Talk about a tough sell. Healthcare bonds have always been considered dicey investments, compared with bonds issued by state and county governments. But ever since the multimillion-dollar belly-flop of Allegheny Health, Education and Research Foundation-the bankrupt Pittsburgh-based system-bond buyers have become tougher customers.
Heightened reimbursement pressures and tighter criteria for obtaining bond insurance also have stoked concerns about buying healthcare bonds. So far this year, Standard & Poor's, the New York bond-rating agency, has lowered 22 healthcare credits, compared with 28 downgrades in all of 1998.
To make healthcare bonds worth the risk, mutual funds and other institutional investors are demanding bigger paydays, particularly for nonrated or lower-rated healthcare paper. But even some A and BBB credits are being viewed with a jaundiced eye.
"I think more people are becoming more conservative and saying, 'You're going to have to pay me for buying this, if I'm even willing to take it to a credit committee,' " says Julian Head, a vice president and portfolio manager in the Nashville office of financial adviser Ponder & Co.
As a result, a lot of deals are not getting done this year, says Seth Crone, vice president of health and education investment banking at Chase Securities of Texas, a Houston-based affiliate of Chase Manhattan Corp. "I think there's a credit crunch coming," he warns. "Credit spreads will widen even more between quality and less-quality (healthcare bonds)."
On the other hand, systems that are well-managed and well-positioned are striking a chord with buyers, underwriters say.
"There are clearly winners being rewarded in today's market, and losers are not," says David Cyganowski, co-head of the healthcare group at Salomon Smith Barney, New York. "If investors believe that a system is on the uptick, they will buy their securities at a lower interest rate, compared with systems that they believe have a negative outlook."
Yield-bondholders' annual rate of return on investments-is a function of the interest rate on the bonds, the length of time until bonds become payable and due, and the price paid for the bonds.
Yield fluctuates depending on market conditions. For much of last year, low interest rates and high demand for lucrative investments created an environment in which bond buyers, hungry for yield, were forced to dip into lower and nonrated categories of healthcare credits.
Head says that phenomenon reached its apex in March 1998, when he saw AAA insured deals at 5.15% and nonrated deals at 5.75%. A mere 61 basis points separated the ends of the spectrum.
Since then, spreads have begun to widen and continue to do so, according to bond buyers and investment bankers.
For example, on April 26, Benedictine Health System-St. Mary's Duluth (Minn.) System Obligated Group sold $24 million of bonds insured by MBIA Insurance Corp. The 30-year bonds were priced to yield 5.3%. A week later, the long bonds on the unrated $29.9 million issue by Chandler Hall Health Services Obligated Group, Bucks County, Pa., went out at 6.4%.
William Douglas, senior vice president and manager of the national healthcare finance group at George K. Baum & Co., Denver, says he is beginning to see the change. But there still are rather narrow spreads between high- and low-grade bonds, he adds.
Take a recent unrated deal by Steamboat Springs (Colo.) Health Care Association, the not-for-profit parent of 22-bed Routt Memorial Hospital, also in Steamboat Springs, and a 50-bed skilled-nursing facility attached to the hospital. The ski resort-based provider issued $15.3 million of unrated debt this April. The 25-year bonds were priced to yield 5.8%, about 65 basis points more than an AAA deal. Historically, the spread between those categories has well exceeded 100 basis points.
Going unrated was the best option available, says Dean Sandvik, Steamboat Springs' chief financial officer. "The (rating) agencies that we talked to generally indicated that rating a facility our size was just not going to be in the cards," he says. The association was considered too small. Sandvik says he also shopped for bond insurance, but insuring the deal would have cost more than going unrated, he says. Still, at 5.8%, the money was relatively inexpensive. "We were happy with the rate we got," he says.
Some investment bankers also report widening spreads in single rating categories. A soon-to-be-published analysis by A.G. Edwards & Sons confirms the trend (See chart).
The St. Louis-based firm compared 55 BBB healthcare issues priced between Jan. 1, 1998, and March 25, 1999, with the insured bond scale of Municipal Market Data, a New York-based financial information services vendor. Before Aug. 21, 1998, when AHERF filed for bankruptcy, spreads in the BBB category averaged three basis points. Post-AHERF, they widened significantly. For example, A.G. Edwards noted an 11-basis-point spread between BBB+ and BBB- issues.
Looser spreads and market uncertainties have caused Steven Davis, managing director of the firm's national healthcare group, to change his tune about bond insurance.
"I've always been not necessarily anti-insurance, but I always questioned why you did the insurance thing," he concedes. In many cases, he says, he encouraged A-rated credits to skip the insurance and issue debt on their own ratings. "Now I'm saying, 'Maybe if they can get insurance, they should do it.' "
Buying healthcare bonds carries significant risks, says one fund manager, who asked not to be identified. Institutional investors don't want to be stuck holding paper that declines in value. "We've pared back on healthcare credits," he says.
Others, however, see plenty of opportunity to make a buck. "We really avoided a lot of healthcare deals generally, and now we're looking to take advantage of the widening of spreads," says Tom Kenny, executive vice president and director of portfolio management and research at Franklin Templeton Group of Funds, San Mateo, Calif.
For healthcare providers, it's a good news-bad news situation.
"To the extent a system is a double-A, they're going to hold their own," says Salomon Smith Barney's Cyganowski. "To the extent that they're lesser rated but have a bright future as determined by investors, they're going to do better than a system that's perceived to be losing market share."