This summer, interest rates within the tax-exempt market hit historical lows, making it a lot easier for organizations like hospitals to issue debt without crippling their ability to repay. Yet, not many hospitals and health systems are taking advantage of the low rates.
From July 16 to August 15, only 11 acute-care hospitals and health systems issued tax-exempt, fixed-rate revenue bonds. The market was even slower during the first quarter of this year.
Pierre Bogacz is managing director and co-founder of HFA Partners, a financial advisory firm for hospitals and other healthcare providers. Here, he explains what the debt markets are like for hospitals (particularly non-profits), how the markets differ between for-profit and non-profit providers and what he expects from the hospital bond markets going into 2013.
Question: Earlier in August, the Wall Street Journal talked about hospital bonds and how they are attracting investors who are seeking higher yields in this low-interest rate market. While hospital bond default rates are relatively high, you think not all hospital bonds have that high degree of riskiness. Can you explain a littler further?
Pierre Bogacz: There are major differences in terms of hospital bond issues, and there's a differentiation between the levels of risks, similar to other sectors. Refunding [refinancing], since it doesn't add any leverage generally, is viewed as less risky. It doesn't have any impact on the hospital's ratings. Refundings are less risky than any kind of new money issue.
Hospital revenue bonds are generally viewed as riskier than state and local government bonds supported by taxes, but default rates among non-profit hospitals are still very low, particularly for "BBB" and higher hospitals. At the end of the day, the hospital's bond rating is there to factor in all the different risk factors, and rating agencies do a relatively good job of assessing risk. Bond ratings are the best way to differentiate between the levels of risk.
Q: So we are in September — are the debt markets still just as favorable now for hospitals as they were earlier this summer?
PB: The tax-exempt bond markets are very favorable right now, and that's due to a couple of factors. The Municipal Market Data index, the tax-exempt, risk-free benchmark index, is still at record lows. Not only that, but in the last two to three months, credit spreads — how bondholders get compensated for hospitals' risk profiles — have gone down significantly. For example, at the beginning of the year, a "BBB"-rated hospital would be paying 2 percent or more over the MMD on the long end and is now looking at about 1.6 to 1.8 percent over the MMD. On a $50 million issue, that's about $250,000 a year in interest rate savings. This is in addition to the drop in the MMD index itself in the last two or three months.
Q: Is the same climate there for for-profit hospitals? Does it matter that for-profit hospital chains generally have worse credit ratings?
PB: In the taxable world — HCA, Health Management Associates, Tenet Healthcare — most of these [bonds] are rated below investment grade. The majority of non-profit hospitals have investment-grade ratings.
Q: Can you explain why that is?
PB: I think a big part of it is most non-profit hospitals have less than 50 percent leverage, whereas for-profit chains average about 65 percent. That's a big deal to rating agencies. Also, the for-profit sector favors short-term funding, which exposes these chains to interest rate risk and refinancing risk, whereas non-profit hospitals tend to fund longer term with 30-year bonds.
There's been a knee-jerk reaction from non-profit hospital boards to the capital market crisis since 2008, and a lot of hospitals are staying away from variable rate debt. Their cost of debt is higher, but they've locked in their coupon and are not exposed to any interest-rate risk.
The supply of tax-exempt bonds is very limited right now, and that puts downward pressure on hospital credit spreads.
However, the large, national non-profit chains tend to be a little more aggressive with their funding and behave more like for-profits with debt management. They end up taking on more interest-rate risk, but they have a lot more liquidity and cash on hand, so they can afford it. They could afford to pay off fairly large variable rate facilities if something happened to the markets. Smaller non-profits typically don't have as good liquidity.
Q: You mentioned liquidity, and it seems like hospitals are definitely placing a priority on their cash flow? Do you see this as a major trend as well?
PB: Yes, they are clearly still doing that. A lot of the boards have become more critical of expansion plans given the uncertainty of reimbursement with Medicare and Medicaid and the economy. They are just not issuing as much debt as they used to. So far this year, levels are similar to last year, which was the lowest of the past 10 years. They aren't using cash either, so cash on hand is going up. That's making for some pretty good ratios, but the average age of plant is going up.
Q: To wrap up, where do you see the hospital debts markets as we head into 2013?
PB: I think this holding back on the part of hospitals and their capital projects is going to work itself out. I don't know if that's going to be as quick as some people expect, but you can't let your age of plant go up indefinitely. At some point, there's going to be a day of reckoning.
This is a very favorable market for selling debt for reasons we talked about — low interest rates, good spreads. As long as that continues, more and more hospitals are going to return to the debt markets and revisit projects they may have put on hold. The economy is a wild card here, as are making decisions on the market and payor mix. If the economy doesn't pick up, [hospitals] are not going to have much of a case going back to projects.
There's a lot of IT that's being financed, but that doesn't usually flow through the bond markets because it's relatively short-term. Spending on IT is a good trend because a lot of hospitals need better information systems, like cost accounting — it's hard to run a business when you don't know what things cost you. But maybe the days of the mega inpatient projects may not return for a long time because hospitals have more incentive to turn to the outpatient setting to preserve costs and improve reimbursements. Generally, I expect activity in terms of bricks and mortar is going to stay low for a while.
From July 16 to August 15, only 11 acute-care hospitals and health systems issued tax-exempt, fixed-rate revenue bonds. The market was even slower during the first quarter of this year.
Pierre Bogacz is managing director and co-founder of HFA Partners, a financial advisory firm for hospitals and other healthcare providers. Here, he explains what the debt markets are like for hospitals (particularly non-profits), how the markets differ between for-profit and non-profit providers and what he expects from the hospital bond markets going into 2013.
Question: Earlier in August, the Wall Street Journal talked about hospital bonds and how they are attracting investors who are seeking higher yields in this low-interest rate market. While hospital bond default rates are relatively high, you think not all hospital bonds have that high degree of riskiness. Can you explain a littler further?
Pierre Bogacz: There are major differences in terms of hospital bond issues, and there's a differentiation between the levels of risks, similar to other sectors. Refunding [refinancing], since it doesn't add any leverage generally, is viewed as less risky. It doesn't have any impact on the hospital's ratings. Refundings are less risky than any kind of new money issue.
Hospital revenue bonds are generally viewed as riskier than state and local government bonds supported by taxes, but default rates among non-profit hospitals are still very low, particularly for "BBB" and higher hospitals. At the end of the day, the hospital's bond rating is there to factor in all the different risk factors, and rating agencies do a relatively good job of assessing risk. Bond ratings are the best way to differentiate between the levels of risk.
Q: So we are in September — are the debt markets still just as favorable now for hospitals as they were earlier this summer?
PB: The tax-exempt bond markets are very favorable right now, and that's due to a couple of factors. The Municipal Market Data index, the tax-exempt, risk-free benchmark index, is still at record lows. Not only that, but in the last two to three months, credit spreads — how bondholders get compensated for hospitals' risk profiles — have gone down significantly. For example, at the beginning of the year, a "BBB"-rated hospital would be paying 2 percent or more over the MMD on the long end and is now looking at about 1.6 to 1.8 percent over the MMD. On a $50 million issue, that's about $250,000 a year in interest rate savings. This is in addition to the drop in the MMD index itself in the last two or three months.
Q: Is the same climate there for for-profit hospitals? Does it matter that for-profit hospital chains generally have worse credit ratings?
PB: In the taxable world — HCA, Health Management Associates, Tenet Healthcare — most of these [bonds] are rated below investment grade. The majority of non-profit hospitals have investment-grade ratings.
Q: Can you explain why that is?PB: I think a big part of it is most non-profit hospitals have less than 50 percent leverage, whereas for-profit chains average about 65 percent. That's a big deal to rating agencies. Also, the for-profit sector favors short-term funding, which exposes these chains to interest rate risk and refinancing risk, whereas non-profit hospitals tend to fund longer term with 30-year bonds.
There's been a knee-jerk reaction from non-profit hospital boards to the capital market crisis since 2008, and a lot of hospitals are staying away from variable rate debt. Their cost of debt is higher, but they've locked in their coupon and are not exposed to any interest-rate risk.
The supply of tax-exempt bonds is very limited right now, and that puts downward pressure on hospital credit spreads.
However, the large, national non-profit chains tend to be a little more aggressive with their funding and behave more like for-profits with debt management. They end up taking on more interest-rate risk, but they have a lot more liquidity and cash on hand, so they can afford it. They could afford to pay off fairly large variable rate facilities if something happened to the markets. Smaller non-profits typically don't have as good liquidity.
Q: You mentioned liquidity, and it seems like hospitals are definitely placing a priority on their cash flow? Do you see this as a major trend as well?
PB: Yes, they are clearly still doing that. A lot of the boards have become more critical of expansion plans given the uncertainty of reimbursement with Medicare and Medicaid and the economy. They are just not issuing as much debt as they used to. So far this year, levels are similar to last year, which was the lowest of the past 10 years. They aren't using cash either, so cash on hand is going up. That's making for some pretty good ratios, but the average age of plant is going up.
Q: To wrap up, where do you see the hospital debts markets as we head into 2013?
PB: I think this holding back on the part of hospitals and their capital projects is going to work itself out. I don't know if that's going to be as quick as some people expect, but you can't let your age of plant go up indefinitely. At some point, there's going to be a day of reckoning.
This is a very favorable market for selling debt for reasons we talked about — low interest rates, good spreads. As long as that continues, more and more hospitals are going to return to the debt markets and revisit projects they may have put on hold. The economy is a wild card here, as are making decisions on the market and payor mix. If the economy doesn't pick up, [hospitals] are not going to have much of a case going back to projects.
There's a lot of IT that's being financed, but that doesn't usually flow through the bond markets because it's relatively short-term. Spending on IT is a good trend because a lot of hospitals need better information systems, like cost accounting — it's hard to run a business when you don't know what things cost you. But maybe the days of the mega inpatient projects may not return for a long time because hospitals have more incentive to turn to the outpatient setting to preserve costs and improve reimbursements. Generally, I expect activity in terms of bricks and mortar is going to stay low for a while.
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