When Champion Healthcare Corp. announced a month ago that it would buy Methodist Medical Center in Jacksonville, Fla., it made some people very happy.
They're Methodist bondholders, who stand to get a sure payoff in the deal. As an investor-owned chain, Houston-based Champion can't assume the tax-exempt debt and has guaranteed to pay investors in full.
Some bondholders will do very well, indeed. For example, $35 million of the hospital's $87 million in tax-exempt bonds are owned by clients of Interstate Johnson Lane, an Atlanta-based investment banking firm. They bought the 8% nonrated bonds at prices ranging as low as $80 over the past two years, a 20% discount on the bond's par value of $100.
Methodist's bonds were among $1.1 billion in nonrated hospital debt issued in 1989. Such bonds, issued by hospitals that can't or won't seek an investment-grade rating, made up 8.7% of the $13.3 billion in tax-exempt hospital bonds issued that year. Usually, less than 10% of tax-exempt hospital bonds aren't rated (See chart).
The rating game.These nonrated bonds aren't affirmed as creditworthy by one of the New York-based rating firms. In addition, like taxable junk bonds, nonrated municipal hospital bonds carry an interest rate that's usually higher than rated bonds.
Even so, unrated hospital bonds aren't necessarily high-risk, and they can be profitable, say traders who buy and sell them. That's especially true now with mergers and acquisitions sweeping the hospital industry.
For example, in the eyes of James Baker, manager of Interstate Johnson Lane's high-yield bond department, Methodist was an acquisition waiting to happen. The 244-bed hospital was destined to move toward a deal that was "somewhere between an alliance and an outright purchase," he said.
What's more, Methodist apparently isn't an anomaly. "These hospitals that are strategically located and provide necessary services, they don't die," he noted.
High yield, low risk.Indeed, few hospitals that issue nonrated bonds default on the debt. According to figures from the Public Securities Association, New York, only 4.1% of the $7.7 billion in nonrated tax-exempt healthcare bonds issued from 1986 to 1991 defaulted. Although that's slightly higher than a 2% rate for all nonrated municipal bonds, it's significantly better than other industries' rates, such as transportation, which had a 7.2% default rate for that period.
Those figures include other types of healthcare bonds, such as ones issued by retirement centers and nursing homes. The group didn't have separate figures for hospital bond defaults.
However, this year's default rate in hospital bonds has been relatively low, according to Defaulted Bonds Newsletter, a Miami Lakes, Fla.-based publication. Only three issues worth $54.4 million have defaulted since January. That's about one-third of the 1993 default amount for the same period. However, like any statistic, that figure needs some explaining.
Only one hospital bond issue defaulted in 1993, but it was a big one-a $167 million funding by Triad Healthcare, an Encino, Calif.-based firm that filed for bankruptcy protection. Ironically, those bonds were rated. That's because they were guaranteed by Cal-Mortgage Loan Insurance Division, a fund designed to guarantee bond issues by healthcare providers. Triad recently filed a reorganization plan to emerge from bankruptcy.
Cash protection.That irony leads to another. Just as Triad's rated bonds were issued by a financially shaky hospital system, so unrated bonds are often issued by hospitals with sufficient cash flow to pay bondholders.
Take Methodist, for example. The hospital lost money on operations in 1993 and 1994. In the fiscal year ended July 31, 1993, the hospital reported an operations loss of $690,090 on revenues of $55.2 million. In fiscal 1994, the hospital reported an operations loss of $3.5 million on revenues of $55.6 million.
However, the hospital continued to make money thanks to a $1 million profit at its foundation. That gave Methodist an overall bottom line of $787,748 in fiscal 1994 and $2.9 million in fiscal 1993.
Methodist apparently was a perfect candidate for an unrated hospital bond investor. The large urban hospital was independent, but it's located in a state that is rapidly consolidating-thanks largely to Columbia/HCA Healthcare Corp. Columbia/HCA, which owns a fourth of the state's hospitals, bought Memorial Medical Center of Jacksonville about a month before the Champion announcement. Methodist had issued its bonds in 1989 as part of a refinancing and renovation program.