Beleaguered HMO Enters HY Arena

Massachusetts officials last week unanimously approved a $147.6 million revenue bond deal and paved the way for a new high yield issue. It is part of a comprehensive plan to boost the sagging fortunes of the state's largest health maintenance organization, Harvard Pilgrim Health Care Inc.

The bonds will be sold as a private placement with the Massachusetts Health and Educational Facilities Authority (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.

Janice Hays-Cha, HEFA's deputy director, confirmed 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 participants contend that investors may demand the full 9.75% in order to complete the deal. Even though such a figure would translate into an 18% yield if the bonds were taxable, the high yield buy-side is not in a very forgiving mood when it comes to health care issues.

"People have been burned pretty badly by this sector," said KDP Investment Advisors analyst Premila Peters.

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, a portfolio manager 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.

The beleaguered Harvard Pilgrim 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 Ratings Service to downgrade it to single-B from double-B and place it on negative credit watch.

But company chief executive officer Charles Baker defended the action during his testimony at a HEFA hearing because Rhode Island represented about 10% of Harvard Pilgrim's membership, but almost 40% of our operating loss."

Furthermore, Harvard Pilgrim spokesman Alan Raymond said the company is engaged in an aggressive turnaround plan that includes about 250 personnel layoffs and premium hikes of up to 20%

Sources close to the deal say that Salomon Smith Barney will conduct an informal launch over the next two weeks and then amplify its efforts in 2000.