The great buyback

Healthcare borrowers stung by the nation’s credit and economic woes have found one way to ease their financial pain: some are buying back their own bonds at fire-sale prices.

Health systems in Florida and Pennsylvania have cut their debt after investors agreed to unload certain bonds back on borrowers at a steep loss and others are considering such a move, according to health finance insiders and financial records.

The bonds in question pay interest tied to the rate banks use to lend among themselves. That rate, known as the LIBOR, has dropped with efforts to revive credit markets, which along with a steep drop in liquidity has sent prices for the bonds into a slump. And at least some weary investors, who maybe needed cash or simply want an out, have cut their losses and sold the bonds back to health systems.

Such deals offer a rare opportunity for health systems to profit from turmoil in financial markets that has otherwise drained cash from balance sheets and made it harder and more expensive to borrow. “Smart people are going to understand that in troubled times, in dislocations, there are opportunities,” said Robert Cimasi, president of Health Capital Consultants.

Shands HealthCare, based in Gainesville, Fla., found investors willing to take a loss of $20 million on roughly $84.8 million of Shands’ so-called index floater bonds late last year, said William Robinson, Shands’ chief financial officer and senior vice president. “Everything else costs me money,” he said of the tight credit markets that have raised hospital and health system borrowing costs. “I get this one little silver lining,” he said.

Shands used $20 million in cash and issued $44 million in alternative bonds with fixed interest rates to buy back the index floater bonds, ultimately lowering the system’s debt by $40 million. Robinson said not all of Shands’ investors sold back its bonds. The system’s outstanding debt includes roughly $135 million in index floater bonds.

Kaiser Permanente bought back $210 million of its index floater bonds in October after investors turned to the 28-hospital system looking for an exit, said Tom Meier, Kaiser’s senior vice president and corporate treasurer. Meier said the system financed the deal with cash and negotiated a 40% discount, which he credited to the index floater bonds’ thinly traded market and investors’ demand for liquidity.

Catholic Health East, based in Newtown Square, Pa., erased $38 million in debt from its balance sheet in recent weeks—plus an undisclosed amount to settle sour interest rate hedges—after investors agreed to unload $195 million in index floater bonds in exchange for $157 million in alternative bonds.

Meanwhile, Guthrie Healthcare System, based in Sayre, Pa., alerted bond holders in mid-March that officials may offer to buy back some of roughly $179 million of similar debt.

David Cyganowski, a Citigroup managing director and one of two bankers who oversee its healthcare business, said that since credit markets seized last September, about a dozen clients are considering or have closed debt buyback deals, primarily for index floater bonds.

Buying back index floater bonds at a discount, for hospitals with adequate cash or capital to do so, could help borrowers endure continued economic uncertainty by lowering their leverage at a time when volatile stock markets have drained liquidity from balance sheets, he said.

“Because no one knows how deep and how long the recession is going to be, issuers have to be even more flexible in terms of their debt structure,” Cyganowski said. The strategy may also help lower the cost of merger or acquisition deals by reducing the liabilities of potential partners, he noted.

By trimming its debt, Catholic Health East’s deal is expected to free up cash from bond payments, credit analysts with Moody’s Investors Service said in late February. The system also ended some of its interest-rate hedges, which have forced borrowers to post significant collateral, also thanks to interest-rate volatility (Dec. 8, 2008, p. 8).

Cash posted as collateral drained liquidity from borrowers’ balance sheets. Catholic Health East’s collateral ballooned to $98 million in late December but eased in mid-February to $50 million, according to the ratings report. Collateral added to the strain on cash from the system’s investment losses and weaker operations. Ending the hedge, known as a swap, shrinks Catholic Health East’s collateral risks, but does so at a cost.

Randal Schultz, Catholic Health East’s vice president of capital strategy and management, said the system factored its swap losses into the price of its recent bond deal, but declined to provide a figure.

Catholic Health East exchanged roughly 84% of index floater bonds eligible under its offer for fixed-rate bonds with a higher interest rate that investors may more easily resell, Schultz said. Investors wanted more liquid investments, he said. The floater bonds were priced in early March between $53.25 and $64.25 per $100 of value at maturity, well below prices in 2007 of $93.50 and $99.30.

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