To successfully navigate the complex landscape of capital finance, hospitals need to know whether their choice of bond-issuing authority affects debt financing costs—and how.

At a Glance

  • All other things being equal, bonds issued by statewide authorities have lower yields than bonds issued by local authorities.
  • However, lower yields may be offset by higher issuance costs for statewide authorities, as reflected in the true interest cost.
  • Higher issuance costs may provide benefits for investors and for issuing hospitals.

To raise capital, many not-for-profit hospitals issue tax-exempt bonds through financing authorities, quasi-public entities at the state or local level that serve as conduits for not-for-profit organizations to access the municipal bond market.

In some states, a single statewide authority is the only organization through which not-for-profit organizations can issue tax-exempt debt. In other states, only local authorities can issue such bonds. Still other states have both local and statewide authorities. Not all authorities specialize in healthcare financings; some also issue tax-exempt debt for higher education. These authorities do not typically deal directly with investors, but simply act as conduits to investment banking firms. 

New research shows that capital costs depend on both the type of issuing authority and the number of authorities that are active in the market.a Previous studies had established that competition among authorities is associated with lower debt financing costs, but those studies did not distinguish between state and local authorities.b To understand this added dimension, capital costs should be examined from more than one perspective: yield from an investor, or “outsider” view, and the true interest cost (TIC) from the hospital, or “insider” view.

Measuring the Cost of Capital

The yield on a hospital tax-exempt bond is the return the investor expects to earn from the interest and principal payments. Yield reflects the market’s evaluation of the quality of a hospital, its ability to make good on the debt, and perhaps, the quality of the authority that helped prepare the bond, among other things.

The TIC represents net proceeds to the hospital, taking into account bond issuance costs, which include gross spread, original issue discount, and insurance. TIC is a more accurate measure of the cost of capital to the hospital than yield. Prior studies have found that TIC was lower in markets with a greater number of issuing authorities, presumably because of competition among the authorities for a hospital’s business. 

How Bond Interest Rates Are Determined

A number of factors collectively determine interest rates on hospital tax-exempt bonds, including characteristics of the bond, financial and operational characteristics of the issuing hospital or health system, and underwriter characteristics, as shown in the exhibit below. Tax-exempt interest rates are also affected by market conditions such as the general level of interest rates at the time of issuance. In addition, instability in the healthcare marketplace can shake investor confidence, as demonstrated by the higher debt costs that prevailed in the wake of the Allegheny Health Education and Research Foundation bankruptcy in 1998.c

Exhibit 1


Perceptions of State Bond-Issuing Authorities

One could hypothesize that bonds issued by a statewide authority would have a lower cost of capital. Under that premise, statewide authorities, by virtue of their size, would be recognized by investors as having greater oversight of the issuing hospitals and less propensity to issue bonds for highly risky institutions. Telephone interviews with executives in several statewide authorities were conducted to substantiate that hypothesis. 

Most interviewees agreed that statewide authorities have more staff to actively evaluate and monitor the hospitals that issue debt through them. Because statewide authorities are among the largest issuers of hospital tax-exempt debt, they have more experience with this market than do local authorities. They usually have full-time staff who can work with finance professionals on a regular basis. Their governing boards meet on a known, regular basis, and the authorities’ policies are well-known by investors.d

One authority executive suggested that the benefit of an active authority includes “better documents and security packages with more protection for bondholders; better access to financial and operating data to monitor financial condition of borrowers after issuance; and a greater likelihood that remedial action will be taken when the borrowers run into financial distress.”

This executive and others noted that staff from statewide authorities can participate in the pricing calls between the underwriter and hospital. That may not be an option for local authorities that have few, if any, staff or that are infrequent issuers. 

A previous study had held that states with lower concentrations of issuing authorities have more competition and, therefore, lower capital costs.f One authority executive disagreed, maintaining that most hospitals do not put their bonds out to bid to competing authorities; rather, they select an authority based on other criteria.g Authority executives disagreed about whether statewide authorities weed out riskier borrowers. In some states, the statewide authority is required by law to serve as a conduit for all not-for-profits, regardless of their risk level. However, one state authority executive maintained that the “well-known and open process [used by statewide authorities] does weed out riskier borrowers and/or transactions, and the market has faith that an issue through an active authority will be conducted in an efficient, effective, and timely manner.”h

Another authority executive director argued that institutional buyers of tax-exempt debt, such as banks or pension funds, are more familiar with the services provided by statewide authorities than are retail investors and may prefer bonds issued through statewide authorities. Because large, institutional investors often dominate the tax-exempt market, that preference might be reflected in the bond issues they choose to purchase. 

Analysis of Bond Issues

To supplement interview findings, a study of all tax-exempt hospital bonds issued from 1994 through 2002 from the Thomson Financial Services SDC Platinum database was conducted. Two dependent variables were used to measure the cost of capital—yield and TIC. Two independent variables related to issuing authorities were used—a Herfindahl index of authority concentration (a common measure of market concentration used in other studies) and a variable that indicated whether the bond was issued by a state or local authority (new to this study). 

Study results corroborate the findings from earlier studies regarding the influence of most determinants on TIC. This study extended prior research by applying the same model to predicting yields. Results are very similar to other studies of the cost of capital for tax-exempt hospital debt with regard to operational and financial characteristics of the hospital or health system, characteristics of the bond itself, and characteristics of the underwriters, as depicted in exhibit 1. Focusing on the results related to the issuing authorities, the exhibit below provides a visual representation of regression results. 

Exhibit 2


As in the previously cited research, the study found that TIC was higher for bonds issued in states with less competition among issuing authorities, as measured by the Herfindahl index of market concentration. The exhibit illustrates this finding. Note that the top row of the exhibit is for markets with less competition among authorities. The TIC box is larger in the top row, indicating that TIC is higher in less competitive authority markets. Viewed another way, TIC is higher in markets that are more concentrated in just a few issuing authorities. 

Unlike TIC, yield does not differ based on authority concentration. In the exhibit, the size of the yield box is the same in each row. In other words, yield is the same in markets with few issuing authorities as in markets with many authorities.

Switching focus from competition level (rows) to issuer type (columns) reveals new insights. Where the bond was issued by a state authority, yield was consistently lower, but for bonds issued by local authorities, yield is consistently higher, regardless of the level of authority competition. However, TIC does not differ based on whether the bond was issued by a state or local authority. 

These findings may appear paradoxical at first. In states with one central state authority responsible for all hospital bond issuance, the issuer concentration will naturally be high; thus, the level of competition will be lower, and TIC—the cost of capital for the hospital—will generally be higher. But state issuers are associated with lower yields. 

The major difference between TIC and yield is the issuance cost—the fees paid by the hospital to the brokers, insurers, attorneys, and issuing authorities. These findings suggest that the higher TIC for bonds issued in states with high authority concentration results from higher issuance costs, not higher yields, because there is no difference in yields between high- and low- competition states. Bonds issued by statewide financing authorities do have lower yields, compared with local authorities, but the lower yields appear to be offset by higher issuance costs, resulting in no difference between state and local authorities in terms of TIC. Higher issuance costs may reflect the more extensive services provided by the statewide authorities.

Implications for Hospital Debt Financing Decision Makers

The choice of financing authority does appear to affect the cost of tax-exempt debt capital for hospitals. Bonds issued by statewide authorities might be expected to have lower capital costs because investors recognize that statewide authorities have greater oversight of not-for-profit hospitals and are less likely to issue bonds for highly risky institutions. Interviews with financing authority executives confirmed that statewide authorities are staffed to be more actively involved in the bond issuance process and to provide more information and protection to bondholders. Investors recognize the value of those services, resulting in lower yields on bonds issued by statewide authorities. Investors are more familiar with the policies and procedures of large, statewide authorities. That transparency helps keep interest costs down. The authority executives who were interviewed suggested that the larger statewide authorities are more professional and methodical about preparing and verifying financial statements, inspiring greater investor trust in the bonds they issue and, therefore, lower yields.

Our findings confirmed this expectation. All other things being equal, bonds issued by statewide authorities have lower yields than bonds issued by local authorities. However, those lower yields may be offset by higher issuance costs for statewide authorities, as reflected in the TIC.

Hospitals and health systems that have a choice of issuing authority should know that the interest rate on bonds they issue will likely be lower if they issue bonds through a statewide authority, rather than a local authority, but the issuance cost may be higher. The services provided in exchange for the higher issuance costs—including enhanced information and protection for bondholders—may benefit both the investors and the issuing hospitals. 

Caryl E. Carpenter, PhD, is professor, health care management, School of Business Administration, Widener University, Chester, Pa., and a member of HFMA’s Metropolitan Philadelphia Chapter.

Patrick M. Bernet, PhD, is associate professor, health administration, Florida Atlantic University, Boca Raton, Fla.


a. Bernet, P.M., Carpenter, C.E. E., and Saunders, W., "The Impact of Competition Among Healthcare Financing Authorities on Market Yields and Issuer Interest Expenses," Journal of Health Care Finance, September 2011.

b. Grossman, M., Goldman, F., Gershberg, A.I.,, "Economic Analysis of Health Care Financing Authorities—Final Report, Grant Number  R01 HS06095-04," Agency for Health Care Policy and Research, Department of Health and Human Services, National Bureau of Economic Research, unpublished, 1996.

c. Bernet, P.M., and Getzen, T.E., “Can a Violation of Investor Trust Lead to Financial Contagion in the Market for Tax-Exempt Hospital Bonds? International Journal of Health Care Finance and Economics, March 2008; and Carpenter, C.E., McCue, M.J., and Moon, S., “The Hospital Bond Market and the AHERF Bankruptcy,” Journal of Health Care Finance, Summer 2003.

d. Personal communication with M.J. Stanard, executive director, Health and Educational Facilities Authority of the State of Missouri, June 2009.

e. Communication from S.M. Fillebrown, deputy executive director and director of research, investor relations and compliance, New Jersey Health Care Facilities Financing Authority, December 2008.

f. Grossman, M., Goldman, F., Gershberg, A.I., Kocagil, P., Thompson, P., and Renn, S., Economic Analysis of Health Care Financing Authorities, Final Report, Grant Number R01 HS06095-04," Agency for Health Care Policy and Research, U.S. Department of Health and Human Services, National Bureau of Economic Research, November 1996.

g. Personal communication with B. Bandi, executive director, Arizona Health Facilities Authority, June 2009.

h. Personal communication with M.J. Stanard, executive director, Health and Educational Facilities Authority of the State of Missouri, June 2009.

Publication Date: Wednesday, May 01, 2013

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