New York nursing home and hospital bonds backed by Federal Housing Administration mortgage insurance provide extra value in today's insurance- saturated market, according to broker Dean Flanagan and analyst Patrick Verdi of Tucker Anthony Inc.
Issued by the New York State Dormitory Authority or formerly by the New York State Medical Care Facilities Finance Agency, the bonds recommended by Verdi and Flanagan are outyielding comparable privately insured paper by 10 to 15 basis points, they said. These issues usually are structured with term bonds callable through an anticipated sinking fund schedule.
"An investor who only buys triple-A bonds, or buys a portion of a portfolio in triple-A bonds, should be looking at these," said Flanagan, a former MCFFA program coordinator, now employed by Tucker Anthony division Gabriele, Huglin & Cashman in New York.
"Even though we sell a lot of these bonds to our clients, many investors still misunderstand these FHA-insured bonds when you try to explain the sinking fund and the ratings. They're not as clean, as a triple-A bond insured by MBIA (Insurance Corp. or) a general obligation bond," Flanagan said.
In a newsletter to clients, Verdi highlighted MCFFA bonds issued for Columbia-Presbyterian Medical Center and for St. Luke's-Roosevelt Hospital. The St. Luke's bonds, for example, are being offered at a price of 95#1/2 for a 6% yield to maturity in 2018 and a 6.61% yield to a 2003 call. But the yield to the bond's 2012 average life - the point at which it is anticipated 50% of the bonds will be retired - is 6.07%.
The extra value on these bonds lies in their higher yields to average life, in addition to their yield to maturity, according to Verdi and Flanagan. Moreover, Verdi said, history has shown MCFFA, now under the Dormitory Authority, adheres to a redemption schedule more like that of a mandatory sinking fund.
With most mandatory sinking funds, some bonds mature, while with anticipated sinking funds all bonds could be retired before the maturity date.
"FHA bonds suffer from negative connotations associated with the term 'anticipated redemption schedule,' but they act remarkably like a mandatory sinking fund," he said. Even so, the anticipated sinking fund does result in a shorter average life for the bonds - an extra dose of value, according to Verdi.
"They have shorter duration and less volatility than typical term bonds with similar maturities and mandatory sinking funds," he said.
Verdi and Flanagan also believe the bonds have "excellent" security. But they and other analysts said investors should understand the credit strength behind these bonds.
FHA insures 99% of the mortgages paid by the hospitals and nursing homes, but does not insure the actual bonds. The monthly mortgage payments are collected and used for semiannual debt payments.
Because the FHA insures only 99% of the mortgages, the issuing authority must provide coverage for 1% of the amount of uninsured mortgages in order to achieve a high rating. In addition, the authority must fill a debt service reserve fund and cover bonds sold to meet issuance costs.
Moody's, as a rule, does not rate the bonds higher than Aa. Standard & Poor's may assign a AAA rating to the bonds based on structure of coverage. The St. Luke's bonds, for example, are rated Aa by Moody's and AAA by Standard & Poor's.
Both Moody's and Standard & Poor's examine the strength of the authority's ability to meet any shortfalls in FHA coverage through letters of credit or investments. They also evaluate the FHA's ability to cover mortgages in the event that a hospital defaults and consider how long it may take the agency to pay.
"We don't look at the project, or the hospital. We are looking directly to FHA to make payments," said Standard & Poor's analyst Louis Louis Jr.
The FHA's insured hospital mortgages are concentrated in New York, raising questions about the agency's ability to cover payments in the event of widespread default among the state's troubled medical facilities.
The New York Times reported earlier this month that 64 hospitals in New York have a combined $4.5 billion worth of mortgages insured by the FHA - more than 80% of the administration's hospital business.
FHA officials fear that New York's very distressed hospitals may be heading toward defaults on their mortgage payments.
But analysts knowledgeable about FHA-supported bonds say that mortgage defaults in the past have never resulted in a bond default.
"You're really not buying the underlying security here, because the financial condition of a lot of the large hospitals is very poor," said one securities firm analyst who asked not to be named.
Still, he noted that investors are safer buying FHA-backed bonds that also carry private insurance.
Louis said the solvency of FHA and its parent agency, the Department of Housing and Urban Development, are evaluated by other analysts at Standard & Poor's. But he said: "We're still comfortable at the triple-A level that they would be able to pay. It would probably be pretty doubtful you would have a significant portion of (hospital mortgages) that would cause a major calamity."
Standing alone, the FHA is considered a triple-A rated mortgage insurer.
Verdi said about four hospital or nursing home mortgage payment defaults have occurred in New York in 15 years since the FHA program started, without interruption of interest payments to bondholders.
Verdi said he does not expect deregulation of health care in New York to have the grave impact on hospitals that market players and officials fear.
"They're worried that if some of these hospitals do default on their mortgage loans, FHA's going to get stuck and it could have a ripple effect. But if you look at history, and you look at deregulation when it hit Massachusetts and New Jersey or other states, the bottom did not fall out."
