Ah, to be a healthcare system with ample stockpiles of cash, a sturdy balance sheet and a strong market niche.
For the Sisters of Mercy Health System in St. Louis, having those stripes made it easier to issue lower-cost, variable-rate debt and free itself from the burdensome reporting and monitoring requirements of traditional bond covenants.
This tiger of the tax-exempt bond market is among the financially fittest not-for-profit healthcare providers in the nation-one of 67 not-for-profit healthcare providers rated AA by Standard & Poor's Corp. Those AA-rated providers account for 10% of all not-for-profit healthcare debt.
Furthermore, the New York-based rating agency's AA universe includes Sisters of Mercy among only three healthcare credits with a "positive" outlook for the future.
Moody's Investors Service, another New York-based rating agency, also maintains an Aa rating on the system for its "very good profitability, high levels of liquidity, and a modest debt load."
For the year ended June 30, 1995, Sisters of Mercy recorded $207.8 million in net income on net patient revenues of $1.5 billion. The figures reflect the performance of the parent corporation and all its affiliates.
Total long-term debt of $299.3 million represents just 21% of total capital. When the Sisters of Mercy's affiliation with Unity Health System is factored in, total long-term debt rises to $472.8 million, but still represents only 24% of total capital. St. Louis-based Unity, created last summer, includes four acute-care facilities, 11 clinics and more than 130 employed physicians.
Sisters of Mercy's debt-to-capitalization numbers outshine other investment-grade providers. The median for all AA-rated healthcare providers in Standard & Poor's universe is 31.8%; for BBB-rated institutions it's 48.8%.
Cash on hand, a measure of liquidity, reached a very robust 236 days in 1995-223 days when Unity's numbers are included. Those figures compare with a median of 177 days for all AA healthcare providers and 49 days for BBB-rated providers, according to Standard & Poor's.
So it's little wonder that Sisters of Mercy's $103.3 million sale of tax-exempt debt late last year left some unique footprints on the bond market.
Because of its financial strength, Sisters of Mercy was able to sell $73.3 million worth of those bonds at variable interest rates. Variable-rate debt is considered riskier than fixed-rate debt because the rates are not predictable.
"First of all, you have to be fairly strong in order to use the variable debt," said Carrol E. Aulbaugh, the system's senior vice president, chief financial officer and treasurer. "But then there are some strong organizations that really don't have the appetite for a lot of variable debt because of the uncertainty of it."
With variable-rate debt, there's always the danger that interest-rate hikes could exceed fixed rates or outpace the provider's ability to repay the debt.
The variable-rate bonds, which are repriced every week, carried an average interest rate of 3.75% through December 1995. However, Sisters of Mercy has entered an interest-rate "swap" program with Bear, Stearns Capital Markets that will effectively fix its floating-rate exposure at 4.55% during the next five years. The bonds mature over a 20-year period ending in 2016.
Such interest rate swap programs are intended to provide a hedge against rising interest rates. The program enables Sisters of Mercy to increase its exposure to variable-rate debt, Aulbaugh explained.
"We're convinced that over the long term you'll save interest dollars," Aulbaugh said. But providers that use variable-rate debt have to be able to tolerate interest-rate peaks, he added.
Calculations made before issuing the bonds clearly showed that the variable-rate debt would save money for Sisters of Mercy. Over the life of the bonds, the lower variable rates are expected to generate present-value savings of $12 million compared with what the system would have spent if all the bonds had fixed rates, said Kathleen A. Costine, senior managing director at New York-based Bear, Stearns & Co., the lead underwriter of the bonds.
"The financing plan here was really to leverage the financial strength of the system," Costine said. While not all providers have the balance-sheet strength to offset the risks of variable-rate debt, Costine believes there will be more efforts to make the most of the spread between the cost of capital and the return on assets. "I think what you're going to see is more of a focus on asset liability management," she predicted.
Sisters of Mercy's bond documents show that total unrestricted cash and investments for the parent corporation and all affiliates topped $959.3 million in fiscal 1995, compared with $805.3 million in the previous year.
The Sisters of Mercy bond deal also amends the legal obligation for the system's debt. Previously, the parent organization and its corporate affiliates were jointly and severally obligated to pay back the debt.
Under the new bond covenants, the parent is directly responsible for repayment. While the affiliates are not directly liable, the covenants enable Sisters of