Analysis: Is Highmark offer to WPAHS enough?

Experts agree that shaving debt isn't the health system's biggest problem

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It's one of the biggest debt-restructuring deals ever in the municipal markets. But is the deal that Highmark cut with West Penn Allegheny Health System's bondholders -- which reduces a chunk of WPAHS's debt by $90 million or so -- big enough?

Consumers will learn more this week when Highmark is scheduled to again amend the official application regarding its proposed takeover of West Penn Allegheny. The application -- called a "Form A" -- should be released by the state Insurance Department perhaps as early as today.

The amended application will reflect the details of last week's announcement that Highmark will be absorbing the outstanding balance on West Penn Allegheny's 2007A bonds -- a balance that Highmark did not provide but that is estimated at $710 million by a Bloomberg financial news analysis.

Highmark has offered to pay the holders of those bonds 87.5 cents on the dollar, a better deal than many were expecting.

The insurer itself had earlier proposed a payoff to bondholders of 45 cents on the dollar. And an October analysis published by Bank of America Merrill Lynch said a system bleeding as much money as WPAHS might pay as little as 38 cents on the dollar.

When the details of the deal came out, some were surprised.

"Frankly, I was shocked. You're thinking at least south of 50 cents on the dollar," said Jim McTiernan, a former Highmark official and now a benefits analyst with Pittsburgh-based Triad USA, a division of Arthur J. Gallagher & Co.

Bondholders were less shocked, partly because most hospital systems that are ailing to the degree that WPAHS is don't have a $15 billion financial life raft (Highmark took in $14.78 billion in 2011 revenues). In other words, Highmark's negotiating leverage wasn't as strong as it hoped, given its own cash reserves.

And if the health system had filed for bankruptcy -- even if the debt restructuring in that process would have paid the bondholders a less-than-optimal amount -- bondholders are first in line to be repaid since they are secured creditors. Money from asset liquidation, cash on hand, etc. could have been bound for the bondholders in some shape or form.

Also strengthening the bondholders' negotiating position was that an unknown buyer could have made a play for WPAHS's assets, perhaps making the bondholders whole and certainly making Highmark's path to an in-house health system more difficult.

A new buyer would surely want WPAHS's hospitals and doctors to be paid better than they are now -- reimbursements comparable to what Highmark is now paying the UPMC system.

In other words, Highmark had plenty of reason to keep WPAHS from ever reaching the open market and the bondholders had almost no reason to settle for a steep discount.

Thus the recovery for bondholders was higher than first projected and the savings for Highmark -- which agreed to cover West Penn Allegheny's junk bond debts as part of the 2011 purchase agreement between the two health organizations -- was lower than the insurer initially hoped.

Still, the only opinion on the debt restructuring that truly matters is that of the state Insurance Department, which has been mum so far.

Previously, the Insurance Department had expressed to Highmark that it wanted the insurance company to shave WPAHS's "level of indebtedness," and not "send good money after bad," according to records and testimony arising from a court case pitting WPAHS against Highmark last autumn.

When Highmark presented its proposed debt reduction deal two weeks ago, Insurance Department officials were "non-committal" on how the savings would affect their ultimate approval of the takeover, according to one Highmark official.

On one hand, it can be argued the debt discount isn't enough. On the other, it can be argued no discount is enough -- because, as many analysts have pointed out, debt load wasn't and isn't WPAHS's primary problem.

In testimony given during last year's WPAHS-Highmark divorce case, former Highmark CEO Ken Melani said that even if WPAHS' total bondholder debt load were halved, the health system would only save $20 million annually.

The debt, he said, "wasn't the biggest thing ... Without [patient] volume, [WPAHS] wasn't going to survive, regardless of what we did about debt."

Analysts reiterated that view last week.

West Penn Allegheny has major challenges beyond annual debt service levels, said Lisa Martin, a senior vice president at Moody's Investors Services. "With West Penn, their liquidity and cash flow [have] been very weak." Low patient flow and high management turnover have also crippled the system over the last decade, according to the Moody's analysis.

So if the debt savings are mostly cosmetic -- amounting to just a few million dollars a year, as it turns out -- why did Highmark, WPAHS and bondholders spend the past few months wrestling over the issue?

Because without that savings, the deal might not have happened at all. If these dollars are indeed the key to getting state approval of the deal, the wrestling was worth it.

"Everybody wins," said Jan Jennings, president and CEO of Pittsburgh-based American Healthcare Solutions. "Employees of West Penn Allegheny win. Highmark wins ... It's even good for the bondholders."

It's also a good time to borrow. With borrowing so much cheaper today than in 2007 -- most of the 2007 West Penn refinancing was borrowed at about 5.375 percent, while debt today costs half of that -- Highmark could actually borrow more than the $620 million or so debt balance that remains and steer the extra capital back toward WPAHS.

Bonds from that 2007 series with a 2040 maturity date purchased on Jan. 18 sold for 70 cents on the dollar, according to data from the Municipal Securities Rulemaking Board.

While the details of the debt restructuring and forthcoming borrowing make good chatter for finance experts and muni-market observers, most people in Pittsburgh aren't interested in every turn of the screw during this extended Highmark-WPAHS courtship, Mr. McTiernan said.

"What the market wants to see [is] OK, what's this integrated delivery system going to look like? What does it mean to me in terms of benefits and cost?"

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Bill Toland: btoland@post-gazette.com or 412-263-2625.


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