each company’s chief executive as a co-CEO is considered unique, “they seem to be working well together; both are aligned on the direction the company is head and they have clearly defined roles,” Gacka said.
The credit upside to the merger is that it improves diversification overall and creates a larger system that has a presence in 21 states, said Brad Spielman, a Moody’s analyst.
“It landed at Baa1 for a number of reasons,” Spielman said. “Some of the markets are positives, others are challenged. All of the combined numbers are below the median for the rating category as are the balance sheet numbers and the debt numbers.”
The strong union representation of the workforce in the California hospitals formerly owned by Dignity is considered a credit risk, said Moody’s analyst Lisa Goldstein.
Weaker markets like Kentucky and Texas also dragged the ratings down, analysts said.