What Is a Hospital Revenue Bond?

What Is a Hospital Revenue Bond?

Let me explain what a hospital revenue bond is: it's a type of municipal bond that finances the construction of new facilities or upgrades for existing hospitals, and it's secured by the revenues that hospitals receive in the course of their normal operations.

Key Takeaways

You should know that a hospital revenue bond is a municipal bond for financing hospital construction or upgrades, secured by hospital revenues from normal operations. These bonds typically command higher yields because their default risk is higher, as they can't raise revenue through taxes like other municipal bonds. Also, income from a hospital revenue bond may be exempt from state, local, and federal taxation.

Understanding Hospital Revenue Bonds

Hospital revenue bonds can also be used to purchase new equipment for these facilities. Generally, bondholders receive payment only after the hospital's operating expenses are paid, which creates risk for you as a bondholder if the hospital isn't as profitable as anticipated.

I consider hospital revenue bonds among the riskiest types of municipal bonds. As their name suggests, revenue bonds are backed by the revenue that the specific project generates. If this revenue is insufficient, municipalities have no obligation to use other funds to pay you back.

Unlike municipalities, hospitals cannot tax residents to cover expenses or repay debt. This inability to raise revenue through taxes means hospital revenue bonds typically command higher yields. The high yield comes from their default risk being higher than a general obligation bond.

Rating firms evaluate a revenue bond issue and assign a ranking indicating the probability that the obligation pays out on schedule. Hospital revenue bonds reliant on government-funded programs such as Medicaid and Medicare are a higher-risk investment for you. Uncertainty surrounding possible changes to the healthcare market and insurance laws creates an unpredictable environment for hospitals and the bonds that support them. Still, when there's a decrease in supply in the municipal bond market, investors like you are more likely to consider hospital bonds that present higher risk.

Tax Considerations for Hospital Revenue Bonds

Income you receive from a hospital revenue bond may be exempt from state, local, and federal taxation. However, this varies by location and the impact of current tax law, which is subject to change. A tax plan introduced by Congress in 2017 initially included an amendment that would prevent hospitals from issuing tax-exempt bonds. This plan prompted many hospitals to rush to seek funding before the proposed legislation could take effect.

Several major hospital groups strongly objected to the proposed change, warning that eliminating the tax break would result in higher borrowing costs. The increased cost would in turn limit or reduce their ability to expand, renovate, or build new facilities, which would be detrimental to local communities. The final tax plan dropped the proposed legislation.

Other Kinds of Municipal Revenue Bonds

Revenue bonds have backing from the money streams created by a specific project. Other types of revenue bonds issued by municipalities may fund projects like toll roads, airports or harbors, public housing projects, or public utilities. These bonds have higher risk than general obligation bonds, but because of that, they can sometimes pay a higher rate of interest.

Revenue bonds contrast with general obligation bonds (GO), which are debt obligations repaid through a variety of tax sources. As a holder of GO bonds, you must rely on the full credit of the issuing municipality, as no assets are used as collateral.

For example, in the case of an airport revenue bond, the municipality issues a bond to build a new terminal. The bond depends on the income generated from airport activities to back the debt. Once completed, airport landing fees, terminal rents, concession revenue, parking charges, and other income streams will generate revenue that the city will use to pay off the bond.