Obama Court Win Proves Lifeline for Health Bonds: Credit Markets

U.S. President Barack Obama
U.S. President Barack Obama. Photographer: Luke Sharrett/Pool via Bloomberg

Junk bonds of health-care providers are beating the high-yield market after underperforming in the first five months of the year, as a U.S. Supreme Court ruling boosts investors’ optimism for the industry.

Speculative-grade debt of borrowers from HCA Holdings Inc., the biggest U.S. hospital chain, to Canonsburg, Pennsylvania-based Mylan Inc. have returned 3.2 percent since the end of May, compared with 2.4 percent for the Bank of America Merrill Lynch U.S. High Yield Master II Index. In January through May, the 4.6 percent gain for health companies trailed the 4.9 percent for the broader index.

The court decision last week, which left President Barack Obama’s transformation of the U.S. health system substantially intact, benefits bond buyers as it reduces the risk that health providers will be stuck with unpaid bills. The justices ruled that Congress has the power to make Americans get insurance or pay a penalty.

“The ruling was better than what most people expected and when it came about, there was follow-through buying,” Brian Tanquilut, an analyst at Jefferies & Co. said in a telephone interview. “The run-up ahead of that was in anticipation of the ruling. There was thinking that if the law was blown out, there would be renewed uncertainty.”

Bad Debts

Bad-debt expenses exceed 10 percent of revenue at major acute-care hospital operators, Moody’s Investors Service said in a June 5 report. LifePoint Hospitals Inc. recorded the highest expense from unpaid bills as a percentage of revenue at 14.6 percent in 2011. The Brentwood, Tennessee-based chain has about $1.2 billion of bonds outstanding, Bloomberg data show.

“Healthcare has a lot of different sub sectors but the dominant one is hospitals,” said Michael Anderson, a U.S. high-yield strategist at Citigroup Inc. in New York. “The hope with the bill is that you would have extra demand for healthcare services and fewer bad debt write-downs.”

Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. rose for the first time in a week, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, adding 2.9 basis points to a mid-price of 109.4 basis points as of 11:31 a.m. in New York, according to prices compiled by Bloomberg.

That’s the first increase since June 28 for the measure, which typically rises as investor confidence deteriorates and falls as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Bank of America

The U.S. two-year interest-rate swap spread, a measure of bond market stress, declined 1.6 basis points to 23.4 basis points as of 11:32 a.m. in New York. The gauge narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.

Bonds of Bank of America Corp. are the most actively traded dollar-denominated corporate securities by dealers today, with 28 trades of $1 million or more as of 11:33 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The Supreme Court’s decision on the Patient Protection and Affordable Care Act, the biggest change to the U.S. health system since Medicare and Medicaid were established in 1965, marked the climax to a legal fight that featured the longest courtroom arguments in 44 years and a record number of briefs.

Chief Justice John Roberts, a Republican appointee, joined four Democratic-selected justices to vote 5-4 in favor of the overhaul that would require every American to carry health insurance.

‘Biggest Winners’

“The biggest winners are the providers with the highest levels of uncompensated care,” said Fitch Ratings analyst Megan Neuburger. “Investors are also starting to see some of the positive things going on in terms of operating conditions being improved.”

The number of people without health insurance swelled to 49.9 million in 2010, or 16 percent of the U.S. population, from 36.6 million or 13 percent in 2000, according to Census Bureau data. The law may add coverage for 32 million people by decade’s end, according to Congressional Budget Office estimates.

The extra yield investors demand to own junk-rated healthcare debt instead of Treasuries shrank to 561 basis points from last month’s high of 673 basis points on June 5, according to the Bank of America Merrill Lynch U.S. High Yield, Healthcare index. The gauge tracks 160 bonds with a market value of about $84.4 billion.

Mylan Bonds

Bonds of Nashville, Tennessee-based HCA have gained 0.5 percent this month following a 2.9 percent return in June. The company, which KKR & Co., Bain Capital and Merrill Lynch & Co. helped to take private in a $33 billion leveraged buyout in 2006, has $18.2 billion of bonds outstanding. That accounts for more than 22 percent of the $80.7 billion of securities in Bank of America Merrill Lynch’s healthcare bond index.

Mylan, the maker of generic and specialty pharmaceuticals with $2.9 billion of bonds, has returned 1.1 percent in July after a 2.2 percent gain last month, Bank of America Merrill Lynch index data show.

“The ruling was a big overhang for healthcare,” Citigroup’s Anderson said. “You have to have conviction to trade. And if there is no conviction one way or the other, people were probably waiting for the ruling to transact.”

Healthcare bonds, which account for 8.4 percent of the high-yield index’s market weight, are trading more since the court decision after being illiquid this year, according to Trace data compiled by Citigroup. The debt represented 10.9 percent of block trades from June 28 to July 2, compared with 6.1 percent before the ruling.

The industry has benefited from “systemic changes in healthcare delivery,” said Fitch’s Neuburger. “The ruling has also helped in removing immediate uncertainty surrounding the sector.”

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