Municipal bond issuance is showing signs of returning to pre-tax reform levels, but hospitals may have hit the snooze button: healthcare volumes year to date are down 57%. Much of the lag is the result of last December’s rush to market, when hospitals sold bonds at twice the rate of other sectors before advance refundings went away. For hospitals willing to buck the trend, the limited supply of bonds is keeping credit spreads low and makes for a favorable borrowing environment.
According to Thomson Reuters, overall municipal debt issuance totaled $161 billion in the first half of 2018, down 20% from the same period last year.
The drop in volumes was anticipated. Last December, municipal borrowers went to market ahead of schedule to beat the proposed prohibition against advance refundings. At the time, observers predicted the spike in inssuance would siphon volumes out of 2018, and that going forward, the loss of advance refundings would reduce annual municipal issuance by 10 to 15%.
Evidently, the healthcare sector has not caught up with the rest of the muni sector. Year-to-date, we show hospitals sold just shy of $6 billion of tax exempt fixed rate revenue bonds, down 57% from the $14 billion sold in the first half of 2016. These figures exclude taxable debt, variable rate debt, tax supported debt, bank placements, and remarketings. The drop in hospital issuance is in line with the figures published by Thomson Reuters, who reports a total $10.2 billion for the entire not for profit healthcare sector, including most forms of debt except bank loans. Annualized, this represents 58% of the $49 billion sold in 2017.
There are several potential explanations behind why hospitals would be slower to return to the bond markets relative to other muni sectors.
The first reason is that last December, hospitals led the pack to beat the prohibition against advance refundings, selling six times more than in December of the prior year. Municipal borrowers in general sold three times more. We estimate that when adjusted by the extra $5 billion that would have otherwise belonged in 2018, year-to-date hospital issuance would be $11 billion, much closer to the $13.6 billion sold in the first six months of 2017.
The second reason has to do with legislative uncertainty. In its sector outlook for 2018, Fitch notes that healthcare continues to face above-average uncertainty, including the future of the Affordable Care Act, which Fitch sees as having a real potential to negatively affect the acute care sector. Faced with uncertainty, many hospitals decided to wait it out until the future becomes clearer, which affects capital projects.
The third reason is continued pressures on healthcare provider margins. According to Moody’s sector outlook, hospitals are experiencing their lowest operating profitability of the last decade. Many are actively pursuing expense reductions and keeping non-critical capital projects on the back burner.
A fourth reason may be the changing nature of the hospital business. Moody’s reports that many hospitals have recently forgone large spending on facility replacements in favor of investments in information technology. These projects tend to be smaller and more likely to be paid for with cash, bank loans or non-traditional debt such as third party financing. Fitch reports that “AA” category borrowers spent an average 131% of depreciation in capital expenditures, up from 121% in the prior year. “A” category borrowers, who represent 40% of this year’s issuance, spent 121%, down from 125% in the prior year. Hospitals in the “BBB” category spent 95%, up from 80% in the prior year, but they represent only 12% of 2018 issuance.
Once hospitals catch up with the volumes lost to last December’s issuance frenzy, we expect the pace will pick up –in spite of the more permanent trends just discussed– although it may take the balance of the year for volumes to revert to historical averages.
Meanwhile, the limitred supply of healthcare paper presents an opportunity for hospitals to borrow under favorable market conditions. Tax exempt benchmark rates are below 3%, and credit spreads remain at historical lows. For most hospitals, this adds up to attractive low rates combined with flexible terms.