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Insecure Bonds

Philip Betbeze, for HealthLeaders Magazine, February 4, 2009
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Turbulence in the bond financing market means significant changes in the way hospitals relate to their investors.

It used to be that hospitals and other borrowers could buy their way to cheaper debt through so-called bond insurance. No more. Due to the probability of large-scale defaults in debt vehicles that mostly have nothing to do with hospitals or the healthcare industry, bond insurers' credit ratings became so impaired that they are struggling to survive. And they certainly have no credibility or inclination to cover new bond issues.

So the days when hospitals could buy bond insurance to bump up their credit rating to investment-grade are largely gone. The disaster with this business model happened so fast, many chief financial officers and bond investors are still dealing with the fallout and figuring out how to navigate a market that is pushing them toward much more transparency and active dialogue with current and potential investors as a major condition in completing future debt offerings.

A game-changer
Although not all hospitals used bond insurance, many that wanted to improve their credit ratings and the primary and secondary demand for their bonds turned to one of several major bond insurance companies. Those companies promised interest and capital payments to the bondholder, usually institutional investment firms, should the issuer fail to do so.

The major bond insurers for healthcare organizations—Ambac, FGIC, Radian, and a handful of others—are impaired to a large degree as part of the credit crisis fallout. Even if the insurers were in a position to write insurance for newly issued bonds, it's unclear whether hospitals or institutional investors would trust their guarantees. To wit: Even the notion that bond insurers would have to pay out on claims seemed to be enough to crater the market, because the insurers didn't have enough reserve capital to cover the insurance they wrote. Further, downgrades of the insurers themselves by the major credit rating agencies—Moody's, Fitch and Standard & Poor's—have piled on the pain for the industry.

Hospital borrowers have responded by refinancing out of insured bonds when possible—and to fill the void of bond insurers by trying to obtain letters of credit from banks that have also been substantially harmed by the credit crisis.

"Where once 50% of hospital issues were done in insured basis, we have one active right now," said Peter Bruton, managing director with RBC Capital Markets, in November. "My guess is most people really aren't aware of that, but in my [30-year] career, this is unprecedented."

Like public companies
Many hospital leaders are already working on changing the way they interact with the institutions that ultimately buy their bonds. Generally, these purchasers have been either dedicated bond fund managers or money market funds that needed a safe place to park their cash.

The new world order for hospitals and health systems will include better, more frequent disclosure by CFOs and CEOs and a much closer relationship with institutional investors—a relationship that until very recently, was at arms-length due to the perceived safety of bond insurance. The upheaval is affecting hospitals in everything from building new bed towers to funding acquisitions. That's what people mean when they say the credit markets are frozen, says Al Stubblefield, president and CEO of Baptist Health Care in Pensacola, FL.

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