Fixed Income

ACA uncertainty has benefitted municipal Healthcare Sector

The Republican Party’s decision to make the repeal and replacement of the Affordable Care Act (ACA) their first legislative initiative is bound to have a significant impact regardless of how it ultimately concludes.

05/04/2017

Philip Villaluz

Head of Municipal Credit Research

ACA Repeal and Replace – On, off, on again

The Republican Party’s decision to make the repeal and replacement of the Affordable Care Act (ACA) their first legislative initiative is bound to have a significant impact regardless of how it ultimately concludes. From an investment perspective, the dramatic fashion in which this process continues to play out has had a noticeable impact on the healthcare sector, resulting in uncertainty and opportunity specifically within the Not-for-profit Healthcare segment. As we await the next round of political debates, one thing seems certain; uncertainty is undoubtedly going to lead to more volatility within this sector. In our view, volatility can be a good thing, potentially.

Obamacare positive for hospitals

In the not-for-profit hospital sector, ACA improved the financial situation.  The uninsured rate declined from 18% to 10% due to people gaining coverage from state exchanges or from Medicaid expansion, and as shown in the heatmap below, 32 states now participate in Medicaid under the recent expansion.  The increase in insured levels resulted in growth in inpatient volumes and a decline in bad debt expenses.  Since 2013, several key metrics, including total operating revenues, margins, and liquidity have improved.

Figure 1. 32 states have now participated in Medicaid expansion   

                                    

Source: JP Morgan, Moody’s

 Figure 2. Hospital operating revenues have improved under the ACA

  

The sector cheapens

The health care debate in Washington during the quarter and perceived implications to the industry have recently led to outsized cheapening (higher yields, lower relative bond prices) in health care issuers compared to other sectors.  The options adjusted spread (a measure of yield differences above the risk free AAA rate) according to Barclays was significantly wider than other sectors including education, state and local GOs.

Figure 3. Healthcare issuers are among the most attractive municipal bond segments

Source: Barclays. Option-adjusted spread (OAS) is the spread relative to a risk-free interest rate, usually measured in basis points (bp), that equates the theoretical present value of a series of uncertain cash flows of an instrument to its current market price.  OAS is from each sector compared to the MMD scale as of March 31, 2017. Yield spread fluctuate over time. 

Julio Bonilla of Schroder’s US Multi-Sector Fixed Income Team says:

 “As a value manager, we always look for opportunities to buy bonds that are cheap because of technical dynamics, but that also have good fundamentals.  Our analysts have taken a deep dive into this sector, and we currently like fundamentally solid, well managed, low beta health care names at extraordinarily attractive spreads.”

Volatility creates opportunity

Looking ahead, House Republicans appear likely to make another attempt at passing the AHCA, after announcing modifications intended to satisfy the conservative and centrist Republicans who signaled they would oppose the prior version.  However, the announced revisions appear likely to increase support among conservative Republican lawmakers but they do not appear to have shifted the views of centrist Republicans nearly as much.  As of now, consideration of the revised health bill within the next week or so appears possible but not likely unless it becomes clear there will be adequate support.  Even if health legislation passes in the House, we do not expect a majority of the Senate to support the House version, and developing a bill that can pass the Senate is likely to take several weeks, at least.  All things considered, Republican leaders will need to decide whether they can pass a health bill in the House, or officially postpone consideration and move on to other issues, since the budget and tax process cannot move forward until they do.

While there remains considerable uncertainty regarding the future of universal healthcare and its impact on providers, we believe the essential nature of the services provided by the healthcare sector should continue to make this an attractive area of the market despite the uncertainty. Further, the level of volatility we are seeing should only lead to opportunities for investors able to identify the right issuers.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.