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Checkup On Not-For-Profit Health Care SBPA-Backed VRDOs In The COVID-19 Era


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Checkup On Not-For-Profit Health Care SBPA-Backed VRDOs In The COVID-19 Era

S&P Global Ratings currently rates 904 primary market variable-rate demand obligations (VRDOs) that are backed by standby bond purchase agreement (SBPA) obligations with a par total of approximately $69.8 billion. VRDOs are bonds with interest rates that reset periodically and may include a bondholder put option. The U.S. public finance (not-for-profit) acute health care sector currently has 86 SBPA obligations that represent about 10% (approximately $7 billion) of all SBPAs (see chart 1).

Although our outlook on the banking sector is negative, we haven't taken any rating actions on our short-term ratings on VRDOs because our short-term ratings on banks that provide liquidity support to these transactions remain unchanged. However, as of July 31, 2020, the percentage of ratings on not-for-profit health care obligors with negative outlooks increased to 26% of the stand-alone providers and 17% of the health care systems we rate. We have also seen a few downgrades in the 'AA' and 'A' rating categories, with slightly more downgrades in the 'BBB' and below rating categories (see chart 2). Further, in April, we took rating actions that negatively affected speculative-grade hospitals (those rated 'BB+' and below) and those with less than 100 days of cash on hand (see "Outlooks Revised On Certain U.S. Not-For-Profit Health Care Organizations Due To Potential COVID-19 Impact," published April 21, 2020).

Our short-term ratings on SBPA-backed issues address the likelihood of the bondholders receiving interest and principal payments if they exercise their put options by paying the purchase price of bonds that were not remarketed. For outstanding SBPA-backed not-for-profit health care providers, our short-term ratings range from 'A-1' to 'A-1+'. These short-term ratings are based on the lower of our short-term rating on the bank or the short-term rating correlating to our long-term rating on the bond issue. The table below shows the standard link between our long- and short-term ratings.

Standard Mappings Of Short-Term Ratings To Long-Term Ratings
Long-term rating Short-term rating
AAA, AA+, AA, AA- A-1+
A+, A A-1
A-, BBB+, BBB A-2
BBB- A-3
BB+, BB, BB-, B+, B, B- B
SD--Selective default.

Chart 1


Chart 2


Potential For An Increase In Tenders

We believe more not-for-profit health care bondholders could elect to tender their bonds due to the negative impact of the COVID-19 pandemic and investors' concerns about the obligors' overall credit quality and the potential loss of put options if SBPAs terminate without notice. An increase in tenders could result in an upsurge in failed remarketing (when the remarketing agent cannot find a buyer) and, ultimately, draws on the SBPA providers. Typically, interest rates on bank bonds, which are tendered bonds purchased and held by banks (also known as "the bank rate"), are significantly higher and have shorter maturity schedules. We believe the existence of these bank bonds could cause heightened pressure on not-for-profit health care obligors. However, we don't expect failed remarketings in the sector because the obligors tend to have higher ratings and SBPA-backed issuances have remained relatively unchanged year over year as of July 27 (see chart 3).

Chart 3


Sector Outlook: Negative

Our sector outlook for the not-for-profit health care sector remains negative as hospitals continue to grapple with increased expenses due to the COVID-19 pandemic and ongoing revenue pressures related to uneven volume recovery over the next year (see "U.S. Not-For-Profit Acute Health Care Mid-Year Sector View: Recovery Continues, Likely Uneven For The Rest of The Year," published Aug. 13, 2020). Although many health care providers have resumed elective procedures and have started seeing increased volumes and improving revenues, they continue to face significant uncertainty due to the ongoing pandemic and economic recession. We expect an uneven recovery as hospitals balance COVID-19 cases with other care needs, and as patients potentially eschew certain nonessential care for health and safety concerns.

Most U.S. health care providers have benefited from significant federal funding with Medicare advanced payments, which will start to be repaid in August, and relief funds from the Coronavirus Aid, Relief, and Economic Security Act (H.R. 748) (CARES Act). However, for many, this funding hasn't fully offset the significant operating losses and negative cash flow impact of the pandemic. We believe there will be an increased risk of covenant violations for some health care providers over the next fiscal year and an accelerated need for some to look to partner or merge with their larger, stronger competitors.

Despite these challenges, not-for-profit health care providers remain opportunistic, and many are refunding or issuing new money debt, such as taxable issuances, to take advantage of low interest rates and gain more flexibility. In addition, many providers obtained lines of credit at the outset of the pandemic to boost their liquidity. However, these generally came at a high cost of LIBOR plus a significant spread, which has left some providers looking at less costly alternatives. We believe there is a bifurcation in the market between higher- and lower-rated providers, which means many providers may not be able to access the public markets and may need to enter into private placements or more costly lines of credit. That said, providers in the 'AA' rating category, which represent 25% of the not-for-profit health care providers we rate (see chart 4), continue to have access to the SBPA market, although pricing has increased somewhat and tenors have shortened. We believe a significant number of these higher-rated providers will be able to withstand the disruption and continue to have access to the markets.

Chart 4


Analytical Considerations In SBPA-Backed VRDOS

SBPA-backed VRDOs differ from other enhanced VRDOs due to specific provisions contained in most SBPAs. Two of the unique SBPA provisions are the "automatic termination or suspension events" and the "most favored nation" provisions. Below we discuss how our criteria address some of the most common risks we find in these two types of provisions.

Automatic termination or suspension events provisions

The SBPA's obligation to purchase tendered bonds is conditional and may terminate or be suspended without notice upon the occurrence of certain events of default consistent with our criteria (see "Standby Bond Purchase Agreement Automatic Termination Events," published April 11, 2008). Immediate termination or suspension events include:

  • Failure to pay principal or interest on the bonds being rated,
  • Failure to pay senior or parity debt,
  • Obligor bankruptcy,
  • Event of taxability, and/ or
  • Lowering the rating on the bonds to speculative grade.

The automatic termination or suspension of the SBPA's obligation to purchase tendered bonds if the rating is lowered to speculative grade is permitted only for debt issues that are rated at least 'A+' at the time of the review. While we don't expect ratings associated with public finance obligors to simply fall off a cliff, the 'A+' rating threshold relative to the 'BBB-' automatic termination event allows ample time for bondholders to exercise their put options prior to the rating on the obligor being lowered to speculate grade. Despite the COVID-19 pandemic, our ratings on not-for-profit health care SBPA-backed providers remain in the 'AA' rating category as of July 27, 2020 (see charts 5-6).

Chart 5


Chart 6


Most favored nation provisions

In addition to automatic termination or suspension events provisions, SBPAs may also contain most favored nation (MFN) provisions. MFN provisions may automatically incorporate certain terms and provisions--without advance notice from other agreements that the obligor may have entered into--that may not be consistent with our published criteria. These MFN events may allow for the amending of automatic termination or suspension events, conditions precedent to purchase, notice termination events, and/or any other events that could affect the bank's obligation to fund. The risk is that "auto amending" these provisions could lead to a loss of liquidity support for non-credit-related reasons. Therefore, automatic amendment of these areas in the SBPA is inconsistent with our criteria. However, we have seen a variety of mitigants to this risk, from prohibitions on MFNs affecting these terms in the SBPA to incorporation of the terms causing a mandatory tender or even a rating agency confirmation (RAC) prior to the MFN provision being incorporated.

Heightened Uncertainty

Despite our negative outlook on the not-for-profit health care sector, we believe providers in the 'AA' rating category and above will continue to have market access and be able to withstand some near-term disruption from the pandemic and economic recession.

Although most banks' rating outlooks remain stable, the proportion of banks with negative outlooks has increased sharply due to the pandemic, rising to 38% in August compared with 7% in early March. The trend for the U.S. banking sector's economic risk is also negative, reflecting the risk that banks may face challenges from declining asset quality due to pandemic-related stress. However, liquidity has improved for most banks, aided by significant deposit inflows on the heels of the Federal Reserve's massive quantitative easing measures (see "Global Banks Midyear Outlook 2020: Temporary Shock, Profound Implications," published July 9, 2020).

S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: As the situation evolves, we will update our assumptions and estimates accordingly.

This report does not constitute a rating action.

Analytical Contacts:John C Mante, Chicago (1) 312-233-7058;
Eli Goldaris, Farmers Branch (1) 214-871-1472;
Bala Ramanujam, New York (1) 212-438-1831;
Anne E Cosgrove, New York (1) 212-438-8202;
Alexander J Gombach, New York (1) 212-438-2882;
Santos Souffront, New York (1) 212-438-2197;

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