CHICAGO – The Cleveland-based MetroHealth System heads into the market next week with a $915 million issue to fund a sweeping campus overhaul that has taken a steep toll on the system’s ratings.

Cuyahoga County, which provides an annual subsidy for the public hospital system, will sell the bonds rated at the lowest investment grade level of Baa3 and BBB-minus after three-notch downgrades from Fitch Ratings, Moody’s Investors Service, and S&P Global Ratings prompted by the unexpected level of the debt being added to MetroHealth’s books.

Publicly owned MetroHealth in Cleveland hits the market next week to fund big plans at its main campus.

About $700 million of the proceeds will cover the largest stage of the $764 million transformation plan to remake MetroHealth’s 52-acre campus.

Proceeds will also cover about $129 million of interest during construction; refinance existing long-term debt that was directly placed as well as a line of credit and capital leases from 2016; and fund some projects at another campus. Management will use system funds to repay $17.6 million of 1997 bonds and cover swap termination fees of $12.2 million.

The bonds are secured by a gross revenue pledge of MetroHealth.

"The rating action primarily reflects our view of MetroHealth's large capital project and the related increased pro forma debt levels from the series 2017 issuance coupled with an existing financial profile that we consider somewhat light," S&P analyst Suzie Desai said of the ratings slap.

“The stable outlook reflects our view of MetroHealth's strong essentiality to the county, return to operating stability through interim 2017 with the implementation of several key initiatives, and unrestricted reserves that we expect will grow over time,” she added.

The system headed into the deal knowing that adding about $800 million of debt would erode its ratings. Officials sought to highlight that the ratings remain investment grade and have stable outlooks after the downgrades.

“We are very pleased with the investment grade ratings, which are consistent with our expectations,” MetroHealth’s chief executive officer Akram Boutros said in a statement. “This is a critical step in our transformation."

The system also underscored rating agency comments that cast a positive light on the long-term benefits of the transformation.

"MetroHealth has been able to demonstrate to the rating agencies that failure to proceed with the transformation project is not a viable option, and MetroHealth's transformation project is essential to the health and welfare of Cuyahoga County's population,” said Chief Financial Officer Craig Richmond.

The system announced the project last year and its board of trustees signed off on up to $1.3 billion of 40-year borrowing in March.

The overhaul calls for construction of a new 12-story hospital building which will begin in July, a 1200-1500 car parking garage and a central utility plant. Buildings will be demolished to make way for green space and internal roads, with additional plans to revitalize the West 25th Street corridor.

Some demolition projects began in 2015 and an $82 million two-story addition to a critical care pavilion opened in 2016 as plans were formulated for the larger transformation. It followed a major overhaul of clinical operations that included the expansion of its ambulatory and physician network.

Work will continue through 2023. The board decided after repairs and rehabilitating facilities now 60 years old that it was now more affordable to make over the main campus than to continue with repairs.

S&P said while the transformation will support MetroHealth's strategy and market position, such a large capital project and debt issuance poses a “significant credit risk given the high debt load and debt burden.”

Bank of America Merrill Lynch and JPMorgan are leading the sale with Fifth Third Securities, Keybanc Capital Markets Inc., and PNC Capital Markets rounding out the syndicate. Kaufman Hall is advising the system. Tucker Ellis LLP and Forbes, Fields & Associates Co. are co-bond counsel.

The deal tentatively will offer serial maturities from 2023 to 2032 with the bulk of the sale in term bonds in 2037, 2042, 2047, 2052, and $270 million in a 40-year 2057 term.

Low-grade healthcare borrowers with large deals have found an eager audience over the last year thanks for demand for yield, but investors will make their decisions based on the system's finances and prospects, said Adam Buchanan, a senior vice president in institutional sales and trading at Ziegler.

“High-yield buyers will take a hard look at the credit and decide whether they are being compensated for the risks,” Buchanan said. Republican threats to try again to repeal and replace the Affordable Care Act will factor in the analysis given the system’s high level of Medicaid patients, he added.

Buchanan cited strong demand for large, nearly $1 billion transactions sold last year by Presence Health, which carries a low investment grade, and junk-rated Loma Linda University Medical Center.

Moody’s attributed the downgrade to “an unexpected and material increase in leverage relative to modest operating performance, while the system is executing new strategies and faces uncertainty regarding Medicaid funding.”

The rating also faces pressures from significant competition in a consolidated market, high exposure to government payers, and construction risk, Moody’s said. The system holds a 12% market share in the county. The Cleveland Clinic Health System and University Hospitals Health System Inc. hold larger market shares of 36% and 32%, respectively.

The rating favorably incorporates MetroHealth's status as a large and essential safety-net provider in Cleveland, a proposed debt structure that limits liquidity needs during the construction period and adequate liquidity.

The system’s balance sheet benefits from solid operating revenue growth which increased to $1 billion in fiscal 2016 from $931 million in 2015 due to outpatient and surgeries. Liquidity is adequate at 129 days cash on hand.

The system’s high 41% ratio of Medicaid patients in fiscal 2016 exposes it to Medicaid risks especially heightened given potential changes in federal matching dollars. The state was among those that expanded Medicaid under the Affordable Care Act.

The system is also reliant on county operating subsidies – down from $40 million in prior years to $32.4 million in fiscal 2016 -- and state support. The state’s Medicaid expansion is up for renewal this summer and there has been talk of restructuring or cutting levels.

“While the rating favorably considers support from Cuyahoga County, it also factors in a recent decline in annual funding and minimal support from the county for the project,” Moody’s said.

Cuyahoga County is not subsidizing the project, but it did agree to guarantee a letter of credit to serve as a debt service reserve funded to cover one year’s maximum annual debt service. The system has estimated the savings due to the county’s help of $160 million over the course of the 40-year bonds. The agreement allows the county to decrease its annual operating subsidy to the hospital if the county needs to draw down on the LOC.

S&P said MetroHealth’s credit benefits from its position as a fully integrated employed medical staff and a comprehensive teaching program through Case Western Reserve University School of Medicine and its operation of the largest Level 1 trauma center.

In addition to outlining bondholder risks associated with the potential repeal and replacement of the Affordable Care Act, future Medicaid funding and other healthcare–related concerns, the offering statement underscores construction and funding risks. “The transformation project is complex with construction expected to take place over a number of years and to involve a significant budget,” it says.

MetroHealth staffs 407 acute care and rehabilitation beds on its main campus near downtown Cleveland and 150 long-term and skilled nursing beds. The system also has 22 community-based ambulatory care centers and other outreach clinics countywide and has three freestanding emergency rooms.

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