General Obligation Bonds: A Matter of Public Support

The article below is reprinted with permission from The Capital Issue, a quarterly newsletter published by Lancaster Pollard.

Throughout the country, a fifth of all hospitals are owned by city, county or state governments. Currently, there are more than 1,000 state and local government hospitals, with 29 states plus the District of Columbia having hospital districts.

State and local government hospitals, both large and small, and hospital districts are able to access tax revenues, which can lead to lower borrowing costs in the municipal bond market. Essentially, they or the government entity that owns them can assess property taxes to pay for operating costs or debt service payments, which can provide a lower cost of capital. The general obligation of the entity's taxing power is the primary support for a bond issue instead of the revenues generated by the hospital itself.

Tax-supported bond basics

GO bonds have historically provided local entities with the lowest borrowing costs among the types of long-term bonds that they may issue because of their broad security. GOs are backed by either the full faith and credit pledge of the issuer or the promise to levy ad valorem (value-based) property taxes. Most local governments use the latter approach because they are generally not authorized to issue full faith and credit bonds. Bonds can be rated or nonrated. Most states legislate that local governments must seek voter approval prior to issuing GO bonds.

There are unlimited tax bonds, which are not limited as to rate or amount. On the other hand, limited tax bonds are used when the taxing power of the government issuer is specifically limited by law. The tax rate on assessed property value or the assessment rate typically has a limit. Some hospitals that receive tax support are in this category or are restricted by dollar amount caps based on the district's or county's assessed valuation.

In addition to GO bonds, government hospitals and hospital districts can access special tax bonds. Usually, this type of tax-supported debt uses sales tax on certain goods or services to pay ongoing debt payments. Areas that have tourism, such as resort towns, may be able to provide enough tax revenue to support long-term debt. Another example is tax-increment (tax-allocation) bonds are based on taxes levied on the incremental growth in assessed valuation in developing and redeveloping areas.

To market, to market

GO bonds are regulated by state law and, therefore, vary widely from state to state. However, there are consistencies about going to market that are the same for all borrowers:

  • The general condition and trends of the economy
  • The condition of capital markets
  • The status of recently sold competitive bond issues
  • The supply of issues coming to market and, in particular, potentially competing issues.

Credit rating agencies generally consider GO bond issues as a strong credit, which lead to an overall investment-grade rating of the long-term debt. Investors view the property tax pledge as their primary security for the bond issue. Both will prioritize their due diligence on the demographics of the voting population (i.e., local employment base, unemployment rate, growth, current taxes, income level and proforma tax per capita, etc.), then on the financial performance of the hospital.

A tale of two hospitals

Each of these hospitals was financed with a different type of tax-backed debt:

Martin County Hospital District manages Martin County Hospital, a 25-bed critical access hospital in Stanton, Texas, and provides operating and maintenance support along with debt service support through property taxes. To replace a small one-story hospital built in 1949 with a 60,000-square-foot replacement facility, the hospital district brought a tax levy, the maximum taxable assessed value of property allowed by statute, to the electorate. It passed with an 82 percent approval rating.

After reviewing credit rating agencies, the hospital's board selected one that would put more emphasis on the tax support and less on the rural hospital's operations when assigning a rating. A BBB+ rating was obtained. Two series of bonds with a par amount of $22 million were issued to provide funding for the replacement hospital.

Jersey Community Hospital District, which operated a 67-bed facility located in Jerseyville, Ill., had a consistently positive, though modest, operating performance. But the hospital's credit profile took a hit as a result of a negative operating margin at its 2009-2010 fiscal year end. Throughout latter fiscal 2010 and into fiscal 2011, the hospital's management took steps that improved operations, but funding its $4 million expansion and $3 million refinance would be a challenge.

As a hospital district in Illinois, JCHD was able to issue $7.05 million of alternate revenue bonds in three series: tax-exempt, bank-qualified bonds; taxable Build America Bonds; and taxable Recovery Zone Economic Development Bonds. The use of this type of conditional tax-backed funding provided needed credit assurance to bond investors. Alternate revenue bonds, a hybrid form of revenue-GO bond financing permitted for governmental districts under Illinois law, enables a hospital district to issue debt that is conditionally backed by property tax revenue should the hospital’s operating cash flow fail to cover debt service.

GO bond market today

In general, the overall GO bond market volume was up 29 percent in 2012, according to The Bond Buyer. This was mostly because of refundings due to historically low interest rates. There were 73 health care GO issues in 2012, accounting for $1.2 billion in volume. This was up by 21 issues representing $0.2 billion in volume from 2011. When compared to the total volume of health care issues in 2012, however, GOs only represent 3.57 percent of the total $34.8 billion.

Most experts agree that 2013 will shape up much like 2012, with more refundings coming to market rather than new money issuances, particularly if interest rates stay at their current low levels. However, each state will vary depending on local economies and elections.

According to Everett B. Martinez, a bond counsel with Peck Shaffer in Denver, even though there has been a large number of refundings in the GO market, there also appears to be a slow, steady rise in new money issuances. "Of course, we have not hit prerecession levels, but the general belief is that as more time passes, the demand and need for projects that have been put on the back burner will cause a more dramatic increase in new money deals in the future."

National issues looming over the municipal bond market will certainly impact GO bonds. These include the continuing slow economic recovery and the uncertainty related to the federal government's handling of the pending sequestration, federal and state funding for entitlements, the debt ceiling and the tax exemption for municipal bond interest. Additionally, some states are facing serious unfunded pension liabilities that will negatively impact state and local budgets.

"The specter of tax reform, specifically the reduction or elimination of tax exemption for state and local governmental bonds, continues to cause concern in the municipal markets and increases price volatility," said Thomas A. Wilson, a partner with Peck Shaffer in Columbus.

Bringing it to a vote

A state's enabling legislation will determine if and when a tax-support measure should be brought up for a vote. For example, some hospital districts and municipalities may be able to issue GO bonds without an election. However, most hospital districts and municipalities will need to put a proposed tax up for a vote… and may not have an easy job of passing it.

"It appears that voters have been gun-shy at incurring additional indebtedness at a time when many are struggling to put food on their tables," Mr. Martinez explained.

Before bringing a bond issue before voters, a hospital should know the existing tax burden of it citizens and ensure that the proposed tax is reasonable and justified by the added benefit to the community.

Finally, it's imperative for the hospital to build community support for the proposed tax well before the referendum. While all states regulate how voters can be approached regarding a ballot issue; states with hospital districts have legislated specifically what hospitals can and can't do to educate the electorate. For example, in Texas, a hospital's management and board members are not allowed to promote the vote to the public nor can hospital district funds be used for advertising. Typically, a citizens committee is formed to serve this role and to raise funding for advocacy, such as advertising, yard signs and mailings.

Assuming that a government-entity hospital is committed about the need for continuing and improved healthcare for the community and can communicate the facts relative to this need, a GO bond election is an avenue for financing a replacement or expanded/renovated hospital facility.

Matthew J. Lindsay is a vice president with Lancaster Pollard. He is the manager for the Pacific Northwest region and is based out of the firm’s headquarters in Columbus, Ohio. He may be reached at mlindsay@lancasterpollard.com.

James D. Neil is a senior vice president with Lancaster Pollard. He is the manager for the South Central region and is based out of Austin, Texas. He may be reached at jneil@lancasterpollard.com.

More From Lancaster Pollard:

5 Observations on the State of Hospital Credit Markets
Mission Possible: Finding Capital for Standalone Hospitals
Opportunity Knocking: Taking Advantage of Low Short-term Interest Rates

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