Why & How Health Systems Can Get “Trapped & Stuck” by Bond Debt
Carrying the interest full term on long-term bond debt is amongst the most costly expenses on a hospital’s balance sheet. This is why heath systems who had signed up for 30,50, & apparently even 100 year bonds exist, can get “stuck” from a structural economics perspective.
What is a Hospital Bond?
A hospital revenue bond is a type of municipal bond intended to support the construction of new hospitals and related facilities. The bonds can also be used to purchase equipment for facilities or to finance upgrades to existing hospitals. The revenue created by hospital operations is then used to repay bondholders. Generally, bondholders receive payment only after paying expenses of running the hospital is complete. This second-layer payment can create risk for bondholders if the hospital is not as profitable as anticipated.
Inability to raise revenue through taxes (like cities can) means the hospital revenue bonds typically command higher yields. The high-yield is due to their default risk being higher than a general obligation bond. This therefore typically costs the hospital borrower more money to access this capital than a city.
When Does Bond Debt Get Risky For Hospitals?
Bond covenants include financial performance requirements that heavily weight towards liquidity. As challenging market conditions reduce margins and days-cash-on-hand dwindles, struggling organizations will risk violating their bond covenants. A violation of bond covenants triggers technical default, which can lead to bankruptcies and closures.
How are Margins & Liquidity Related For Hospitals?
Healthy margins build liquidity & liquidity mitigates effects of margin instability. Sufficient liquidity allows hospitals to pay expenses inclusive of their borrowing costs and allow them to continue operating even when margins dry up. Bond markets reward health systems demonstrating strong liquidity with good borrowing terms. Bond holders punish health systems demonstrating weak liquidity when they enter technical default.
How Relatively Recent Tax Code Changes Impact Cost of Bonds to NonProfits
Though NonProfits dodged a tax exempt bullet from a threat to changing the tax code on private activity bonds last year in 2017, as HFMA reports, “reductions in the corporate tax rate from 35 percent to 21 percent had an impact.
The change would sharply limit the attractiveness to investors of the after-tax yield of tax-exempt bonds compared with taxable yields, he said. Investors thus would be expected to ask for higher yields on tax-exempt bonds, thereby making tax-exempt borrowing more expensive for hospitals.
The change would affect not only future tax-exempt bonds but also existing ones with “yield maintenance” provisions, a common clause that gives the lender the right to adjust the yield higher.
Because of the corporate-rate change, banks to which hospitals are paying a 3 percent rate likely would increase that by a full percentage point, for example.”
Bonds have played a role in hospital finance for a long time and to understand healthcare finance, it’s essential to understand the basics of bonds.
By: Sherri Douville, CEO at Medigram
Sherri Douville is CEO and board member for Medigram, the modern, mobile communication platform and system for physicians. At Medigram, Sherri leads a world-class team of technology, healthcare, physician, and business executives in Medigram’s mission to eradicate the leading cause of preventable death, a delay in information. Sherri has 15 years of healthcare experience in product development, sales and marketing including with Johnson & Johnson, and as a health care product development and business consultant. She has a BioPhysics degree and has completed three certificates in electrical engineering and computer science through MIT. Ms. Douville has held a variety of industry and other leadership positions. She serves on the board of the NorCal HIMSS (Health Information Management and Systems Society) as membership committee chair. Sherri has previously been both co-chair of the NorCal HIMSS Annual Innovation conference and a member of the board nominating committee. Sherri also advises Health IT, Medical Informatics, and genetics startup companies; Sherri and her husband, Dr. Art Douville have volunteered together with a variety of NonProfits including as a member of the Board of Fellows for Santa Clara University.