An industrywide credit crunch spurred by the 1998 bankruptcy of the Allegheny Health, Education and Research Foundation is coming home to haunt former Pittsburgh affiliates of AHERF as they head to the bond market.
The West Penn Allegheny Health System, being formed through the merger of four former AHERF hospitals with the Western Pennsylvania Healthcare System, began an uphill battle to woo investors last week. But its reception was chilly, as credit-rating agencies gave the bonds junk status.
The $429.5 million offering, scheduled for pricing in mid- to late July, constitutes the centerpiece of a turnaround plan for the former AHERF affiliates. The offering is designed to consolidate West Penn Allegheny into a single credit, boost liquidity and postpone debt payments while the fledgling system gets on its feet.
Pittsburgh-based West Penn Allegheny includes former AHERF affiliates Allegheny General Hospital, Forbes Health System, Allegheny Valley Hospital and Canonsburg Hospital, along with Western Pennsylvania Hospital and its affiliate, Suburban General Hospital.
Moody's Investors Service assigned a B1 rating with a stable outlook to the uninsured bonds, while Standard & Poor's gave them a B+ rating.
Though the Pittsburgh hospitals were rescued from bankruptcy by the merger, they're under the same dark cloud that has moved over the entire healthcare industry in the past two years, thanks to AHERF and subsequent deteriorating financial conditions of hospitals.
Demand for healthcare debt has withered, and yields for risky credits such as West Penn Allegheny have increased substantially since AHERF declared Chapter 11 bankruptcy.
West Penn Allegheny expects to pay a yield of 8.5% to 9% for its $354 million of uninsured debt, or about two percentage points more than what A-rated hospitals are paying these days, said Tom Whalen, a director at Salomon Smith Barney, the lead underwriter.
In an effort to drum up demand for the bonds, West Penn Allegheny Chief Executive Officer Charles O'Brien and other top system officials planned to visit institutional investors in at least four cities this week.
In its report last week, Moody's cited the system's weak financial profile, integration risks and competitive market.
In particular, Moody's stressed the need for the system to lure back physicians who were lost during AHERF's financial deterioration and integrate the cultures of the merging organizations.
Likewise, Standard & Poor's stressed the system's high leverage, declining admissions caused partly by physician flight, a competitive market and uncertainty about the new system's ability to retain doctors.
West Penn Allegheny spokesman Thomas Chakurda called the reports "very straightforward and candid." He added, "The ratings give us some room to grow, and that's clearly what our intent is."
Whalen said a noninvestment grade was anticipated. "We're quite pleased with the rating and the rating report. I think they point out some of the strengths of the system," he said, referring to the Moody's report, which was released first.
He pointed out that West Penn Allegheny will be the No. 2 player in the Pittsburgh market, with a solid clinical reputation and a purportedly lower cost structure than the No. 1 player, UPMC Health System.
While the rating agencies warned of the dominance of one insurer in the market--Highmark Blue Cross and Blue Shield--Whalen called Highmark's support of West Penn Allegheny a "very big strength." Highmark has provided West Penn Allegheny with a $125 million subordinated loan for working capital.
Part of the new system's financial burden was eased by concessions negotiated with the credit guarantors of the former AHERF hospitals. MBIA Insurance Corp. agreed to guarantee $100 million of the system's bonds under its Aaa rating, which practically guarantees buyers for that portion of the debt.
Both rating agencies noted the possibility of a future upgrade.
Standard & Poor's issued a developing outlook, which indicates a possible change up or down in one to three years.
It said an upgrade is a "good possibility" if operations stabilize, but continued defections among medical staff threaten that prospect.