Hospital Revenue Bond
A type of municipal bond secured by the revenues of hospitals that earn in the course of their normal operations
What A Is Hospital Revenue Bond?
A hospital revenue bond is a type of municipal bond secured by the revenues of hospitals that earn during their normal operations. It is used to fund the building of new facilities or modifications to existing hospitals.
Hospital revenue bonds have a higher default risk than municipal bonds since they cannot earn money through taxes like other municipal bonds. Also, the income from a hospital revenue bond may be tax-free on a state, local, and federal level.
The revenue generated by the hospital is utilized to make interest payments to bondholders once it is functioning. On the other hand, bondholders do not get payments until the hospital has paid its operating expenses, such as payroll, utilities, and hospital equipment maintenance.
In addition, the hospital is not obligated to use other sources to pay bondholders if revenue is insufficient to cover the required payments. As a result, hospital revenue bonds are considered to be among the higher-risk revenue bonds.
In this article, we will explain the hospital revenue bonds, tax considerations, types of municipal revenue bonds, and which bonds have more or less business risks.
Key Takeaways
- Hospital revenue bonds are municipal bonds secured by the revenues generated by hospitals during their operations. They are used to finance hospital facility construction or upgrades.
- Hospital revenue bonds carry a higher default risk compared to other municipal bonds because they cannot rely on tax revenue. They depend solely on hospital-generated income.
- The income from hospital revenue bonds may be tax-free on state, local, and federal levels, making them attractive to investors.
- Bondholders of hospital revenue bonds receive payments only after the hospital covers its operating expenses, potentially putting them at risk if the hospital is not profitable.
- Hospital revenue bonds are considered risky due to uncertainty in the healthcare market and insurance rules, making their future unpredictable.
Hospital Revenue Bond Explained
Revenue bonds for hospitals can also be utilized to buy new equipment. However, bondholders are generally paid only after the hospital's operating expenses have been paid, which can put bondholders at risk if the hospital is not as profitable as expected.
Hospital revenue bonds are considered one of the most dangerous municipal bonds. As their name suggests, revenue bonds are often secured by the revenue that a specific project can generate. Municipalities are not obligated to use other money to repay bondholders if this revenue is insufficient.
Furthermore, hospitals cannot tax residents to cover finance costs or repay debt. As a result of the inability to raise revenue through taxes, hospital revenue bonds usually have higher yields.
The high yield is attributable to having a higher default risk than a general obligation bond.
However, some rating agencies evaluate a revenue bond issue and assign a score indicating the probability that the obligation will be paid on time. Also, hospital revenue bonds that rely on government-funded programs like Medicaid and Medicare carry a higher risk investment.
Uncertainty about potential changes in the healthcare market and insurance rules makes the environment for hospitals and the bonds that support them unpredictable.
Nonetheless, when there is a shortage of municipal bonds, investors are more likely to consider hospital bonds, which carry a higher risk.
Taxation of Hospital Revenue Bond
The income from a hospital revenue bond may be tax-free on a state, local, and federal level. However, the impact of existing tax law, which is subject to change, differs by location.
In addition, an amendment to a tax plan offered by Congress in 2017 initially prohibited hospitals from issuing tax-exempt bonds. Due to this scheme, many hospitals rushed to get financing before the new legislation took effect.
Investors who earn interest on hospital revenue bonds are excluded from paying federal income taxes on their earnings. In addition, interest income from hospital revenue bonds can also be excluded from state income taxes for revenues earned within the state.
However, interest earned on revenue bonds issued in other states can be subject to taxation. In favor of an alternative minimum and other special taxes, corporate taxpayers may use interest income from tax-exempt hospital revenue bonds in their income computation.
Several major hospital organizations highly objected to the proposed change, warning that abolishing the tax break would lead to greater borrowing costs.
On the other hand, the higher costs would limit or prevent them from expanding, renovating, or building new facilities, harming the local community. Also, the proposed measure was removed from the final tax proposal.
Advantages and Risks of Investing in Hospital Revenue Bonds
Hospital revenue bonds have caught the attention of investors because they offer a mix of advantages and disadvantages that are distinct. In this comparison, we'll take a close look at these financial instruments, pointing out both their advantages and challenges
| Advantages | Risks |
|---|---|
| Potential for Tax Benefits: Income from hospital revenue bonds may be tax-free on state, local, and federal levels, making them attractive to investors. | Higher Default Risk: They have a higher default risk compared to other municipal bonds since they rely solely on hospital-generated income and cannot use tax revenue. |
| Diverse Investment Option: Provides investors with diversification opportunities in the municipal bond market. | Uncertainty in Healthcare Market: Hospital revenue bonds are considered risky due to uncertainties in the healthcare market and potential changes in insurance rules, making their future unpredictable. |
| Attractive Yields: Hospital revenue bonds typically offer higher yields compared to bonds with lower default risk, attracting investors seeking higher returns. | Limited Revenue Sources: Hospitals cannot tax residents to cover finance costs or repay debt, limiting their ability to raise additional revenue beyond operations. |
| Supports Healthcare Infrastructure: Investment in hospital revenue bonds contributes to the development and improvement of healthcare facilities, which can benefit communities. | Dilution Risk: Bondholders are paid only after the hospital covers its operating expenses, potentially putting them at risk if the hospital is not as profitable as expected. |
| Financing Hospital Expansion: Hospitals use revenue bonds to fund expansions, renovations, or new facilities, which can lead to improved healthcare services in the area. | Dependency on Government Programs: Hospitals relying on government-funded programs like Medicaid and Medicare carry higher investment risk, as changes in government policies can impact revenue. |
Types of Municipal Revenue Bonds
Revenue bonds used to be backed by the money streams generated with a specific project. Municipalities may issue revenue bonds to fund projects such as toll roads, airports or harbors, public housing projects, or public utilities.
These kinds of bonds can carry a higher risk than GO bonds but can pay a higher interest rate in return. Furthermore, no assets are used as collateral since holders of GO bonds must rely on the issuing municipality's full credit.
There's are two main municipal bond types, each tailored to a distinct purpose:
1. General Obligation (GO) Bonds
These bonds draw strength from the unwavering backing, creditworthiness, and taxation authority of the issuing municipality. Their security lies in the government's capacity to impose taxes on its populace.
Typically, GO bonds find purpose in funding communal projects like schools, parks, and public facilities, enriching the entire community.
2. Revenue Bond
Distinguished by their reliance on revenue derived from a specific project or enterprise, revenue bonds are utilized to finance ventures such as toll roads, airports, water treatment plants, and electric utilities.
Their repayment hinges on the prosperity and earnings generated by the underlying initiative. This distinctive structure aligns bond success with the financial health of the supported project.
| Municipal Bonds | General Obligations Bonds | Revenue Bond |
|---|---|---|
| Stand as a bridge between the needs of communities and the resources required for their advancement. | Hinge on the trust and fiscal capabilities of governments | Derive their strength from project-specific revenues, offering investors an opportunity to contribute to local development and reap returns in tandem with the projects' success. |
General Obligation Bonds vs. Revenue Bonds
Generally, general obligation and revenue bonds are the two basic municipal bonds. However, they fund important revenue-generating projects such as airports, hospitals, and toll highways.
In addition, the main difference between the two kinds of bonds is the revenue source is mainly used to make interest and principal payments to bondholders.
Bonds not attached to a specific project are known as general obligations bonds, and the issuer can pay interest and principal to bondholders from various sources.
To pay interest and principal to bondholders, the issuer can use a variety of sources of revenue, including tax money, internal fees, and new security issuance.
In case the main source of finance is insufficient, then the issuer has the opportunity to use other revenue sources to fill the revenue shortfall. Also, general obligation bonds are safer than revenue bonds due to this.
On the other hand, the bonds connected to a specific project whose income is used to pay interest and principal to investors are known as revenue bonds.
A state agency may sell revenue bonds to investors, with the money raised toward the construction, renovation, or upgrade of a project. The revenues collected are utilized to pay interest and principal on the bond to the investors once the project is completed.
Furthermore, the project does not have an alternative source of revenue to pay investors if the revenue generated is insufficient to satisfy bondholders. It also raises the default risk of revenue bonds because revenue bonds are often riskier than general obligation bonds.
Also, revenue bonds are used to fund important infrastructure projects such as houses, airports, hospitals, toll highways, and bridges.
Researched and Authored by Naden
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