Supreme Court Decision and the Muni Health Care Market

Supreme Court Decision and the Muni Health Care Market
John Mousseau & Michael Comes
July 5, 2012

Last week’s Supreme Court decision that upheld the Patient Protection and Affordable Care Act (PPACA) has implications for the health-care sector of the municipal bond market.

What did the court decide?

On the question of mandating insurance, the court opined (in a 5-4 decision) that a penalty levied on an uninsured person who does not purchase coverage constitutes a tax and is, therefore, within the purview of Congress to pass and enforce it.  This was a surprise, because the Affordable Care Act (ACA) was NOT upheld under the commerce clause of the US Constitution, which was the focus of arguments.

With regard to Medicare, the ACA expands the scope of the Medicaid program beyond its current limits.  The Supreme Court did curtail the ACA’s provision to REQUIRE states to expand Medicaid programs or lose federal funding for existing programs. This was ruled unconstitutional and that part of the ACA was removed.

Who does the decision affect when it comes to municipal bonds?

It really affects two broad groups: states and hospitals.

States

As stated above, the provision to block federal funding to states that do not EXPAND Medicaid was removed.  Medicaid expansion will be funded 100% by the federal government until 2017, at which time funding will decline to 90%.  This is where political issues may get thorny.  The states that decide against expansion will have to bear the rising costs of UNINSURED citizens without federal funding.  Already there are a number of states, including Louisiana and Florida, whose governors have said they will opt out of Medicaid expansion.  Why would states want to turn down programs that are almost entirely federally funded?  Clearly, part of the reason is ideology on the part of these states; but it also seems that states feel that the federal government, seeking to balance its own budget, will curtail federal support down the road, leaving states to pick up a large bill.  Realistically, these costs should be much smaller than the costs resulting from states shoring up pension funds and benefits other than pensions (“OPEB”).

Hospitals

The ruling should benefit not-for-profit hospitals, as well as for-profit ones.  One of the benefits of increased health insurance coverage is that the amount of uncollected bills from hospitals should decrease over time.  Overall, the number of insured patients should rise as the benefits of insurance expansion help the utilization rate of hospitals across the board.

Since the beginning of this year, the issuance of hospital and health-care debt has been reduced on a RELATIVE basis.  For a market that has seen an almost 70% increase in overall issuance, hospital issuance is only up about 21% (courtesy, Bank of America/Merrill Lynch).  This reflects the fact that many systems were reluctant to issue debt until the Supreme Court provided some clarity to the situation.

This reluctance has been clearly reflected in the yield spreads of hospital bonds over the general market in the past year (courtesy, Bloomberg and Municipal Market Advisors).  For investment-grade debt, the market has seen significant narrowing from a year ago.

07/02/2012   12/30/2011   07/01/2011

This narrowing has come about from both the relative drop in health-care issuance as well as the fact that, in periods of low NOMINAL yields, such as we are in now, bonds like investment-grade health care are often the source of marginal INCREMENTAL yield for portfolio managers; and they have bid this incremental yield down.

Going forward, what does this mean for hospital debt?

There is no question that we should see a sharp increase in health-care debt issuance as hospital systems gear up for the requirements of ACA.  Will investors perceive the financial situation as improving?  And will this perception of improvement be enough to bring in more buyers of hospital debt to offset the increased supply?

Our thoughts are that the muni market is often caught in periods of sharp increases in supply and that the dealers will quickly price debt to clear the market.  Thus, we will be content to wait until the first wave of supply is behind us.  The subsequent waves should provide better relative value.

In summary, we believe that those states that do not participate in this new Medicaid expansion may want to wait until after the election – especially if President Obama is reelected.  We also think the overall market for health-care bonds should improve: better utilization rates in hospitals, a deeper market if incremental buyers emerge, and better liquidity due to an increase in ISSUANCE of health-care debt.  But the timing of the issuance will be critical.

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This commentary was co-authored by John Mousseau, who is a portfolio manager and heads the tax-free muni section of Cumberland, and Michael Comes, Research Analyst. Their bios are found at www.cumber.com. Their email addresses are John.Mousseau-at-cumber.com and Michael.Comes-at-cumber.com.