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Bond Growth Anticipates Tax Reform

According to figures on selected use of proceeds categories for tax-exempt financings during the first half of 1985, resource recovery bonds ballooned in volume by 224 percent over the first half of last year, industrial development bonds (IDBs) jumped by 219 percent in volume, and housing bonds increased in total volume by 195 percent. By contrast, health care financings rose only 27 percent in total volume during the same period last year to $5.3 billion in 1985, ranking eighth in a listing of nine selected categories of tax-exempt bonds.

Revenue bonds of all types represented 62.4 percent of all tax-exempt securities during the first half of 1985--or almost $41.9 billion of more than $67.1 billion total volume. Health care financings--including revenue bonds, general obligation bonds, and IDBs--represented less than 8 percent (more than $5.3 billion) of the total volume during the first half, compared with 9.5 percent (more than $4.1 billion) of total volume one year earlier.

Tax-exempt hospital revenue bonds totaled about $4.56 billion during the first half of 1985, according to preliminary figures from Prescott, Ball & Turben, Inc., New York City, or more than 10 percent of all revenue bonds during that period. All other figures were supplied by Securities Data Co., Inc., New York City.

Meanwhile, Goldman, Sachs & Co., New York City, and Merrill Lynch Capital Markets, New York City, led in both the senior managers only and the senior and comanagers categories in terms of the total volume of tax-exempt health care financings during the first half of this year (see tables 1 and 2). Three of the 10 largest health care issues during the first half were for equipment loan pools, six were variable rate financings, and eight of the 10 carried some form of bond insurance (see table 3). The rankings of investment banking firms and top 10 issues were provided by Securities Data. Total volume and firm rankings were based on a compilation of underwritten financings with aggregate par amounts of $5 million or more. Private placements were excluded.

"Last year, the volume was heavy," but the volume of health care issues will increase even more dramatically this autumn and winter, predicts Jud Bergman, an associate with the Chicago office of John Nuveen & Co., Inc. "We're the busiest that we've ever been," says Bergman, adding that his office has 23 health care financings scheduled from September through December, "which is more than we did all last year."

The anticipated tax reform bill "scares some people, but the fear that advance refunding bonds will be severely restricted in use is more responsible for the rush to issues than the fear of the elimination of tax-exempt financing for hospitals," Bergman says. Refundings of all kinds represented $1.52 billion during the first half of 1985, according to preliminary figures from Prescott, Ball & Turben.

Earlier this year, Tim Schwertfeger, Nuveen's vice-president and national director of health care practice, had predicted that "most of the capital that will be needed in health care in the coming years will be consolidation capital." Specifically, that means more advance refundings, Bergman observes, and advance refundings are the kinds of issues that involve arbitrage benefits. The expectation is that the administration will push to have arbitrage benefits eliminated or curtailed.

During the first half of this year, "there's been very little new project money" among hospital issues, Bergman notes. Perhaps "20 percent to 25 percent of issues represent refinancing to insure greater flexibility in the future," and that includes replacing restrictive covenants. "Another one-third of the issues went to fund prospectively hospital capital investment or capital improvement items," he adds.

Because of the enormous supply of revenue bonds in general, "the interest rates on the tax-exempt revenue bonds haven't dropped as greatly as those on taxable bonds have. As a result, the spread between the taxable and tax-exempt bonds has narrowed significantly," Bergman says. Interest rates on taxable bonds are higher than on tax-exempt issues.

"Interests rates are terribly attractive right now, on a historical basis," says Peter Schmitt, director of fixed income research for Prescott, Ball & Turben. Three years ago, he notes, rates hovered at 13.5 percent, whereas a hospital issue today can be as low as between 4 percent and 5 percent.

"Lower interest rates make fixed rate issues more attractive," which is why fixed-rate issues comprised 69.1 percent or $3.15 billion of all hospital revenue bonds during the first half of this year, Schmitt explains. Variable or "put" option bonds made up the remaining $1.41 billion, according to preliminary estimates from Prescott, Ball & Turben.

Moreover, "bond insurance is way up this year," Schmitt says. Bond insurance and various forms of credit enhancement often allow a hospital better interest on a tax-exempt issue. Issues carrying bond insurance represented $2.61 in volume or 57.2 percent of all hospital revenue bonds during the first half of this year, he says.

Schmitt estimates that there were more tax-exempt bond issues floated on behalf of freestanding hospitals than on behalf of multihospital chains or consortiums during the first half, probably because many freestandings have new capital needs right now. Schmitt is editor of Prescott, Ball & Turben's newsletter, Health Care Financing.