CHICAGO — Beacon Health System is bringing $157 million of double-A-minus rated hospital bonds to market Wednesday, marking the first borrowing for the new credit, which was created last year by the merger of two Indiana-based hospitals.

The transaction will refund outstanding debt issued separately by Memorial Health System and Elkhart General Hospital, bringing the debt under a new bond indenture that features a pledge of the combined revenues of both hospitals.

The finance team expects to see strong savings from the deal, which will refund bonds originally issued in 1998 and 2007, hospital officials said.

Beacon should see a strong response to its offering, buoyed by its ratings in the double-A category -- considered strong in the health care market -- and the good fortune of entering a market during a week with light volume, market experts said.

 “It’s a good time to come to market if you’re a new credit, a new name and a new story,” Susannah Page, director, municipal bond research, Bank of America Merrill Lynch, said. “There will be a food fight with something that’s this high quality.”

Beacon’s AA-minus ratings may attract investors who don’t always consider buying hospital bonds, Page added.
“You could probably see interest from your traditional hospital buyers who will have to look at it even if they don’t usually go as high as double-A minus because they have to buy something,” she said. “Then there’s also the more high-grade portfolios or accounts that could take a look too.”

The finance team is expecting the deal to be at least two to three times oversubscribed given the low amount of paper in the market this week, according to Beacon Health’s chief financial officer Jeff Costello.

When Memorial Health and Elkhart General merged to form Beacon in late 2011, they joined a trend that has come to dominate the non-profit health care sector over the last few years. Providers like Beacon are partnering and consolidating at an unprecedented pace to help prepare for the upcoming new health care law and the uncertainties and changes the law is expected to bring to the sector over the next several years.

 Credit analysts who cover the space say the trend is generally positive for the sector, providing scale and resources and  often sparking upgrades among the smaller credits.

Before the merger, Elkhart, a 357-bed community hospital, was rated A-plus by Fitch Ratings, while Moody’s Investors Service had downgraded it to A2 from A1 in late 2011.

Memorial Health, a 657-bed facility located in South Bend, in northwest Indiana, about 15 miles east of Elkhart, was rated AA-minus.

After the merger, Fitch upgraded Elkhart to AA-minus, and last year Moody’s revised its outlook on the hospital to positive from stable. Moody’s does not rate Beacon Health. 

Memorial and Elkhart had partnered for years before the merger became official in late 2011, including running a provider-owned health plan from the late 1980s through the early 2000s.

“During that time we were able to create solid relationships from among administrators,” Costello said. “As health care reform started to pick up steam and size and scale was playing into the way health systems were developing, we decided it was appropriate to talk about coming together to see if it made sense,” he said. “We decided it did make sense.”

“It was a smooth merger because they had a working relationship with some overlap of their medical staff and services prior to merging,” said Dana Sodikoff, an analyst with Fitch Ratings, which upgraded Elkhart to AA-minus from A-plus after the merger was announced.

“Like a lot of mergers, they were also able to achieve strong savings early on,” she said, noting the system achieved $13 million of savings during the first year of the partnership. The savings came mostly from the ability to bring down purchasing costs, Costello said.

Merging health care issuers don’t always combine their debt, but Costello said officials realized early on the benefits that would likely come from an upgrade and market savings.

“The advantage to us is a combined credit at a higher overall bond rating,” Costello said. “The new obligated group allowed us to have higher savings costs.”

Combining debt under a new indenture is usually good for the investor as well, Page said. She added that some bond buyers are on the lookout for weak health care credits that are likely merger or acquisition candidates, buying the debt with the hopes that it will soon be taken over by the larger, healthier system. 

Wednesday’s bond sale consists of $115.6 million of hospital revenue bonds issued through the Indiana Finance Authority and $41.1 million of bonds that will shift variable-rate debt originally issued in 2007 into a fixed-rate mode. Those bonds will be issued through the Hospital Authority of St. Joseph County, where Memorial Health is located.

The finance team expects to achieve savings of $1 million a year on debt service on the bonds issued in 1998, Costello said.

Beacon last week closed on a $7.5 million new-money deal that was structured as a private placement with Bank of America Merrill Lynch. Proceeds from the loan raised money to buy a new helicopter, Costello said.

Wells Fargo Securities and JPMorgan are the underwriters and Barnes & Thornburg LLP is bond counsel.

The debt will be a mix of serial and term bonds with a final maturity of 2044.

The bonds will refund debt issued by Memorial in 1998 and by Elkhart in 1998, 2007 and 2008. The transaction leaves some debt outstanding, including variable-rate bonds issued by Elkhart in 2008 and variable-rate bonds issued by Memorial in 2008 and 2007.

Beacon has seven interest-rate and basis-rate swaps hedging roughly $83 million. Beacon terminated four swaps last year and two in 2010, but opted to leave the remaining outstanding to avoid termination fees, though it might move to unwind the derivatives later, Costello said. “We have more swap exposure from a notional value than what we want long term,” he said. As of April 2013, the swaps had a negative value of just under $29 million, which is below the required collateral posting threshold, according to bond documents.

Beacon plans to come back to market in early 2014 with another bond deal to finance a chunk of a $320 million capital plan that includes a new surgical center and an expansion of a children’s hospital.

The surgical project at Elkhart is expected to cost $74 million, with up to 90% financed with bonds, Costello said. The issuer will come to market in early 2014 to float debt to finance the project.

A $46 million expansion of a children’s hospital will likely be financed with a mix of cash and gifts.

As of Dec. 2012, Beacon’s cash and investments were equal to 333 days’ cash on hand, according to Standard & Poor’s.

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