If the pending sale of two large nonprofit health care systems to for-profit entities proves a trend, it could be good news for bondholders of low-rated hospital debt, Moody’s Investors Service said in a report out this week.
The announcements in March that two major for-profit entities — Tennessee’s Vanguard Health Systems Inc. and private-equity group Cerberus Capital Management LP — want to buy the struggling Detroit Medical Center and Boston’s Caritas Christi Health Care, respectively, could signal a future wave of acquisitions, Moody’s said.
For nonprofit hospitals, increasing consolidation could mean more competition and operational challenges.
For bondholders, mergers could mean a boost in the bonds’ value, said Brad Spielman, who wrote the report: “For-Profit Investment in Not-for-Profit Hospitals Signals More Consolidation Ahead.”
The Detroit Medical Center’s bonds, for example, have seen a boost in prices since Vanguard announced in mid-March a plan to take over the struggling system. On April 22, 2010, a 5.25% coupon with a 2028 maturity was trading at an average yield of 6.8% compared to a yield of 7.9% on March 5, according to Thomson Reuters. The same coupon was trading at a yield of 10.5% in April 2009.
Investors who hold lower-rated hospital bonds could also see their bonds’ credit improve when those hospitals are acquired by higher-rated nonprofit systems, Spielman said.
For example, Moody’s recently upgraded Willamette Falls Hospital’s debt to Baa2 from Baa3 and revised the outlook to positive from developing after the hospital was acquired by Aa2-rated Providence Health and Services.
The security on the Willamette bonds did not change after the merger — and Providence has no legal obligation to Willamette’s bondholders — but Moody’s upgraded the debt nevertheless, Spielman said.
“We feel that even though Providence doesn’t have the legal obligation to help in a distressed situation, there’s a likelihood they would, and with Providence’s expertise, they will help improve the organization,” he said. “There’s an immediate upgrade due to that fact alone.”
Larger, nonprofit health care systems have been acquiring smaller nonprofit providers for a few years. A newer trend could be the interest of for-profit entities in struggling nonprofits, Moody’s said.
One factor driving the appetite of for-profit entities could be the new health care reform legislation. Systems like DMC and Caritas Christi, which are two of the largest charity-care providers in their respective states, stand to benefit the most from the new law, according to health care experts. The systems would likely see a big drop in their uncompensated care and an increase in insured patients and patients covered by Medicaid.
“There are many factors that are contributing to making an environment that is conducive to mergers, and one of those factors is health care reform,” Spielman said. “Historically, exposure to Medicaid is a huge liability, and while it’s still not an enormous asset, it’s perceived as a decreased liability. That probably is a larger piece of how DMC was valued [by Vanguard].”
The two sales continue to advance. Last week, a Michigan state board approved the establishing a tax-free Michigan Renaissance Zone on the Detroit Medical Center’s main campus that will offer various tax advantages there. The deal now only awaits approval from Attorney General Mike Cox.
Cerberus’ $830 million bid to take over Caritas Christi still needs approval from the Massachusetts Supreme Court and Cardinal Sean P. O’Malley of the Archdiocese of Boston.