Over a 16-month period – between November 2018 and February 2020 – investors poured $80 billion into the municipal bond market, delivering a prolonged improvement in both the absolute and relative value of fixed-rate, tax-exempt debt as a financing vehicle for healthcare borrowers. Key observations during this time period were a significant decline in 30-year MMD, from 3.46 percent to 1.38 percent, as well as relatively stable and narrow tax-exempt, healthcare investment-grade credit spreads averaging about 60 bps. Additionally, the market demonstrated a narrowing of the spread between long-term, tax-exempt fixed-rate and variable-rate debt as the difference between 30-year MMD and SIFMA declined from 182 basis points to only 31 basis points. This improvement in the value of fixed-rate debt over variable-rate debt led many health systems to issue fixed-rate bonds and intermediate tax-exempt put bonds, forgoing the short-term market.  

 

Furthermore, even though we witnessed an increase in the value of issuing tax-exempt bonds relative to taxable bonds (the ratio of 30-year MMD-to-U.S. Treasury declined from approximately 100.3 percent to 86.7 percent), health systems still issued a significant amount of taxable bonds. Primary drivers included the combination of incredibly low rates and the advantages of unrestricted use of bond proceeds, including the ability to advance refund tax-exempt bonds for significant savings.

 

In early March, however, both the fixed-rate and variable-rate markets experienced significant volatility and rapidly increasing rates as investors withdrew more than $30 billion in assets from long-term municipal bond funds and tax-exempt money market funds, placing a premium on their most liquid assets. Within two weeks, 30-year MMD increased by 199 basis points, and tax-exempt healthcare issuance came to a standstill. Simultaneously, the markets for tax-exempt, variable-rate bonds were disrupted as rates increased from 1 percent to nearly 10 percent (SIFMA increased by 390 basis points in one week) and broker dealers were forced to hold more than $30 billion in variable-rate demand bonds (VRDBs) on their balance sheets – more than 10 times normal levels.

 

By mid-April, we saw some modest stabilization in the capital markets that presented new opportunities for health systems. Most important, in this new environment, we have seen an improvement in the value of using variable-rate debt relative to fixed-rate debt. Since early March, SIFMA decreased by 104 basis points to 0.21 percent, while 30-year MMD increased by 75 basis points to 2.13 percent, raising the spread between tax-exempt fixed and variable rates to 192 basis points. Credit spreads have also increased by 48 basis points since February.  

 

Driving variable rates lower is the Federal Reserve’s expansion of the Money Market Lending Facility to include purchases of short-term municipal bonds, including VRDBs. As with the aftermath of the financial crisis in 2008 and 2009 – the previous time that the Federal Reserve intervened in markets at such high levels – we expect rates on short-term debt may outperform rates on long-term debt for the foreseeable future. Further, the Fed is likely to keep short-term borrowing rates at or close to 0 percent. An important added consideration for health systems is access to cost-effective credit support from banks for VRDBs, which may be limited to only highly rated borrowers in this environment.

 

Adapting Your Investor Relations Strategy

 

Market uncertainty causes investors to be more selective. In this environment, market receptivity will depend not only on issuers’ current credit quality, but also on their willingness to be transparent regarding their expected future financial performance. Accordingly, health systems may benefit from a proactive investor communications strategy, even while many facets of the impact of COVID-19 on operations and finances remain unknown.

 

Many health systems are struggling with difficult questions about the risks and responsibilities of disclosing information to the market about the impact that COVID-19 will have on revenues and profitability. While not directly applicable to not-for-profit health systems, the SEC recently provided guidance to organizations on the importance of investor disclosure, commenting that companies should “provide as much information as is practicable regarding their current financial and operating status, as well as their future operational and financial planning … Providing detailed information regarding future operating conditions and resource needs is challenging, including because our response strategies are in their incipient stages (and are likely to change), but it is important on many levels ... Providing forward-looking information, particularly detailed information regarding future operating conditions and resource needs, may present difficulties, including because any shift to a forward-looking health and welfare strategy is at most in its incipient stage.”                   

 

The SEC’s guidance indicates that issuers should communicate to investors what they know as the crisis evolves, rather than waiting for a resolution. Although the SEC acknowledges that there are many unknowns about the operating and financial conditions for borrowers, it also encourages the disclosure of good faith forward-looking estimates to investors, even if these estimates change. “High-quality disclosure will not only provide benefits to investors and companies, it also will enhance valuable communication and coordination across our economy — including between the public and private sectors — as together we pursue the fight against COVID-19,” SEC guidance states.

 

Determining the Right Path Forward

 

Recent changes in the capital markets, driven primarily by investor and government reactions to the COVID-19 healthcare crisis, have created new opportunities for healthcare system borrowers. Positioning your organization to take full advantage of these new opportunities requires a proactive approach to communicating with investors and managing existing capital structures and strategies. H2C is following the markets closely, and we look forward to sharing our observations and analyses with you as new developments take place.

 

Now more than ever, the need for professional guidance and counsel from an experienced financial advisor is critical. If your organization is seeking informed insight, contact H2C’s capital markets professionals at capitalmarkets@h2c.com.