Last July, we discussed how the shrinking cost advantage of tax-exempt debt made taxable bonds more attractive for hospitals. This year, more healthcare borrowers are issuing taxable bonds, and some have lowered their interest expense.
A review of recent taxable transactions reveals a mixed bag: some borrowers achieved savings, others didn't. Those who saved did it with large offerings, well beyond the capacity of most smaller providers.
Mayo Clinic, NYU Hospitals Center and Dignity health recently sold index-eligible taxable bonds. Mayo and NYU saved some interest expense, but Dignity Health didn't:
- Mayo Clinic (Aa2/AA) sold $300 million of taxable bonds in September at a yield of 3.77%, about 100 basis points over the 30-year Treasury. Had they gone the tax-exempt route, they would have likely paid more, but the savings are the result of the deal size: greater than $250 million makes it index-eligible, which is more attractive for bond funds to hold. Index eligibility is worth about 25 basis points (0.25%).
- NYU Hospitals Center also took advantage of the index eligibility in July when the system sold $250 million of unrated taxable bonds at 4.43%, about 190 basis points over the 30-year Treasury yield. A comparable tax-exempt yield would have been closer to 4.7%.
- Yesterday, Dignity Health fka Catholic Healthcare West (A/A3) sold $600 million in taxable bonds, well above the index-eligible minimum deal size. The 30-year portion priced at 4.58%. Had the bonds been tax-exempt, the yield would have been about the same.
Most standalone hospitals and small systems cannot meet the $250 million minimum deal size so cannot replicate these results.
North Shore - Long Island Jewish (A-/A3) sold $135 million of taxable bonds in September at a yield of 4.84%. Had the same bonds been tax-exempt, the yield would have been around 4.25%, which would have saved about $800,000 a year in interest expense.
The cost advantage of tax-exempt debt is minimum in the short-term debt markets, where the SIFMA and LIBOR indexes are trading at similar levels. Sentara sold taxable commercial paper back in June to refund tax-exempt commercial paper. With short-term rates near zero, there was very little savings to be had from going with tax-exempt debt. However, the commercial paper structure required self-liquidity, which isn't an option for most hospitals. The other drawback of taxable variable rate paper is that as rates climb, so will the spread between taxable and tax-exempt debt, which will cause the cost advantage of tax-exempt debt to grow.
There are other penalties with taxable bonds, including so-called make-whole provisions which often result in expensive redemption if the hospital decides to call the bonds.
So for most hospitals, the cost advantage still goes to tax-exempt bonds. But the ability to bypass the tax exemption process is looking more attractive than ever, and can justify taxable bonds even at a higher cost.
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