Financially challenged since it was created nearly three years ago, Pittsburgh's West Penn Allegheny Health System took a turn for the worse in the third quarter of fiscal 2003.
A deficit of $33.1 million-half of that amount posted in the third quarter alone-is looming over the six-hospital system for the nine months ended March 31. The system pulled in $887 million in revenue for the same period, an 8% increase over the year-ago period, but it had less than 50 days' cash on hand. Its ability to cover its long-term debt fell well below the criteria established when the system issued $476 million in junk bonds three years ago. If the situation does not change by June 30, West Penn Allegheny will be forced by its agreement with bondholders to hire a turnaround specialist to help get it out of its troubles.
West Penn Allegheny officials blamed cuts in reimbursements, medical education costs, decreases in outlier payments and rising operating costs for the sudden turn south. But they insist they will weather the storm.
"It is no secret that our system and our industry face significant challenges from inadequate reimbursement and ever-increasing operational costs," said Tom Chakurda, a West Penn Allegheny spokesman. "Our expectations for the fiscal year were significantly higher than what was delivered. But while key variables have not been favorable, we remain confident that we will meet that which is required of us and witness a much improved financial performance in fiscal 2004."
Financial prospects at 3-year-old West Penn Allegheny have never been great, but the general economic climate nationwide apparently has caused the fragile system to slip more than most.
It's especially of concern in Pittsburgh, where the demographics are skewed by an aging and ailing population, fierce competition and the nation's largest hospital bankruptcy ever-that of the Allegheny Health, Education and Research Foundation, which in fact gave rise to the health system (March 25, 2002, p. 28).
Nearly three years ago, the newly created West Penn Allegheny mounted an ambitious and controversial financing plan to revive the local affiliates of bankrupt AHERF. The newly formed system issued $476 million in junk bonds at correspondingly steep interest rates-some as high as 9.7%. Because of its unique circumstances, West Penn Allegheny now finds itself unable to take advantage of plunging interest rates through a refinancing.
"It would be more advantageous to wait until the bonds achieve investment-grade status," Chakurda said.
Much to the chagrin of West Penn Alle-gheny's most threatening competitor, UPMC Health System, Pittsburgh's powerful Highmark Blue Cross and Blue Shield stepped in at the system's inception with a $125 million loan aimed at maintaining competition in the market, officials said at the time. Highmark also has provided the system with grants, although officials at both Highmark and West Penn Allegheny declined to disclose the amounts, citing confidentiality. Highmark, which has seen its own considerable fortunes decline recently along with the economy-it posted a net loss in 2002-declined to comment on whether it would continue to support the struggling hospital system.
"That would be speculation," said Michael Weinstein, a Highmark spokesman. "Up to now we've provided a loan and grants, and we've provided grants to other hospitals as well. That's an issue we take on a case-by-case basis with all hospitals in the region."
Through the first half of this fiscal year, West Penn Allegheny was maintaining its unique status quo. Standard & Poor's affirmed its B+ bond rating with a stable outlook. Moody's Investor Service likewise last year rated the system B1 with a stable outlook-several notches below investment grade.
"They have done a decent job of hitting their forecast, so we've all been very encouraged by that. They even have held up their cash numbers, but they are beginning to slip," said Martin Arrick, managing director at S&P. "They have been spending less on capital, but they have big, dynamic competitors who have plenty to spend. . . . At some point the fact that they don't have the same amount of capital to spend as their competitors will over time hurt them, I think."
In addition, at the halfway mark into the year, the system's pension plan was "significantly underfunded" with officials estimating they would have to make as much as a $20 million cash contribution in the fall of 2005, S&P said in a May 5 credit report. West Penn Allegheny also may have to take an equity charge of up to $70 million when the current fiscal year closes on June 30, S&P said. The report was based on the financials for the first six months of this fiscal year, but in the latest third-quarter report, that charge jumped to a high of $110 million.
Lisa Martin, senior vice president at Moody's, noted West Penn Allegheny's third-quarter losses exceeded the system's own modest expectations, but the low credit rating for Moody's adequately reflects the risks for the time being. "I think they are facing a number of issues that a number of hospitals are facing nationally and some are exacerbated by their location in Pittsburgh," Martin said. She cited rising labor costs, a large Medicare population and rising pension and malpractice costs among the issues.