What is a Hospital Revenue Bond

A hospital revenue bond is a type of municipal bond intended to support the construction of new hospitals, nursing homes or related facilities. The bonds can also be used to purchase new equipment for these facilities or to finance upgrades for existing hospitals. The revenue created by the hospitals is then used to repay bondholders. Generally, bondholders receive payment only after paying the expenses of running the hospital is complete. This second-layer payment can create risk for bondholders if the hospital is not as profitable as anticipated.

BREAKING DOWN Hospital Revenue Bond

Hospital revenue bonds are considered to be among the riskiest types of municipal bonds. As their name suggests, revenue bonds are generally backed by the revenue that the specific project can generate. If this revenue is insufficient, municipalities have no obligation to use other funds to pay back bondholders. 

And unlike cities, hospitals cannot tax residents as a way to cover expenses or repay debt. This inability to raise revenue through taxes means the hospital revenue bonds typically command higher yields. The high-yield is due to their default risk being higher than a general obligation bond. 

Rating firms evaluate a revenue bond issue and assign a ranking indicating the probability that the obligation pays out on schedule. Hospital revenue bonds which are reliant on government-funded programs such as Medicaid and Medicare are a higher-risk investment. Uncertainty surrounding possible changes to the healthcare market and insurance laws create an unpredictable environment for hospitals and the bonds used to support them. Still, when there is a decrease in supply in the municipal bond market, investors are more likely to consider hospital bonds that present a higher risk.

Tax Considerations for Hospital Revenue Bonds

Income received from a hospital revenue bond may be exempt from state, local and federal taxation. However, this varies by location and the impact of current tax law, which is subject to change. A tax plan introduced by Congress in 2017 initially included an amendment that would prevent hospitals from issuing tax-exempt bonds. This plan prompted many hospitals to rush to seek funding before the proposed legislation could take effect. 

Several major hospital groups strongly objected to the proposed change, warning that eliminating the tax break would result in higher borrowing costs. The increased cost would in turn limit, or reduce, their ability to expand, renovate or build new facilities. Ultimately, the communities and their residents would receive the most significant damage. The final tax plan dropped the proposed legislation.