Genesis High-Yields Show Why Oh Why Ohio Improving: Muni Credit

Photographer: Ron Chapple/Getty Images

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Photographer: Ron Chapple/Getty Images

Genesis HealthCare System in southeast Ohio sold $295 million of municipal bonds in the biggest junk- rated hospital deal since 2011 as investor demand for extra yield shrinks the penalty on such borrowers by 50 percent.

Debt-holders are joining the longest rally since 2007 in lower-rated hospital munis. With the Federal Reserve holding its benchmark interest rate near zero, investors are attempting to pad returns by adding riskier debt. High-yield hospital securities have earned 2.9 percent this year, almost twice the broader muni market, Barclays Plc data show.

Pending changes to the nation’s health-care system and predictions by BlackRock Inc. (BLK), the world’s largest asset manager, that riskier munis will suffer outsize losses should interest rates rise didn’t deter Genesis buyers. Investors placed orders for three times the amount of bonds available at the April 23 sale, said Paul Masterson, the Zanesville, Ohio- based chief financial officer for Genesis.

“You really want to look for the strongest provider” in the area, said Jim Murphy, who oversees the $2.6 billion T. Rowe Price Tax-Free High Yield Fund (PRFHX) from Baltimore and bought some Genesis bonds. “That’s what these guys are. They have a chance to get into investment grade.”

Market Dominance

Genesis, a nonprofit system about 60 miles (97 kilometers) east of Columbus, has a 50 percent market share in a six-county region of southeastern Ohio with a population of about 229,000, according to offering documents for the issue.

Amid a boost in natural-gas exploration and a resurgent automobile industry, Ohio’s jobless rate is close to the lowest since 2008. Since the second quarter of 2009, when the 18-month recession ended, Ohio ranks fourth among U.S. states in terms of its economic improvement, according to the Bloomberg Economic Evaluation of States index. It trailed only North Dakota, Michigan and California.

Columbus was featured in the 1953 Broadway musical “Wonderful Town,” based on the stories of Ruth McKenney and featuring a score by Leonard Bernstein and lyrics by Betty Comden and Adolph Green, according to the Leonard Bernstein Office Inc.’s website.

The show follows the adventures of two sisters, Ruth and Eileen Sherwood, who leave the state capital to find their fortune in New York City. In a moment of homesickness, they sing, “Why, oh why, oh why, oh -- Why did I ever leave Ohio?”

Construction Financing

The hospital system issued revenue debt rated BB+, one step below investment grade, to finance construction of a 221- bed medical center to consolidate two facilities 1.5 miles apart.

Plans call for a new tower, renovations, a new cancer center and medical offices, according to bond documents.

It was the biggest noninvestment grade, nonprofit hospital deal since August 2011, when Community Memorial Health System in Ventura, California, issued $350 million, data compiled by Bloomberg show.

Murphy said he was attracted to the Genesis offer because of the system’s market position, “pretty strong” operating income of $4.1 million in 2012 and the security provided to bondholders through a mortgage on the facility.

Cost Difference

Genesis bonds maturing in 10 years yielded 3.95 percent, or 2.2 percentage points more than top-rated munis.

By comparison, similar-maturity bonds in the Community Memorial deal priced at about 4.1 percentage points above benchmark munis. The issuer is rated one level lower than Genesis.

Investors bought Genesis debt even as hospital margins are getting squeezed. Reimbursements from commercial insurers, Medicare and Medicaid are falling while spending grows on technology and systems changes, including better coordinating care among doctors, hospitals and other health-care providers, said George Huang, a senior analyst at Wells Fargo & Co. (WFC) in New York.

President Barack Obama’s health-care overhaul will extend coverage to as many as 30 million people by requiring individuals to purchase insurance and expanding Medicaid, the federal-state program for the poor.

Hospitals may benefit under the law, which will be more broadly implemented in 2014, because they may spend less for charity care as the formerly uninsured enroll in Medicaid or buy policies on exchanges set up to boost competition for health insurance.

Expansion Debate

Ohio is also among 26 states that aren’t creating their own health exchange, defaulting to a federally run system. Seven states are opting for a partnership exchange with the federal government. Ohio’s Republican-led House of Representatives also hasn’t signed off on approving a Medicaid expansion that would bring the state $13 billion over seven years.

“Some states are planning to be just completely hands- off” said Huang. “If you don’t have people signing up for commercial insurance with subsidies, you’ll still be stuck with a high uninsured rate. That could be a problem for hospitals in these states, especially if they opt out of the Medicaid expansion.”

Hospital munis rated BBB, or two steps above junk, have outpaced the rest of the $3.7 trillion local-debt market for eight straight quarters, the longest streak since 2007, Bank of America Merrill Lynch data show.

Rally Duration

The extent of the rally means investors already have reaped much of the gains, said Murphy at T. Rowe.

Peter Hayes, who oversees $114 billion as head of munis for New York-based BlackRock, recommends selling lower-rated bonds because of the risk that yields will rise as the economy strengthens.

Yields on 10-year Treasuries will climb about 0.6 percentage point to 2.25 percent by year-end, according to the median forecast of 66 analysts in a Bloomberg survey.

When interest rates rise, investors will move to higher- rated securities and away from speculative-grade, Hayes said.

For Murphy, however, economic growth in the U.S., China and Europe isn’t strong enough to merit a jump in interest rates.

“The buzz word for first three months of 2013 was the Great Rotation, the Great Rotation, rates are going up,” Murphy said. “We’ve seen this movie probably three or four years in a row now.”

2013 Sales

Three junk-rated non-profit health systems have sold municipal bonds this year, the same number as all of 2012, data compiled by Bloomberg show.

Genesis formed in 1997 when two Zanesville hospitals combined. The system continued to operate both hospitals while recruiting medical staff, investing in electronic medical records and offering new services such as heart surgery, said Masterson, the chief financial officer.

“The vision was to get to a single campus,” Masterson said. “Each time we tried to do it, the market wasn’t right.”

Consolidation will save an estimated $17 million, Masterson said. He estimated the new medical center will help cut the number of patients who go to Columbus hospitals to 15 percent from 30 percent today.

Lower-rated hospitals that want to strengthen their balance sheets by borrowing at historically low interest rates or take advantage of consolidations or acquisitions to save may lead to more issuance this year, said Jay Sterns, a Barclays (BARC) banker in Chicago who managed the Genesis deal.

Management Bet

“If you’re an investor, you’re really betting on the management teams, on who can implement operationally and who can respond to the changes coming down the pike,” said Sterns.

Tax-exempt debt is rallying for a seventh straight week, pushing yields to the lowest since January.

Benchmark munis due in 2023 yield about 1.71 percent, down from a 2013 high of 2.08 percent in mid-March. Local debt is still trailing gains this quarter in Treasuries. The benchmark federal 10-year note yields 1.62 percent, close to the lowest since December, after the Fed this week repeated a pledge to buy U.S. securities as it tries to spur the economy.

Ten-year muni yields have exceeded those on Treasuries on all but one day since mid-March, showing city and state debt has cheapened relative to federal obligations.

To contact the reporter on this story: Martin Z. Braun in New York at mbraun6@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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