CHICAGO - A quietly gathering tidal wave of bond issuance from health care borrowers will hit the market in the coming months as issuers seek to convert their auction-rate paper - but it's still too early to predict how the restructured debt will look, public finance professionals at Ziegler Capital Markets said Friday in a conference call.
Whether borrowers will look to convert their auction-rate debt to fixed-rate bonds, swap to another floating-rate mode with a bank letter of credit or liquidity, or seek out another option entirely is still too difficult to predict, said officials from Ziegler, a Chicago-based investment bank that specializes in health care, long-term care, and education.
"Everything is fluid," said Mark Baumgartner, Ziegler's group head of health care financing, in an interview after last Friday's conference call. "There are no absolute rules for how people are going to proceed here. The only thing it's safe to say is that the supply is coming."
As the auction market continues to falter - up to 75% of the auctions held last week failed, according to Ziegler - and the stream of credit downgrades among monoline insurers continues, borrowers that plan to refinance should take their underlying credit stories directly to potential buyers.
"This market is really kind of going back to the basics, and the underlying credit is becoming much more important today than ever," said Don Carlson, vice chairman and senior managing director at Ziegler. "Even if [the borrower has] credit enhancement, the investors really want to understand the underlying credit. There's a real opportunity here as borrowers change modes or issue new debt, to have the time to adequately explain the underlying credit to the buy side."
Since it is the overall credit crunch stemming from the subprime market collapse and ensuing liquidity concern that have driven interest rates up, auction-rate borrowers would serve themselves well to share their stories as they are generally rated in the double-A category and have a favorable credit profile, Ziegler officials said.
Part of the difficulty in predicting the shape or scope of issuance over the next several months is that auction-rate securities vary widely in their structure and in a borrower's ability to alter the structure depending on provisions in a deal's original documents, Ziegler's Ed Merrigan, a managing director for research, said on the conference call.
"I don't doubt we'll see a pick up in issuance, but it's hard to predict because of the inconsistency of structural options in each of these auction-rate structures," Merrigan said. "And many [borrowers] have swaps integrated into their structures which also complicates the process."
Swap rates remain attractive for borrowers that are considering entering the market with new-money or refunding issues over the next three to six months, said John Kautz, head of risk management and advisory at Ziegler.
"A forward swap is possibly a viable option. Those forward [swap] premiums have increased quite a bit over the last few months - they're not near the levels we got spoiled with over the last few years - but it still can make sense in the right situation," Kautz said. "Even with that forward premium, the rate you can lock in is very attractive at times."
The spread of volatility in interest rates to the variable-rate demand market has eliminated, at least temporarily, the benefit of synthetic fixed-rate swaps for some borrowers as the payments they receive from counterparties - which are based on various indexes - have in some cases fallen short of what's needed to cover debt service.
"For the most part we still see a high demand for synthetic fixed-rate product right now," Kautz said. "The rates still look very attractive. You'll have to deal with that volatility right now as rates jump around, but overall we think your hedge is going to remain viable and provide a good risk management goal over time."
Though rating analysts remain concerned with a borrower's exposure to the variable-rate market, so far analysts have penalized very few credits for rising interest costs that may be taking a bite out of balance sheets. Ziegler bankers urged borrowers to talk often with their rating analysts as market turmoil plays out.
"The failed auction-rate market is not a transparent market," Merrigan noted. "Not everybody knows whether an auction has failed or not. Keeping rating agencies informed week to week is not a bad idea. Being proactive with rating agencies to maintain your good underlying credit is very important at this time."
