Hospitals Hit By Bond Yields Giving Investors Instant Profits
“Investors rush to buy the cheap securities, and many flip them the next day for a quick profit,” said Chicago-based Ziegler, which specializes in tax-exempt issues sold by hospitals and nursing homes, in a letter to clients July 27.
Prices of 28 health-care issues sold in the first half of the year rose enough immediately after underwriters set prices that yields fell on average 0.11 percentage point, the Ziegler letter said. The extra interest would cost a borrower $110,000 of interest annually per $100 million of bonds.
The bankers are warning issuers about unnecessarily high rates comes as federal and state regulators investigate the municipal bond market following losses from derivatives, auction-rate bonds and other securities that local officials didnt fully understand.
“Flipping” bonds to generate quick profits is part of “an unhealthy relationship between dealers and institutional investors,” said Christopher “Kit” Taylor, a former director of the Washington-based Municipal Securities Rulemaking Board, the self-regulatory organization that polices underwriters, traders and salesmen in the market for state and local bonds, where $2.72 trillion of securities are outstanding.
Setting prices low enough so investor demand exceeds debt available allows bankers to select buyers who “then dribble it out through the same dealer at higher prices,” Taylor said. Individual investors get the bonds after prices rise again.
Monitor Bank
Ziegler tells issuers that they can reduce interest costs by monitoring bankers more closely and attracting additional investors to their debt. David Johnson, a senior managing director and a former employee at Citigroup Inc. and Merrill Lynch & Co., described the letter as “self-serving,” intended to highlight his firms approach. He wrote it with Kerry Rudy, another managing director, who previously worked at Goldman Sachs Group Inc.
Issuers negotiating bond sales need to be aggressive, “otherwise, the million-dollar bonus banker on the other side of the table will likely serve his firms interests first,” said Joseph Fichera, the chief executive officer of Saber Partners, a New York-based adviser to businesses and governments, and a consultant to Bloomberg News.
Regulator scrutiny of the municipal market led to payments by banks, including Citigroup, Bank of America Corp. and its Merrill Lynch & Co. unit, Morgan Stanley, JPMorgan Chase & Co. and Goldman Sachs, of $572.5 million in penalties for improperly selling auction-rate bonds to investors. The settlements with 13 states occurred last year after the $330 billion market collapsed when banks stopped buying the bonds, causing borrowers to pay penalty rates as high as 20 percent.
Probing Underwriters
The Financial Industry Regulatory Authority, which oversees 4,900 securities brokers, said in June it was conducting “sweeps” to gather information on firms that underwrite securities tied to derivatives for small municipalities. known as interest-rate swaps. Derivatives are contracts whose value is derived from assets including stocks, bonds, currencies and commodities, or from events such as interest-rate changes.
Banking Oligopoly
Five banks — Citigroup, Morgan Stanley, Bank of America, JPMorgan and Goldman Sachs — handled 82 percent of health-care bond sales this year, and have shown “quasi oligopoly-style behavior,” Johnson said. The number of underwriters was reduced by the collapse of Lehman Brothers Holdings Inc. in the worlds biggest bankruptcy in September and the takeovers of Bear Stearns Cos. and Merrill Lynch.
Spokespeople for the banks declined to comment. All are located in New York, except Bank of America, which is based in Charlotte, North Carolina.
The Ziegler letter didnt identify issuers “because we dont want to embarrass” potential clients, Johnson said.
Beaumont Hospital in Royal Oak, Michigan, sold $293 million of 8.25 percent bonds due 2039 on Jan. 15 through Morgan Stanley at an initial price of 95.709 cents on the dollar to yield 8.65 percent, according to data compiled by Bloomberg. The next day, they were sold to individual investors at prices of 98.7 cents and 100.28 cents, with trades of $1 million or more between securities firms as high as 98.31 cents to yield 8.4 percent.
Mispriced Issues
Dennis Herrick, Beaumonts chief financial officer didnt return calls seeking comment. Jennifer Sala, a spokeswoman for Morgan Stanley, declined to comment.