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Low-Rated Hospitals Selling as Changes in Health Funding Loom: Muni Credit

Two non-profit hospital systems rated BBB- or lower are among the largest sellers of municipal debt this week as potential reductions in federal aid boost their borrowing costs.

Community Memorial Health System will issue $345 million through the city of San Buenaventura, California, and MaineGeneral Health will sell $290 million via the Maine Health and Higher Educational Facilities Authority.

Hospital bonds may be vulnerable to downgrades because of potential reductions in U.S. reimbursements for Medicare, the government health system for the elderly, and cuts to Medicaid, the joint state and federal insurer of low-income patients, Standard & Poor’s said last week. That’s contributing to the highest relative borrowing costs since 2009 for hospitals with low investment-grade ratings.

“There’s a change in Medicare coming,” said Tim Pynchon, who specializes in high-yield bonds and oversees $3 billion in municipals for Pioneer Investment Management Inc. in Boston. “It’s not enough to say it’s a BBB hospital and I’m investing in it because it has yield.”

The extra yield investors demand to hold BBB rated 10-year hospital bonds instead of top-rated general-obligation debt widened to as much as 2.43 percentage points July 22 from 1.93 points Jan. 17, according to data compiled by Bloomberg. The spread reached 2.74 percentage points May 13, the widest since October 2009.

Replacement Building

The Community Memorial Health System revenue bonds will finance a six-story replacement hospital in Ventura, as the city is commonly known, to comply with California earthquake-safety rules, according to offering statements. The securities are rated Ba2, two levels below investment grade, by Moody’s Investors Service.

MaineGeneral Health, the third-largest health system in the state, according to Fitch Ratings, will use its revenue issue for a 192-bed replacement hospital in Augusta, the capital. The debt is rated BBB- by Fitch, its lowest investment grade.

Pynchon, who was born in the 59-year-old hospital being replaced in Maine, wants to do more research before investing. He said management must be “ahead of the curve” in adjusting expenses for potential revenue reductions.

The quality of not-for-profit health-care bonds hinges on legislation that will determine how much hospitals are reimbursed for providing services through Medicare and Medicaid, S&P said it its report.

Revenue Contraction

“We would expect revenues per unit of service to gradually contract with a clear risk to ratings over the long term,” wrote Steve Murphy, S&P’s managing director of U.S. public finance.

MaineGeneral Health received about 47 percent of revenue from Medicare and 16 percent from Medicaid in the nine months ended March 31, Fitch said in a report.

The dependence on government revenue is “high,” which makes the system “susceptible to state-level reimbursement changes, presenting a credit concern,” Fitch analysts Emily Wadhwani and Eva Thein said in the report.

With yields on top-rated debt near the year’s low of about 2.6 percent, investors seeking extra return are better off buying bonds with lower credit ratings than those with longer maturities, said Ben Pace, who helps oversee about $385 billion as chief investment officer of Deutsche Bank Private Wealth Management in New York.

“It’s dangerous to stretch for yield by going longer duration” because interest rates could rise, Pace said in a presentation to reporters July 20. “It’s better to spread on credit quality.”

Following is a description of a pending sale of U.S. municipal debt:

MARYLAND, one of five states Moody’s said could lose top credit ratings if the U.S. is downgraded, leads this week’s calendar with $718 million in general-obligation bonds for a variety of projects. The bonds are rated AAA, the top investment grade of S&P. M&T Securities Inc. will lead underwriters in the sale.

To contact the reporters on this story: Sarah Frier in New York at sfrier1@bloomberg.net

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net

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