CHICAGO - Ohio's University Hospitals Health System plans to enter the market today with $110 million of fixed-rate bonds to finance a series of major projects intended to keep the system competitive in the Cleveland area.
The system plans to hold a one-day retail order period today for the single-A rated debt followed by an institutional pricing Thursday.
Today's transaction could be followed by more borrowing, depending in part on market reaction to the deal, UH officials said.
The finance team originally planned to issue $220 million of new-money debt as one of the last financing pieces of an ambitious $1 billion capital improvement plan. But officials recently decided to gauge investor interest with a scaled-back issue for $110 million while also considering using cash to finance some of the plan before moving forward with more borrowing.
After a year of dealing with problems with its floating-rate debt portfolio, including the collapse of the auction-rate market, the system decided to issue fixed-rate debt this time around, said officials. UH has also seen negative swap valuations and been forced to post collateral.
Though the hospital is currently enjoying interest rates of less than 1% on much of its variable-rate demand bonds, the fixed-rate debt will allow it to eliminate a number of risks, including "market blow-up risk," according to Bradley Bonds, UH's vice president of treasury.
The second-largest health care system in the Cleveland area, UH has enjoyed growing volume and margins since a new management team took over in 2003. Its major competitor in the area is the prestigious Cleveland Clinic Health System, which enjoys a 46% market share compared to UH's 27% in the eight-county region. Proceeds from today's sale will finance a number of projects that UH hopes will help increase market share across the region.
Ahead of today's transaction, Standard & Poor's lowered its underlying rating on University Hospital's debt to A from A-plus, citing in part the pressure that the new debt issuance could put on the system's balance sheet. The outlook is stable. Moody's Investors Service rates the debt A2 rating with a stable outlook.
The Ohio Higher Educational Facilities Commission will issue the bonds on behalf of the system. Citi is senior manager and Merrill Lynch & Co. is co-senior with Ohio firms KeyBank Capital Markets Inc. and NatCity Investments Inc. rounding out the underwriting team. Bond counsel is Squire, Sanders & Dempsey LLP, and Ponder & Co. is the financial adviser.
The bonds are backed by revenues of the obligated group, which includes University Hospital Case Medical Center, the primary teaching affiliate of Case Western Reserve University's medical school.
UH is entering a market that has seen a decreased number of health care transactions since last September amid the credit crunch and increased caution among institutional investors. Like other issuers, the hospital is marketing more heavily to retail investors this time around, according to Bonds.
"In the past there's been very high risk tolerance and as a result it's been very easy to sell bonds to the institutional marketplace," he said. "Now the landscape has changed dramatically."
To appeal to investors interested in both short- and long-term products, the finance team plans to offer about a third of the $110 million issue with five- and seven-year puts, with the remaining bonds structured as long-term serial bonds.
UH, like many health care providers, got stung last year by the collapse of the auction-rate securities market, and was forced to quickly restructure $264 million of ARS. It refunded the debt into variable-rate demand bonds supported by four letters of credit from different banks.
Those VRDBs are performing "extremely, extremely well right now," with interest rates below 1%, Bonds said. But a number of market factors that have developed since then - including rising fees, letter of credit renewal risk, and negative swap valuations - prompted the system to go with fixed-rate debt this time around, he said.
Underwriting fees and letter of credit-related fees were lower early last year when UH refinanced most of its auction-rate debt. But since then the fees have spiked. LOC fees have gone up amid tighter credit capacity, and underwriters' fees have risen "to reflect more difficult access to the market," Bonds said. "Fortunately for us we were early to the market and our terms were pretty reasonable. Fees have gone up quite a bit since last year."
With interest rates on variable rates so much lower than fixed-rate debt in the current market, much of the cost of those higher fees can be absorbed, according to Bonds. But coupled with higher fees is the relatively new risk that banks will balk at renewing LOCs - another factor driving UH's decision to go with a fixed-rate structure, he said.
Because hospital system's current debt structure has some bank-related exposure, as most of its variable-rate debt is supported by letters of credit or bank loans, the system's liquidity could be pressured if the banks decline to renew the LOC or if the obligations are unexpectedly accelerated, noted Moody's analyst Lisa Martin.
But those risks are mitigated by UH's adequate cash cushion - as of the end of last year, the system's cash-to-puttable debt was at 123% - as well as the fact that four separate banks have provided support on the biggest chunk of LOC-related debt, Martin said.
Standard & Poor's analysts warned that the new debt issuance, coupled with potential future borrowing and recent liquidity declines, could further soften UH's balance sheet. At the same time analysts praised the system for good fiscal margins and debt-service coverage levels.
Analysts also praised UH's management team for continuing "to focus on addressing the issues of providing quality health care in the Cleveland market as well as how to complete a major capital spending program during a challenged economic climate."
After the transaction, University Hospitals Health System will have about $950 million of outstanding debt, of which $333 million is floating rate. A total of $300 million is hedged with swaps.