Three weeks after Sacred Heart Hospital closed its doors and left Municipal Bond Investors Assurance Corp. on the hook for an almost $25 million bond default, another Pennsylvania hospital appears on the brink of creating similar headaches for MBIA.
Montgomery Hospital, also located in Norristown, Pa., "may be even worse in some facets than the one that just defaulted," said Richard Ciccarone, director of tax-exempt research at Kemper Securities Inc.
"The financial condition of the facility as reported leaves me with the impression that they could be headed for a similar fate as Sacred Heart," Ciccarone said.
The evaluation is based on preliminary data and research, he said.
As with Sacred Heart, Montgomery Hospital's performance in several key areas has declined since 1989, Ciccarone said, citing figures from the Merritt System, a database containing audited financial reports on more than 1500 hospitals.
Montgomery's debt service coverage, for example, fell to negative 2.24 times in 1993 from 1.85 times in 1992 and 4.41 times in 1990. The hospital's cash flow to debt ratio has also fallen significantly, to negative 24.32% in 1993 from 9.15% in 1992 and 23.44% in 1990.
Montgomery Hospital's profits have also plummeted in recent years, with return on equity and profit margins solidly in the negative range in 1993.
Montgomery also had a $3.2 million loss from non-operating revenues in 1993, which is "really exacerbating the situation," Ciccarone said.
Unlike Sacred Heart, Montgomery does have some liquidity on hand, with more than $1 million in cash at yearend 1993 and a $6.8 million liquid board designated fund, Ciccarone said.
~Only for So Long'
However, "that can only last for so long," Ciccarone said.
One hospital analyst said that Montgomery's outlook should be improved now that Sacred Heart has closed.
Elizabeth Rorison Bantely, a spokeswoman for Montgomery Hospital, said it is "too early to tell" how Sacred Heart's closing will affect Montgomery's financial standing, but "we've definitely increased [patient] volume without a significant increased in overhead.
"In the past three years we've had a few rough years, but with a month left to go in our financial year, it looks like we'll break even," Bantely said.
"Now that the surrounding area's overcapacity problem has improved significantly, the prospects for Montgomery are considerably better," said William P. Condon, senior vice president at MBIA, noting that occupancy at the hospital is bordering on 90%.
MBIA has a $11 million net par exposure to Montgomery Hospital, stemming from a $14 million revenue bond issue sold by the Montgomery County Higher Education & Health Authority in 1988 on behalf of the hospital.
As with the Sacred Heart bonds, MBIA assumed liability for the Montgomery issue when it acquired Bond Investors Guaranty Insurance Co., or BIG, in 1989.
The problems with Sacred Heart reached a climax on April 15, when the hospital failed to make a $600,000 interest payment. The trustee, Continental Bank, was forced to draw on the hospital's debt service reserve fund, which constituted an event of default.
On May 17, the hospital abruptly closed its doors and filed for bankruptcy about a week later, leaving MBIA on the hook. Connie Lee Insurance Co. has about a $2.5 million exposure through reinsurance agreements, and AMBAC Indemnity Corp. has a $400,000 exposure from a separate issue sold on behalf of the hospital in 1988.
MBIA officials said that about $1.8 million remains in the debt service reserve fund, which should last until August 1995. After that, MBIA and Connie Lee will have to assume principal and interest payments unless another plan is agreed upon.
Ironically, merger talks between Sacred Heart and Montgomery were in the works before Sacred Heart closed.
Bantely said that Montgomery, Sacred Heart, and Norristown's third hospital, Suburban General, had entered merger talks more than a year ago because "it became readily apparent that the best way for us to be competitive would be to stand together."
In April, Montgomery and Sacred Heart signed a "letter of intent" to merge, Bantely said. When Sacred Heart defaulted in April, the merger talks were accelerated "with the intent that Suburban General would come in" at a later date. But Sacred Heart closed its doors before the deal could be finalized, she said.
Montgomery is now negotiating to buy the facility and some of Sacred Heart's equipment, she said, but the possibility of a merger where Montgomery would assume Sacred Heart's debt obligations is probably lost.
Paying Not a Problem
With a qualified statutory capital base of $1.5 billion at March 31, MBIA is clearly able to make the scheduled payments on the defaulted Sacred Heart bonds, and for the Montgomery issue if necessary, without affecting the firm's ratings or ability to write new business.
"From our perspective, the [Sacred Heart] default is immaterial," said Laura Levenstein, vice president and assistant director at Moody's Investors Service.
But the default raises a variety of issues that the bond insurers -- and the market in general -- will be paying close attention to.
The trading performance of the Sacred Heart bonds this week demonstrates the limits of bond insurance. Insured bonds are generally more liquid than uninsured because of the triple-A backing, but traders are loathe to ignore the underlying credit altogether.
"When we're marketing or trading [insured] bonds, there's a tremendous demand on the institutional side to understand the underlying credit, and rightly so," said Troy Gerleman, assistant vice president at Kemper Securities. "Municipal bond insurance serves as a second engine to the credit, but [Sacred Heart bonds] lost one. Would you rather be in a plane with one engine or two?"
On Tuesday, a block of the bonds were out for bid and sold at a significant discount compared to other insured hospital issues, traders said.
"The bonds were at a discount. No question," one trader said. "With a high coupon they should be a premium bond. Anything close to a 7% [coupon] on triple-A rated paper is pretty outrageous in this market."
A $200,000 block of Sacred Heart bonds maturing in 2013 with a 6.80 coupon were priced to yield from 6.90% to 6.95%, market sources said. The bonds are callable at 102 in 1997 and at par in 1999.
By comparison, market sources reported that a similarly structured insured hospital bond was trading to yield 6.40% to 6.50% on Tuesday.
One bond insurance official said the performance of the Sacred Heart bond this week was not surprising, noting that when Bridegport, Conn., and Philadelphia, Pa., were on the brink of default, their bonds "immediately traded at a discount bur eventually came back."
However, neither Philadelphia nor Bridegport actually went into default, so a direct correlation to the Sacred Heart situation cannot be made, market sources said. Furthermore, there are not very many defaulted tax-exempt insured bonds that were not part of unit investment trusts or insured by the Federal Housing Administration. Thus, there is a little in the past to indicate what will happen to the Sacred Heart bonds.
There is "some logic" to the market's treatment of the bonds "even though the quality of the insurance companies is unquestioned right now,"Ciccarone said. "MBIA will have no problem paying, but it comes down to the concept of an insured bond being a two barrel credit and one barrel being gone. That's the way the market looks at the situation."
The situation also bolsters the theory that insured bonds should trade better than so-called natural triple-A credits, Ciccarone said.
"The theory suggests that when you have two strong investment grade credits working, [trading value] should be amplified when they're both working," he said, particularly if the market is going to diminish the value of the bonds when the underlying credit quality deteriorates.
Ironically, the Sacred Heart default could prove to be a boon for the bond insurers, because it would heighten demand for their backing, Kemper's Gerleman said. Conversely, the insurers might tighten up their underwriting standards for health care issues in the wake of the default, he said.
Faced with uncertainty over pending health care reform, the bond insurers have already begun to adopt stricter underwriting criteria for health care issues, industry observes said.
MBIA has the industry's highest concentration in health care by a significant margin, with $27.6 billion, or 17%, of its gross par outstanding insured bonds in the sector at yearend 1993, according to Moody's annual report on bond insurance.
But the report also said that MBIA has had "the largest decrease in this sector among the rated insurers" since [99] and that "the credit quality of [the] health care portfolio improved slightly in 1993."
Levenstein said MBIA's "underwriting standards have improved, so you'll see an improvement [in the health care portfolio] over time, but that's not unique to MBIA," Levenstein said.
MBIA's efforts to "slightly decrease the company's exposure to health care [and] a fair amount of runoff of older issues" also contributed to the positive trend, she said.
But Robert R. Godfrey, executive vice president at MBIA, said, "we're still underwriting health care credits using the same standards as when we started 10 years ago. The reason it's scaled back is that health care has been receding as a percentage of the overall market."
The Sacred Heart default raises the specter of how such a scenario affects the stock of a publicly traded insurer. In the past, near defaults in Philadelphia and Brevard County, Fla., sent MBIA's stock tumbling. However, equity analysts said, the market better understands the bond insurers' ability to weather an isolated default, leaving the companies less susceptible to a downturn when one does happen.
MBIA's experience in recent weeks seems to support that contention.
On April 15, the day of the Sacred Heart default, shares of MBIA Inc., the bond insurer's holding company, closed up 3/4 at 58 1/8 on the New York Stock Exchange. On May 19, when news of the hospital's closing was first circulating, the stock closed at 54 3/8, up 1/8. Yesterday, the stock closed up 1 3/8 at 59 1/8.
