Commentary says Highmark-West Penn deal not breached

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Despite West Penn Allegheny Health System's protest to the contrary, Highmark Inc.'s suggestion that WPAHS file for bankruptcy or otherwise reorganize its debt does not constitute a breach of the affiliation agreement between the two health organizations, according to an analysis of the agreement conducted by Bank of America Merrill Lynch.

The municipal bond industry commentary, issued Friday, says, "We found no language to support the idea that these actions constitute a cause for termination. ... And if the agreement is not terminated, the transformation of the loans into gifts is not triggered.

"WPAHS's position that there has been a termination-causing breach of the agreement is untenable."

The financially ailing WPAHS announced Sept. 28 it was calling off its partnership with Highmark because of the health insurer's insistence that the health system take measures to restructure its debt. WPAHS also claimed that, because Highmark had violated the affiliation agreement, WPAHS could keep $200 million the insurer had already issued to the hospital system.

Highmark responded by suing WPAHS to prevent the health system from searching for new investment partners, a move that drove down the trading prices on WPAHS's long-term bonds, which mature in 2040.

Highmark spokesman Aaron Billger said Tuesday: "We've reviewed the recent report and are glad that our thinking is confirmed."

WPAHS spokeswoman Kelly Sorice said Tuesday the analysis is off-base. "We respectfully disagree with Bank of America's conclusions, particularly those surrounding Highmark's breach.

"Highmark breached the affiliation agreement, informing West Penn Allegheny repeatedly that it would not close the current transaction, even if the Pennsylvania Insurance Department approved it. Bank of America [does] not take this vital fact into consideration," she said.

The analysts at Bank of America Merrill Lynch were also skeptical that a new full-price partner for WPAHS can be found. And if there is no new partner -- and supposing that WPAHS does not want to be broken up and sold for scrap -- the best option, they said, is to return to the negotiating table with Highmark and agree to some kind of structured bankruptcy or debt reorganization.

So why would West Penn Allegheny threaten to walk away?

"Their access to the market may be compromised if they don't treat the bondholders well," said Susannah Page, the municipal research strategist at Bank of America Merrill Lynch who wrote the Highmark-WPAHS commentary. "They really don't want to file Chapter 11. ... The market doesn't like it. Bondholders hate that."

Resisting bankruptcy, she said, would demonstrate to bondholders that WPAHS is looking out for them, and preserve the system's marketability at the tax-exempt bond window -- which could be a signal that WPAHS intends to stay with Highmark or another nonprofit, rather than risk acquisition by a for-profit player such as Nashville, Tenn.-based hospital operator Vanguard Health Systems.

Bondholders already seem to recognize the possibility of a haircut, given the lower trading prices; they are anticipating a lower payout "either in or out of bankruptcy court. [WPAHS] may not want to file Chapter 11, but [at] the end of the day, given the magnitude of its financial difficulties, we cannot imagine that any suitor would offer more than a very distressed hospital price for West Penn," the report said.

How much of a bondholder haircut? A "typical" distressed system might expect to receive 75 cents on the dollar, but the WPAHS debt situation is remarkably atypical. "In our view, it is a deeply speculative grade credit with a long history of financial deterioration. ... This would theoretically cut the West Penn recovery down to 38 cents on the dollar," the report said.

Highmark, the analysis noted, was likely spooked by WPAHS's deteriorating financial condition -- and its own growing price tag for the deal -- which accounts for the insurer's stronger push for bankruptcy.

WPAHS has more at stake than Highmark. West Penn Allegheny's cash on hand is down by nearly 12 days, from 57 days at the end of fiscal year 2011 to about 45.7 days now, "despite the infusions of cash from Highmark." WPAHS's debt-service coverage -- the amount of cash flow available to meet annual interest and principal payments -- is almost at zero.

If the two sides don't work something out soon, Bank of America Merrill Lynch cautioned, the parties could reach the May 1, 2013, "end date" of the original affiliation agreement. At that point, either party is able to walk away from the merger.

The report is available online at


Bill Toland: or 412-263-2625.


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