Health care and housing remain two of the most risky sectors in the municipal market, with the federal health care bill and the sluggish real estate market contributing to skepticism about the sectors. But muni experts say some distressed debt is safe enough to be a buying opportunity.
“The concern there is health care legislation from a federal level and what that might mean for local hospitals,” said Howard Cure at Evercore Wealth Management. “Look at hospitals and the payer mix. If a large proportion of the mix is poor citizens and higher Medicaid recipients, that is a concern.”
Cure noted that states are looking to make cuts in Medicaid programs.
Nonprofit hospitals continue to struggle, according to Moody’s Investors Service. While only six hospitals were downgraded and five were upgraded in the first quarter of 2011, the rating agency said the trend of downgrades outpacing upgrades will continue for the rest of 2011.
Standard & Poor’s said that in the second quarter, one of the two rated issuers that defaulted was a health care issuer — Northern Berkshire Healthcare. NBH filed for bankruptcy in June and the obligated group has not made monthly principal and interest payments since last November.
And while defaults make investors nervous, not all credits in the health care sector are struggling.
Between June 30, 2010, and July 15, 2011, Standard & Poor’s upgraded 16 hospital systems, and only lowered the ratings on five.
There were 18 positive outlooks revisions, compared to only six negative outlooks changes.
But the statistics aren’t as good for stand-alone facilities. As of July 15, 50% of the hospitals that Standard & Poor’s rates are either BBB or speculative-grade. About 43% were rated A while 7% were rated AA.
The lagging real estate market that has yet to recover continues to put pressure on housing debt. Burton Mulford, portfolio manager in the tax-exempt fixed-income group at Eagle Asset Management, said there are pockets of the country that are notable in terms of risk, including land-secured deals in California, Nevada, Arizona and Florida.
Indeed, the second Standard & Poor’s rated issuer that defaulted in the second quarter was in the housing sector.
That would be the Texas State Affordable Housing Corp.’s Series 2002A multifamily revenue bonds, which were in default as of May 18. The rating agency downgraded the bonds to D from BBB due to the cancellation of the bond insurance policy.
Problems in the housing market are more widespread as Standard & Poor’s downgraded 171 issues in the second quarter and only upgraded five.
The rating agency lowered 169 issues of the California Housing Finance Agency due in part to the still weak California housing market, “which has contributed to high nonperforming assets,” analysts wrote.
Cure said this is not necessarily surprising, and that local and state housing agencies could face potential defaults because of the lackluster real estate market in some areas.
He added that community development districts dependent upon the sale of newly built properties are also at risk.
In early July, Moody’s lowered the rating on $526.7 million of outstanding Southeast Housing LLC’s taxable military housing revenue bonds to Baa3 from Baa2 and revised the outlook to negative.
Of the residential family housing units that serve personnel in 11 naval bases, six of them were in Florida. Moody’s analysts said “lower-than-expected occupancy rates and a weakening real estate market may present credit challenges in the near term.”
And some local issuers relying on property taxes may continue to struggle, according to Rob Williams, director of fixed income and planning at Charles Schwab.
“So certainly local issuers will continue to have to tighten purse strings to make sure they can continue until they see an impact of a slowly recovering housing market,” he said.
Not all credits in the health care and housing sectors are in distress. But attractive spreads can be found even among high-quality housing bonds, wrote Tom Kozlik, municipal credit analyst at Janney Capital Markets, in a July 18 note. The spread between Municipal Market Data’s double-A single-family housing scale and the triple-A scale has widened from 85 basis points in January to 115 in July, he wrote.
Kozlik said the spread has widened in part because investors avoid anything relating to housing due to lingering fears of the subprime mortgage market, and in part because of the slight credit deterioration and negative rating actions involving state housing finance agencies’ single-family programs.
In mid-July, $36 million of North Dakota Housing Finance Agency Series 2011B bonds, maturing in 2021 and 2025, priced 109 basis points and 118 basis points respectively over the triple-A MMD scale, Janney said.
As of July 28, triple-A rated Florida Housing Finance Corp. Series 2011A bonds maturing in 2026 had a 131 basis point spread over the 15-year triple-A Municipal Market Advisors scale.
The Series B Florida single-family housing bonds had a 141 basis point spread over the 14-year triple-A scale.
Pennsylvania Housing Finance Agency bonds that were rated Aa2 saw spreads widen to 141 basis points over the 14-year scale.
Others think the buying opportunities extend beyond housing and health care.
“We could continue to see some distress and even defaults, but limited primarily to non-investment-grade categories,” Williams said. “For most, problems don’t lead to defaults, and cities and GO issuers are resilient and on a whole maintain a commitment to pay.”
Only 42 rated non-housing obligors have defaulted between 1986 and 2010, according to Standard & Poor’s.
“That’s a very low number,” said Kathy Evers, head of municipal research at BMO Capital Markets.
Indeed, Littlefield, Texas, is showing signs of distress but has yet to default. City bonds maturing in 2021, 2026 and 2030 have spreads of 253, 175, and 128 over the triple-A MMA 10-year, 15-year and 19-year scales, respectively.
Spreads on bonds for Bell, Calif., maturing in 2020, 2024 and 2029 are trading at 44, 115 and 62 basis points, respectively, over the nine-year, 13-year, and 18-year AAA MMA scale.
And earlier this week, Central Falls, R.I., filed for Chapter 9 but plans to keep paying its debt.
“I’ve seen this movie before,” said Gregg Fisher, president and chief investment officer of Gerstein Fisher. “What I find is investors in general see these risks, and the fight or flight [instinct] is to pull away. And credits look alarming, but they will not all default.”
Evers added that in this time where there are more credits in distress, there may be buying opportunities.
“While bonds are being downgraded, look at the impact on the value of the bond. Is the bond going to default? Defaults are rare and the likelihood is no,” she said. “There will be opportunities to pick up attractively priced triple-B to single-A credits that may be upgraded if investors can be patient.”
