A Mixed Bag: 5 Things to Note on the Hospital Debt Markets for 2013

In 2012, non-profit hospitals hit the bond markets more frequently than in 2011, as healthcare borrowers sold $33.5 billion in municipal bonds. This was a 25 percent increase from 2011, which was one of the most sluggish years for healthcare bonds, but still less than the 10-year average of roughly $39 billion per year.

Pierre Bogacz, managing director and co-founder of HFA Partners, a healthcare capital market firm, says the debt markets were a mixed bag for hospitals last year. The increase in bonds sold was a positive, but much of the increased volume was not due to traditional behaviors. Here, Mr. Bogacz explains some of his key observations on the hospital bond market that hospital CFOs and other finance executives should be aware of right now.

1. Low new money issuances in 2012 signal lingering uncertainty. In 2012, more hospitals sold more debt than in 2011, but Mr. Bogacz points out that is somewhat misleading. Bond volumes increased last year mostly due to refundings instead of "new money."

New money issuances are when hospitals issue new debt, say a $60 million bond, to be used for projects that haven't been funded before. This increases the supply of the bond market. However, refundings are similar to house refinancings — hospitals tinker with their currently issued debt to get lower rates. So in refundings, hospitals take supply out of the market and replace it with new supply — but supply hasn't really increased overall.

Mr. Bogacz says the high number of hospital refundings is not a surprise, considering how low interest rates are. Last November, the 30-year Municipal Market Data index on an "AAA"-rated organization was at an all-time low, and as of January 2013, the 30-year MMD was still at a low 2.92 percent. In addition, he says many hospitals would rather save money now and refinance their bonds instead of taking on new debt due to the uncertainty facing their revenue streams.

"A majority of hospitals and other healthcare providers are continuing to put off new money projects for a number of reasons," Mr. Bogacz says. "There is still uncertainty about what healthcare reform means, what reimbursements are going to look like, etc. What about ACOs? A lot of clients are looking at new money more carefully."

2. Supply is still very limited for investors who want to buy healthcare bonds. Municipal healthcare bonds are attractive investments for many people because they pay a higher yield, and they are relatively less risky than going to the stock market, Mr. Bogacz says. However, investors are having a hard time buying hospital bonds due to the short supply.

Refundings have contributed, in part, to the short supply of healthcare bonds, and another contributing factor has been healthcare IT projects. Health IT projects have been a top capital project for hospitals for several reasons — meeting federal meaningful use standards, creating interconnected delivery systems, etc. — but IT has a relatively limited life and doesn't get funded through the bond markets. "It doesn't make sense to fund a new information system, or a five-year asset, with a 30-year bond," Mr. Bogacz says.

For health IT and other projects with shorter useful life, many hospitals are turning toward bank direct placements instead of the bond market. Bank direct placements are like publicly sold bonds in that they are issued for new money or refunding purposes and can be tax-exempt. However, they are sold directly to a single bondholder, such as a bank, that holds the bonds to maturity.

"Bank direct placements are taking a lot of supply out of the markets," Mr. Bogacz says. "With bank direct placements, there is less supply for traditional investors, which is contributing to the imbalance. The hospital bond market is a borrower's market, in my opinion."

3. The incidence of hospitals issuing bonds is likely to pick up from last year. Despite the lack of new money being issued by hospital, Mr. Bogacz predicts that trend may reverse this year because many hospitals have been putting off too many facility-based capital projects.

"The fundamentals haven't really changed. Acute-care providers are basically facility-based," Mr. Bogacz says. "You see average age of plant going up — and how could it not go up? If you're not reinvesting in plant and routine maintenance is not matching depreciation, hospitals are falling behind, and the age of plant goes up. As soon as hospitals regain confidence, you'll see some of these projects coming back to the table."

4. Rating agencies remain relatively bearish on the hospital industry. Earlier this month, Moody's Investors Service released a report saying it had downgraded $20 billion in non-profit hospital and health system debt in 2012, the highest amount Moody's has recorded since it started tracking the data in 1995.

Mr. Bogacz says it is unwise to view the large amount of downgraded debt as a trend considering three health systems — Englewood, Colo.-based Catholic Health Initiatives, San Francisco-based Dignity Health and New York City-based Memorial Sloan-Kettering Cancer Center — comprised almost $13 billion of that total downgraded figure.

However, it does reiterate the point that Moody's, Fitch Ratings and Standard & Poor's Ratings Services have "negative" views on the non-profit hospital industry due to declining reimbursements and other factors. And those agencies also don't want a repeat of 2008 when toxic financial instruments were ultimately given credit ratings that were too generous.

"[Credit rating agencies] are going to take the worst-case scenario," Mr. Bogacz says. "Otherwise, you're going to end up with the mortgage-backed securities situation where everyone is pointing their fingers at the rating agencies, saying they didn't scrutinize the situation hard enough."

5. Keep an eye on credit spreads. Mr. Bogacz says it's nearly impossible to try and forecast whether the MMD index and other rates will stay as low as they are. However, he says he is focusing his attention on credit spreads.

Credit spreads — the premiums charged by investors to take on a hospital's credit risk — came down in 2012 due to the low volume of new money issues, and he says it's worth monitoring to see if the spreads continue to decline, or if they will increase as more hospitals issue new debt.

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