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In proposed OHSU-Legacy deal, each side attracted by other’s strengths

Joining financial clout with feeder hospitals and clinics, the business thinking behind merging is clear — even if the effect on patients and the public is not
August 22, 2023

If opposites attract, it’s small wonder that leaders at Legacy Health and Oregon Health & Science University are drawn to a merger.

OHSU is a staggeringly wealthy blue-chip brand but largely focused on one campus, while Legacy is financially wobbly but rich in physical assets spread across the region. 

On Aug. 16, the two systems announced a proposed deal that amounts to OHSU taking over Legacy’s hospitals, clinics and other facilities. If approved, it would create the largest health system in the greater Portland area, overshadowing Kaiser Permanente and Providence Health, and be a major player in the state as well.

In the coming months, regulators, employees, patients and the public will have ample opportunity to research and debate the effects of the proposal. For now, what’s clear is the business thinking behind it.

A zest to grow

OHSU, with its hospital, medical school and research facilities, is a magnet for patients across the Pacific Northwest. Other hospitals often transfer complex cases there.

And with huge investment reserves and strong bond ratings, OHSU has ready access to low-cost bond financing that can fuel expansion. 

From its bastion-like main campus on Marquam Hill overlooking Portland, OHSU leaders have long sought to grow:

Other efforts have not been successful. In 2017, OHSU and Salem Health, which owns Salem Hospital, dropped their plans to become a partnership. 

And in 2021, OHSU’s alliance with the aging and financially strapped nonprofit Mid-Columbia Medical Center in The Dalles fell apart.

These days, the university system is financially flush. Fed by years of strong annual operating profits and investment portfolio gains, OHSU’s net worth — assets minus liabilities — has ballooned. It topped $4 billion at the end of March and includes investment portfolios of OHSU and its foundations totaling $2.7 billion, its latest filings show.

While many hospital systems nationwide have flailed amid operating losses, OHSU for the nine months that ended March 31, notched an operating profit of $82 million, plus $40 million growth in its investments, the latest filing shows.

Those kinds of results earn OHSU an Aa3 Moody’s bond rating. That’s a “high quality” rating, 4th from the top of Moody’s 10-step premium “investment grade” bond scale. It helps OHSU borrow relatively inexpensively.

A system with needs

Portland-based Legacy Health has a sprawling service area with seven hospitals and 70-plus clinics reaching from southern Washington through the Portland metro area to the north Willamette Valley.  

But to stay competitive, that network needs hundreds of millions of dollars of upgrades in coming years, according to the Aug. 16 statement issued by Legacy and OHSU. 

Legacy Health:
Facilities in Oregon: Legacy Emanuel Medical Center, Randall Children’s Hospital at Legacy Emanuel, Legacy Good Samaritan Medical Center, Legacy Meridian Park Medical Center, Legacy Silverton Medical Center, Legacy Mount Hood Medical Center; In Washington: Legacy Salmon Creek Medical Center.
Employees: 13,000
Financials for 12 months ended March 31, 2023
Operating revenues: $2.6 billion
Operating loss: $171 million
Investment portfolio loss/decline: $60 million
Investment portfolio: $1.2 billion
Net worth: $1.9 billion, down from $2.2 billion a year earlier.

And Legacy, facing what it calls “financial difficulties,” is not in great shape to borrow heavily to fund that. Labor costs for its 13,000-employee workforce have soared. Legacy faces competition from other hospitals and clinic systems, including Providence and Kaiser Permanente. For the fiscal year that ended March 31, Legacy suffered an operating loss of $171 million, plus a $60 million drop in its investment portfolio, the filings show.

As of June 30, it had $84 million in cash, down from $317 million 18 months earlier.

The system has managed to keep its investment portfolio largely intact, and as of June 30 it stood at $1.2 billion. But that’s not spectacular for a system of Legacy’s size. And last fiscal year’s severe loss underscored how quickly even a big financial backstop can be depleted.

One sign of its woes: It has used so much of its cash covering operating losses that since last September, it has had to negotiate special permission from three banks to temporarily violate the conditions of its loans.

Legacy’s public filings show it has been operating under special temporary agreements with the three banks that have loaned the system a total of about $263 million. The agreements have let Legacy spend down its cash, even though that violated the lenders’ requirements for how much cash Legacy should keep on hand to cover routine debt payment installments. As part of the agreements, one bank doubled the interest rate it is charging Legacy, to an annual rate of 3.62%, a filing showed.

A Moody’s analysis noted in April that Legacy has more than enough reserves to pay off its bank loans if it needed to.

‘A strong network’

But Legacy’s sprawling network of hospitals and clinics, especially in the Portland metro area, are a big asset. For accounting purposes, they’re worth $808 million.

The emergency department at Legacy Good Samaritan hospital in Portland on July 30, 2023.

Legacy’s strengths include “a leading market position in the Portland metropolitan region; good organizational size and footprint; a strong network of clinics and relationships; very strong clinical offerings,” Moody’s wrote in its April analysis.

The analysis also praised Legacy’s “history of good long-term revenue growth.”

Moody’s kept Legacy’s bond rating at A1. That’s an “upper-medium grade” rating in the middle of Moody’s 10-step “investment-grade” rankings. But Moody’s dropped Legacy’s outlook from “stable” to “negative.”

By early next year, Legacy’s business may bounce back enough to meet bank cash-on-hand requirements, according to Moody’s. But if that doesn’t happen, Legacy’s credit rating could suffer, Moody’s warned. And that could drive up the interest rates Legacy would have to pay to borrow via bond issuances.

The dynamics behind the match

In short, OHSU brings the financial clout to issue tax-exempt bonds to raise a massive sum: $1.5 billion over 10 years. Legacy brings the footprint into which much of the money would be poured.

Facilities: OHSU hospital, medical school and research campuses in Portland; affiliation system that includes Hillsboro Medical Center and Adventist Health Portland hospital.
Employees: 20,000
Financials for nine months ended March 31, 2023
Operating revenues: $3.4 billion
Operating profit: $82 million
Investment profit/gain: $40 million
Investment portfolios (including foundations): $2.7 billion
Net worth: $4.1 billion, up from $3.9 billion nine months earlier.

The systems have “complementary strengths,” and the merger would let both entities “exceed what either organization could accomplish independently,” the systems said in their joint announcement. About $1 billion would be plowed into “primary/secondary care and community facilities, capabilities and programs” mainly at Legacy facilities, the announcement said.

Under the proposed deal, Legacy’s physical assets and businesses — excluding its share in the PacificSource health insurance business — would transfer to OHSU, free and clear of any debt. Legacy would use its reserves to pay off all its roughly $475 million in bond debt and $263 million in bank debt, and would transfer what money remained — probably about $500 million — into an independent foundation focused on remedying health inequities and social conditions that contribute to poor health. The foundation would also take on Legacy’s half-interest in PacificSource, the insurer.

By adding Legacy’s property and equipment to OHSU’s assets, OHSU’s bond borrowing power would be supercharged — unless Legacy’s operations continue to suffer operating losses.

Over time, the new joint entity would go on the tax-exempt bond market to borrow $1 billion for health care projects, plus another $500 million to put away as a financial cushion, the announcement said.

Debt strategy central

The strategy shines a light on the importance of taking on debt, even when institutions have big reserves. Why borrow money when you already have lots of it on hand?

The answer lies in part in the low interest rates that nonprofit hospitals typically pay to borrow though tax-exempt bonding for capital projects.

Rather than using their reserves for capital work, hospital systems like to invest their money in the stock, bond and other markets in search of big returns. The strategy was hugely profitable for many hospital systems during the long stock market boom of 2009-2021 that in some years yielded double-digit returns. Systems like OHSU and to a lesser extent Legacy, with their stock portfolios, saw their wealth skyrocket.

Meanwhile, the systems were paying only a few percentage points annual interest to raise money through tax-exempt bonds for capital needs.

Religion not an issue

Besides their declared common goal to improve health care, the two have another shared value: They are both non-religious. Neither imposes religion-based restrictions on services such as reproductive care, gender-affirming care or end-of-life decisions. In the health care sector, it can be tricky for a non-religious entity to find a suitable non-religious partner. 

The industry in Oregon and nationwide is heavy with religion-affiliated systems. In Oregon, these include Providence Health & Services, with eight hospitals spread across the state; PeaceHealth, with four hospitals in Lane County and one in Vancouver, Washington; and religious-based out-of-state chains Adventist Health, Trinity Health and CommonSpirit Health that own other Oregon hospitals.

Benefits touted, but details sketchy

OHSU and Legacy present their plan as an all-around win: improving patient care and community health, increasing the training of medical professionals, and ensuring job continuity for the workforce. But the announcement didn’t have specifics about exactly when or where patients and residents might expect improvements

Nor did it spell out how Legacy’s workforce — the vast majority of it non-unionized — will be integrated into OHSU’s heavily unionized public-employee workforce. 

OHSU's campus in Southwest Portland, Ore.

“Over time, some employees may migrate to a different employer within the (merged entity), or to a different location or job function, to enhance system effectiveness and operational integration,” OHSU and Legacy said in their announcement.

The broad-brush-stroke nature of the plans has left many observers hungry for more information. The Oregon Nurses Association in a statement took jabs at both sides, criticizing Legacy management’s track record and slamming OHSU for not agreeing yet on a new labor contract with its 3,000 nurses. Still, the union said the merger “is likely to be in the best interests of Legacy’s patients and their 13,000 staff members.” It could open the door to a big union drive at Legacy. Nurses at OHSU — and many other Oregon hospitals — have long been unionized. But that’s not the case at Legacy. The nurses at only two of Legacy’s smallest hospitals, Mount Hood and Silverton, are currently unionized.

Merger review still to come

The deal is large enough that the Federal Trade Commission is also expected to review it. In recent years, it’s become more aggressive in the area of hospital mergers, based on research showing that consolidation decreases competition and raises costs.

State regulators, including Oregon’s new health care merger oversight program, similarly are expected to spend months evaluating the proposed deal’s effects on competition, health care prices, the delivery of health care, and other factors.

It will be the largest such deal yet considered by the new program.

“This will be a great opportunity for the new merger and acquisitions (program) to review and provide assurance that this merger will benefit Oregonians,” said Dr. Bruce Goldberg, the former director of the Oregon Health Authority and a professor of health management and policy at OHSU/Portland State University.

Correction: The initial version of this article mischaracterized OHSU's business relationship with Portland Adventist and Hillsboro Medical Center, formerly known as Tuality Healthcare. The Lund Report regrets the error.

You can reach Christian Wihtol at [email protected].