West Penn Allegheny Health Soars With Highmark Deal: Muni Credit

Investors betting on the takeover of Pittsburgh’s West Penn Allegheny Health System, whose 2007 tax-exempt junk deal is the biggest for a U.S. hospital in more than two decades, are benefiting from a four-year rally in such debt.

In an agreement that steered West Penn away from bankruptcy, Highmark, a health insurer, offered to buy the hospital system’s bonds at 87.5 cents on the dollar. Bondholders sold it $604.2 million worth, or 85 percent. Since the April 29 purchase, investors who held onto the obligations have seen prices rise as much as 14 percent, data compiled by Bloomberg show.

Some bondholders are wagering that the merger will bolster West Penn’s finances, said Lyle Fitterer, a managing director at Wells Capital Management. Amid the longest rally in junk-grade hospital munis in six years, he kept nearly $7 million of West Penn debt maturing Nov. 15.

The acquisition and the purchases from the majority of bondholders “gave us comfort to just basically hang on to the bonds with the view that we would get paid par when they mature,” said Fitterer, who helps oversee about $31 billion of munis from Menomonee Falls, Wisconsin.

Credit Appeal

Investors have been buying lower-rated munis for their higher relative yields as interest rates on local bonds approach generational lows. High-yield hospital debt has outpaced the broader muni market for the past four years, the longest run since 2006, Barclays Plc data show. Lower-rated hospital bonds have gained 3 percent this year, compared with 1.3 percent for the rest of the market.

West Penn, which admitted almost 56,000 patients in fiscal 2012, borrowed $752 million in 2007 to refinance debt. It was the largest tax-exempt hospital deal rated below investment grade, according to Bloomberg data starting in 1990.

Bondholders kept $105.5 million of the West Penn securities, with $70.2 million maturing in November 2040, Bloomberg data show. Bonds maturing Nov. 15 traded May 1 at 100 cents, 14 percent more than Highmark’s tender price, Bloomberg data show. That’s still down from the initial 2007 pricing level of 101.6 cents.

Gains in lower-rated munis may encourage high-yield investors to hold the West Penn bonds in a bid to profit or receive full payment at maturity, said Matt Fabian, a managing director with Concord, Massachusetts-based Municipal Market Advisors.

Cushion Effect

For high-yield funds, “it may make sense for them to speculate a bit more on transactions like this,” Fabian said. “They have substantial gains acting as a cushion to the potential downside.”

Consolidation among health-care providers has increased with rising costs and federal cuts in Medicare, the government health plan for the elderly and disabled, according to a 2012 Moody’s Investors Service report. Hospitals are addressing more than $300 billion of cuts in Medicare payments through 2019 and more reductions will probably be part of strategies to reduce the federal deficit, Daniel Steingart, an analyst at New York-based Moody’s, wrote in a Jan. 22 report.

Merger Trend

As more hospitals merge with other health-care providers or insurers, investors need to consider consolidations when buying hospital debt, said John Miller, who helps manage about $95 billion of munis as co-head of fixed income at Nuveen Asset Management in Chicago. Nuveen was among bondholders that agreed to sell West Penn bonds to Highmark, which is also based in Pittsburgh.

“Mergers and acquisitions is a major trend in hospitals both for profit and nonforprofit, and bondholders or potential bond investors, they need to be aware of it and to think about those possibilities,” Miller said.

On the other hand, hospitals stand to benefit from President Barack Obama’s health-care overhaul, which will be more broadly implemented next year. The plan would add as many as 800,000 people to Pennsylvania’s Medicaid rolls, Governor Tom Corbett said April 30 at the Bloomberg Link Washington Summit. The Republican has yet to decide whether to expand Medicaid, the joint federal-state medical program for the poor.

New Network

Following Highmark’s purchase of West Penn debt and approval from the state Insurance Department, the insurer announced the formation of the Allegheny Health Network. It comprises West Penn’s five hospitals and Highmark-owned health-care providers in the Pittsburgh area as well as in Erie.

“Allegheny Health Network is focused on preserving health-care choice for all consumers and patients in our region,” William Winkenwerder, president of Highmark, said in a statement last month.

In addition to buying West Penn debt, Highmark has committed $450 million in loans and grants to the health-care system, according to a Moody’s report.

Following the merger, Moody’s cut Highmark’s rating to Baa3, the lowest investment grade. It also assigned a negative outlook because of increased financial and operating risks.

Conversely, West Penn’s credit rating improved.

Moody’s raised the system to Caa2, eight levels below investment grade, with a developing outlook. Its highest rating was Ba2, two levels below investment grade, when West Penn borrowed in 2007.

“Highmark’s driving the bus right now,” Fitterer said. “And if you’re willing to let Highmark drive the bus and you want them being the one directing, then you take the risk.”

Market Movement

In the $3.7 trillion municipal market, Illinois is set to sell $300 million of sales-tax bonds in the week’s biggest offer.

With issuance falling to the least since March, benchmark munis are beating Treasuries this week. At 1.75 percent, yields on benchmark 10-year munis compare with 1.78 percent for like-maturity Treasuries.

The yield ratio of the two securities, a gauge of relative value, is about 98 percent, the lowest since March 12 and down from as high as 113 percent last month. A falling value means munis are gaining relative to Treasuries.

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