Hospital issuance rebounds though credit challenges hang over

Bonds

After a down year, healthcare issuance has rebounded as systems reenter the bond market to deal with pent-up needs. Despite this recovery, challenges still persist.

Healthcare issuance is up 122.2% year-over-year through April, rising to $9.062 billion through the first four months of 2024 from $4.078 billion over the same time period in 2023, LSEG data shows.

Many of the healthcare systems have been steadily growing since the pandemic, said Chris Brigati, senior vice president and director of strategic planning and fixed-income research at SWBC.

However, this will be a multiyear process, not something “they can flip the switch and get done in short order,” he noted.

The increase in issuance comes after several years of declining volume due to “the combination of federal stimulus funding, strong investment returns, deferred capital plans, and rising rates led to a sharp decline in issuance in the subsequent years,” said Vikram Rai, head of municipals market strategy at Wells Fargo.

Hospital issuance total $14 billion last year, the lowest figure in at least a decade, he noted.

Supply has somewhat “normalized” during the first quarter of the year, as “systems returned to the market to tackle deferred capital needs despite the higher rate environment,” Rai said.

Helping the increase were two billion-dollar-plus deals: $3 billion from CommonSpirit Health and $1.9 billion from Novant Health.

The latter came to market Tuesday through the South Carolina Jobs-Economic Development Authority, with larger bumps out long from the preliminary pricing: 5s of 11/2031 at 3.37% (-2), 5s of 2034 at 3.50% (unch), 5s of 2039 at 3.88% (-3), 5.25s of 2044 at 4.26% (-3), 5.5s of 2049 at 4.40% (-11), 5.5s of 2054 at 4.47% (-9) and 4.5s of 2054 at 4.68% (-3), callable 5/1/2034.

“The Novant bonds are expected to be delivered in May, when hospital bond issuers are scheduled to redeem $1.1 billion of older bonds,” said Pat Luby, head of municipal strategy at CreditSights.

Chris Brigati, head of municipal trading at Advisors Asset Management

Many of the healthcare systems have been steadily growing since the pandemic, said Chris Brigati, senior vice president and director of strategic planning and fixed-income research at SWBC.

There is demand for these bonds, Brigati said.

“Healthcare usually offers a slightly higher yield than nonhealthcare issuers,” driving demand toward market participants attempting to add an opportunity to capture more yield and returns in their portfolios, he said.

A down year will be “offset” by a higher issuance year with ample opportunities, he said.

The yield volatility from 2023 posed concerns for issuers tapping the muni market, “scaring” some issuers off and giving them pause, he noted.

This trend of rising yields has continued somewhat this year, but “people are more used to the new normal, where yields are now and more willing to bring bonds to market to continue with their operational plans,” Brigati said.

Some of these healthcare systems must “move forward” with their plans and reenter the capital markets, Brigati said.

“There are things in place; they’re getting back to a more normalized process of running their infrastructure and systems, which requires bringing bonds to market to fund their ongoing operations,” he said.

Supply remains “robust,” as the second quarter gets underway, with visible supply sitting at least $4 billion through the end of Q2, Rai said.

Into the summer, supply may increase “as borrowers accelerate debt issuance to get ahead of the election,” he said.

Despite the increase in supply, “investors shouldn’t misinterpret the surge as an ‘all clear’ signal for healthcare credits: Financial performance and bond ratings are likely to remain volatile and inconsistent as the sector emerges from a range of post-pandemic issues,” said Build America Mutual’s Martin Arrick, Gia Calabrese, and Rebecca Sullivan in a guest commentary.

As certain financial weaknesses “subside” and partial recovery is underway, longer-term problems have returned, they said.

One such concern is “labor costs, shortages, and talent retention,” Rai said.

This is further complicated by the recently announced Federal Trade Commission rule “banning non-compete clauses could add staffing complications to not-for-profit hospitals that are still adapting to the upward reset of wages and have only recently begun to rein in labor costs,” according to Fitch Ratings.

Other challenges include “rising pharmaceutical prices, changes to the Medicaid program … the emergence of new types of competition, natural evolution in the practice of medicine, and the aging U.S. population, which continues to drive weakening payor mixes for many providers,” Arrick, Calabrese and Sullivan said.

Downgrades have “exceeded” upgrades in the last year, they said, “reflecting the negative impacts on both income statements and balance sheets.”

The challenging environment has also led to increased merger and acquisition activity as hospitals are “seeking” partners despite increased regulatory scrutiny, according to Rai.

Credit quality continues to be impacted by these issues, but the extent varies, he said, as “those in high-growth markets or facing less labor stress having an advantage.”

This differs from rural area hospitals or those that do not have a “sufficient” network to move patients to outpatient care,” which lag their peers,” Rai said.

Additionally, he noted credits more dependent on federal or state funding “will be more susceptible” to policy changes following the election.

While the challenges have been “immense,” the sector is seeing progress, though Arrick, Calabrese, and Sullivan said recovery may take two to three years to be more in line with pre-pandemic performance.

“A multiyear recovery is consistent with the sector’s history of needing time to mend following sharp downturns, as the shock and magnitude of the most recent one was too significant to recover quickly,” they said.

But while recovery is “broadly evident,” it still remains on a “case-by-case” basis, they said.

Hospitals and health systems with “robust enterprise profiles and experienced management teams” can better tackle any problems, but those unable to “sufficiently recover” may have to partner with other entities,” Arrick, Calabrese and Sullivan said.

“While the pandemic was an unprecedented event in modern times, the broader challenges facing healthcare are not,” they said. “Industry consolidation, governmental support, and sector essentiality all play an important role in supporting the long-term health of the sector.”

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