Overcoming financing challenges with bond insurance

Healthcare Financial Management, March, 1995 by Hillary J. Demby

CAPITAL

As the revenues of healthcare organizations continue to decline, finding ways to raise low-cost capital has become increasingly important. By incorporating municipal bond insurance into a finance plan, healthcare organizations can achieve sizable debt-service savings for both new-money projects and refunding transactions.

Bonds insured by one of the major municipal bond issuers are enhanced and carry AAA ratings from Moody's Investors Service, Standard & Poor's Corp., and, in some cases, Fitch Investors Service. Thus enhanced, they can attract a broader range of investors than uninsured issuers and can make it easier for healthcare organizations to raise long-term capital in a cost-effective manner.

Raising low-cost capital has become more important than ever for healthcare organizations of all sizes. Investor interest no longer can be generated by an organization simply publicizing its historical market dominance or touting comparative financial ratios. Although even astute investors often are unfamiliar with the financial performance of a specific healthcare organization, they generally are aware of the financial uncertainty facing the healthcare industry because of the transition to capitated payment and the proliferation of mergers and consolidations. Because of this awareness, investors are at times reluctant to invest in bonds issued by healthcare organizations.

But the dynamics of the municipal bond marketplace have created opportunities for healthcare issuers. By incorporating municipal bond insurance into a finance plan, healthcare organizations can achieve sizable debt-service savings for both new-money projects and refunding transactions. Hospital bonds insured by one of the major municipal bond insurers carry AAA ratings from Moody's Investors Service, Standard & Poor's corp., and Fitch Investors Service. Insured financing can attract a broader range of investors than uninsured transactions and can result in lower interest rates.

In many instances, healthcare organizations issue bonds infrequently and, therefore, are not well-known by investors in tax-exempt bonds. This lack of recognition tends to indicate higher risk. Bond insurance, however, can improve marketability because insured bonds offer investors greater security.

Depending upon state and local tax exemptions, healthcare organizations rated as high as A have been able to benefit from using municipal bond insurance in financing projects. The lower an organization's credit rating, the greater the savings potential available from selling insured bonds.

Organizations turn to bond insurance

The volume of insured tax-exempt bonds in the healthcare industry has grown dramatically over the past decade, as illustrated in Exhibit 1. In 1983, less than 10 percent of the $10.2 billion of hospital bonds issued were insured. By 1990, however, 44 percent of the $14.2 billion of hospital bonds issued were insured. And over the past three years, as the municipal bond market has set new record volume levels, nearly 50 percent of all hospital bonds have been underwritten on an insured basis.

In contrast to the overall municipal bond market, the healthcare industry has shown a higher volume and a deeper penetration of insured underwritings. Since 1990, only 34 percent of the total municipal bond market - which is approximately 10 times larger than the healthcare industry bond market - was insured.

Municipal bond insurance enables a healthcare organization to consider many new or complex financing options. Since early 1992, for example, the use of derivative products such as interest rate swaps and interest rate caps has become commonplace in the municipal market. Depending upon market conditions, underwriters can create a "synthetic fixed rate" for a bond issue by using swaps or hedges in combination with variable-rate bonds or with fixed-rate bond structures whose early maturities have a floating-rate portion. In many cases, the result will be a lower "all-in" debt service payment schedule compared to a traditional serial and term bond financing structure. From a ratings perspective, the derivative product market is a high-quality market because institutional buyers of these types of tax-exempt bonds, as well as swap underwriters, require AAA ratings for the bonds issued and for payment obligations generated under swap agreements.

What types of organizations benefit from bond insurance?

Urban, suburban, and rural healthcare organizations that range in size from the largest tertiary care facility to small community hospitals all can benefit from bond insurance. Insured organizations tend to be mostly single-site facilities, but the geographic diversity and operational efficiencies of multihospital systems make healthcare networks attractive insurance candidates. Specialty hospitals, such as rehabilitation facilities and children's hospitals, also can be attractive candidates for insured bonds if they can show a history of solid market presence and wide regional draw. Other facilities, such as skilled nursing facilities and start-up hospitals (those operating for less than five years), tend to be ineligible for insurance unless their debt has been guaranteed by a credit-worthy hospital.