Massachusetts officials last week unanimously approved a $147.6 million revenue bond deal as part of a comprehensive plan to boost the flagging fortunes of the state's largest health maintenance organization, Harvard Pilgrim Health Care Inc.

The proposed debt offering is predicated on the imminent sale of eight Harvard Pilgrim buildings to Civic Investments Inc., a single purpose holding entity set up by the Massachusetts Health and Educational Facilities Authority (HEFA). Harvard Pilgrim will then lease back the facilities from Civic Investments with the lease payments, construction mortgages, and actual real estate assets being securitized by HEFA.

HEFA has recently fallen on bad times. The beleaguered company is expected to record a $100 million loss this year. That is almost twice its 1998 deficit of $54 million. That news, along with the HMO's unexpected decision to discontinue its Rhode Island operations, recently caused Standard & Poor's to downgrade Harvard Pilgrim from a double-B to a single-B rating and place it on negative credit watch.

The bonds will be sold as a private placement with the HEFA acting as the issuer. HEFA is an independent public authority that provides access to capital markets at low costs to nonprofit health, educational, and cultural institutions. In May, HEFA helped Harvard Pilgrim raise $77 million through a program that allows non-profits to convert furniture and equipment assets into cash.

Massachusetts will not guarantee the bonds nor are there any plans to include an insurance wrap or other credit enhancements. In addition, the notes will be kept unrated both in an effort to reduce cost and in light of the transaction's private nature.

A portion of the difference between the $147.6 million bond amount and the $125.9 million actually being paid for the buildings will be used to pay service fees to HEFA and investment bank Salomon Smith Barney. Also, $14 million will be put into an emergency fund held by the state's Debt Service Reserve Fund and managed by an as-of-yet-unnamed trustee bank.

Structured in both 30-year and 20-year maturities, the notes are being issued with tax-exempt status because proceeds will be used to lease health care facilities. Janice Hays-Cha, HEFA's deputy director, confirms that the bonds have been capped at 9.75%, but strongly emphasized that such an interest rate is significantly higher than the intended pricing.

However, some market analysts contend that investors may demand the 9.75% level in order to get the deal closed. Even though such a figure would translate into an 18% yield if the bonds were taxable, the high yield buy-side is not currently in a very forgiving mood when it comes to health care issues. As Premila Peters, an analyst with KDP Investment Advisors, said, "People have been burned pretty badly by this sector."

Such a sentiment is especially prevalent when it comes to the HMO subsector. "The appetite in the high yield market for HMO's is absolutely nil right now," said Margie Patel, an analyst with The Pioneer Group. "The tide has turned against them in that they're being squeezed by both the acute side and being squeezed by the government," she added.

However, Harvard Pilgrim is confident that its deal will find significant interest. As spokesman Alan Raymond explained, "The value of the real estate itself is very strong and there's the reserve fund." He also stressed that the company is engaged in an aggressive turnaround plan that includes about 250 personnel layoffs, 15%-20% premium hikes, and the decision to withdraw from Rhode Island. As company CEO Charles Baker recently noted during his testimony at a HEFA hearing, "Rhode Island represents about 10% of Harvard Pilgrim's membership, but almost 40% of our operating loss."

HEFA's Hays-Cha added, "While Harvard Pilgrim has experienced financial distress like other health maintenance organizations throughout the country, it is still very well-positioned in Massachusetts."

Sources close to the deal say that Salomon Smith Barney will conduct and informal launch over the next two weeks and then amplify its efforts in 2000. This approach is being taken in large part because a final public hearing on the offering is being held on December 20, following which Massachusetts Governor Paul Cellucci is expected to give the official go-ahead.

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