Investors spooked by distressed states and the economy's uncertain direction are making debt more costly for not-for-profit hospitals and health systems, forcing some borrowers to scale back, restructure or delay financing plans.
Hospitals adjust or delay plans as debt grows more costly, investors flee
Officials at one Maryland hospital went to market last week prepared to walk away should investors demand rates that add more than $2.9 million a year to expenses. A major California system dropped $150 million from a $900 million deal that went to market last month. In Wisconsin, executives with a planned $99 million deal decided last week to wait—at least for a few months—to see if interest rates retreat after a recent climb.
“We pretty much have to live with what the markets are dictating,” said Sidney Sczygelski, chief financial officer and senior vice president of finance for Wausau, Wis.-based Aspirus, which owns four hospitals in Wisconsin and Michigan and had hoped to ask investors to refinance $34 million and lend another $65 million in March.
Sczygelski said the system can afford to spend cash reserves on construction that began last month—at least until the fall. “I think the municipal markets are right now being unfairly impacted by news” of severe budget stress among state and local governments, he said.
Hospitals and health systems borrow alongside states and counties in the municipal bond markets, where uncertainty since last November has contributed to higher borrowing costs. The municipal market has seen investors pull back sharply during the past few months as government deficits have increasingly made headlines, though analysts also cite other factors for the retreat and higher yields.
Borrowers flooded the market in the final weeks of 2010 to beat the expiration of temporary programs designed to improve credit access after the financial crisis. Investors gained leverage to demand higher rates with the rush of borrowers. The Federal Reserve's plans to boost the economy, announced last November, further unsettled interest rates.
But news of state fiscal distress, notably the controversial comments by a high-profile analyst about potential municipal defaults, appears to have fueled investor anxiety, analysts and healthcare finance insiders say.
Meredith Whitney—introduced on “60 Minutes” in December as “one of the most respected analysts on Wall Street” after her warnings of bank distress ahead of the credit crisis that shook markets in the fall of 2008—drew sharp criticism in news reports after she predicted municipal defaults during the news show.
Whitney was described last week as “a media luminary” by Bloomberg Businessweek and “a media darling” by the New York Times, and the significance of her comments was also apparently on the minds of participants at a hearing last week on state and municipal debt by a House Oversight and Government Reform subcommittee.
“This isn't about one analyst,” Rep. Patrick McHenry (R-N.C.) said in his opening remarks. “It's about the looming fiscal crisis in states and municipalities and the lack of transparency in their pension obligations.”
The latest unrest in the municipal market comes as Congress and regulators have expressed a growing concern with borrowers' transparency. Results of a survey by DPC Data, released this month, found municipal investors lacked yearly financial reports for at least one of the past five years for more than half of 17,000 bonds issued since 1996. Among general hospitals included in the survey, disclosure was not much better: 47% failed to release yearly financials at least one of the past five years.
“In times of concern, and maybe call it paranoia, on the part of municipal investors, spotty disclosure is not going to appease them,” said Pierre Bogacz, a managing director of HFA Partners, a healthcare financial adviser. “It's not going to take away the concern,” he continued. “If anything, it amplifies” investor anxiety.
John Topper, senior vice president and CFO of Mercy Medical Center, a 298-bed hospital in Baltimore, began preparations last fall to refinance roughly $79 million in variable-rate bonds considered to be a higher risk to balance sheets as banks have faltered and failed in recent years.
“The debt issue occurred before the economic blows that we've been suffering in the recent years,” Topper said. Mercy borrowed $305 million in late 2007 to build a patient tower; roughly half of the bonds were sold to short-term investors as variable-rate debt.
Investors buy variable-rate bonds as often as weekly or monthly and may demand repayment from the borrower if bonds fail to sell in the market. Banks often back hospital variable-rate bonds with a credit and cash guarantee that must be renewed after one or more years. Weak banks prompted some investors to demand higher interest rates for variable-rate bonds and raised the risk borrowers would find no buyers, which would force hospitals to rapidly pay off or refinance the debt.
“We've learned a lot about variable-rate debt,” Topper said. Mercy's governing board, eager to reduce such risks, approved refinancing plans despite the significantly lower interest rate on variable-rate bonds. An expected slump in borrowers in January—and an anticipated corresponding dip in rates—prompted Mercy Medical Center to schedule its planned refinancing for after Jan. 1.
Rates didn't drop, Topper said. “It didn't happen to the extent we expected.”
As the higher cost of refinancing held, Mercy Medical Center moved to scale back the municipal bond deal to $40 million and restructure the rest with a direct bank loan, he said. The board finance committee met again in late January, Topper said, and agreed the potential extra cost was worth less risk—up to a point. The hospital could assume an additional $2.9 million in annual interest expense, the committee said, but no more.
The Central Florida Health Alliance won't scale back a planned $72 million deal in March, though rates may delay the deal, said Dale Hocking, CFO for the Health Alliance. Most of the deal will refinance outstanding variable-rate bonds; $20 million will finance capital projects.
Hocking said the refinancing will lower the system's balance sheet risk as it readies for significant capital projects to meet demand in the growing areas surrounding its two hospitals: 120-bed Villages (Fla.) Hospital, which opened with 60 beds in 2002, and 429-bed Leesburg (Fla.) Regional Medical Center. The system has proposed spending $240 million on capital projects in the next five years, according to Moody's Investors Service.
The Health Alliance is also seeking to reduce possible risk from variable-rate debt, which Hocking said he believes may benefit the system's credit rating.
Higher rates have enticed nontraditional investors—those usually uninterested in normally staid municipal debt—to buy tax-exempt bonds, which has helped to stabilize the market, said Jim Cain, managing director of healthcare investment bankers Cain Bros. “The municipal bond market is one that is driven very much by supply and demand.”
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