Report: Health Care Nonprofits Have to Renew $31.5B of Credit-Backed Debt

CHICAGO — Nonprofit health care providers continue to grapple with fallout from the collapse of the auction-rate market, and the sector now faces up to $31.5 billion of bank-credit-supported debt that needs to be renewed by 2013, according to a new report by BMO Capital Markets.

Providers who have spent the last two years restructuring troubled variable-rate debt could see a new market open up as Congress considers whether to allow nonprofit hospitals to issue taxable, direct-subsidy Build America Bonds. But BABs come with their own risks, BMO warned.

Many nonprofit providers appear to be enjoying at least a partial recovery after two years of being hit hard by falling profits, limited capital markets access, and declining liquidity. Investors have started to show renewed interest as the sector shows signs of recovery, according to one investment adviser.

“Health care bonds present an opportunity to invest now that many hospitals appear to be recovering financially from the tumultuous financial and operating environment of the last two years,” said Gordon Murray, vice president-senior credit analyst at White Plains, N.Y.-based Belle Haven Investments.

But the sector continues to face a big potential problem tied to the collapse of the auction-rate market in early 2008 — the huge wave of credit-supported debt that needs to be renewed between this year and 2013.

“People tend to fall in love with certain structures until they over-consume, and we saw that with auction-rate securities and insured deals,” said Brian McGough, managing director for health care at BMO, who wrote the report entitled “Build America Bonds and Credit Bubble Will Challenge Hospital Systems.”

“The smart health care providers are definitely being very aggressive about getting in front of this wave,” McGough said. “They are planning ahead and considering alternate sources of capital.”

The failed auction-rate securities market drove a wave of restructurings by health care providers throughout 2008 and 2009. Many opted to issue variable-rate debt backed by letters of credit. A significant number of providers have since shifted at least a chunk of their variable-rate debt into a fixed-rate mode, but many continue to hold letters of credit that feature renewal dates between now and 2013.

A potential $31.5 billion of health care related credit-supported bonds need to be renewed over the next three years — an average of $9 billion annually, compared to the average of $1.5 billion annually since 2004, according to BMO.

Issuing fixed-rate debt makes sense in the current market, where interest rates are relatively low. But it is difficult to predict how interest rates will look in two or three years.

“Any borrower that is waiting around and predicting access to the fixed-rate tax-exempt market in 12 or 13 months is making an unqualified bet,” McGough said.

Providers with a substantial amount of bank-supported debt have a number of options, he said. One is to renew their credit before it is scheduled to term out. Another is to issue so-called index notes — a product with a short-term remarketing cycle and a spread to an index like the Securities Industry and Financial Markets Association municipal swap index. Privately placed short-term debt instruments are another option.

The Obama administration’s proposal to expand BABs to include nonprofit health care issuers could mean another new market — but could also mean new risks, McGough said.

Chief among those risks is the possibility of changes in federal policies and regulation over the 30-year life of much of the bonds. For example, Congress is already considering decreasing the 35% direct-pay subsidy.

“CFOs and the leaders of these health care systems should be aware of and be able to assess the new set of risks particular to the BABs program,” McGough said.

The lessons learned amid the volatile capital markets over the last two years could make for a stronger industry in the future, McGough said.

“Not because of legislation by folks in Washington,” he said, “but because of some of the capital market’s discipline that’s been learned and appreciated by borrowers over the last two years.”

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Healthcare industry
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