What is a Hospital Revenue Bond?
A hospital bond is a type of municipal bond that is issued to raise financing for the construction of a hospital, nursing home, or other hospital facilities. The bond can also be used to purchase new equipment or upgrade existing equipment within the hospital. Hospital revenue bonds are issued by a state agency or the municipality where the hospital is located.
Once the hospital is operationalized, the revenue generated by the hospital is used to make interest payments to bondholders. However, bondholders only receive payments after the hospital pays its operating expenses, such as salaries, utilities, and maintenance costs of hospital equipment. If the revenue is not enough to pay the required payments to bondholders, the hospital is not under any obligation to use other funds to pay bondholders. It makes hospital revenue bonds among the high-risk revenue bonds.
- A hospital bond is a type of revenue bond that is issued to raise financing for the construction of a new hospital or nursing home.
- A hospital bond can also be used to upgrade existing hospital facilities and to purchase new hospital equipment.
- The hospital uses the revenue generated from its products and services to pay interest and principal to investors.
Hospital Revenue Bond Explained
State agencies can use different types of revenue streams to support their bond issuance. Usually, the bonds may be issued to construct or support the upgrade of various facilities, such as sewer utilities, toll roads, airports, power plants, hospitals, and industries. The facilities must be revenue-generating so that the revenues generated can be used to make interest and principal payments to bondholders. Agencies or state facilities that do not generate revenues cannot be used to issue revenue bonds since their only source of revenue is tax money.
Unlike the other types of revenue bonds, such as sewer utilities, toll roads, and airports, hospitals lack the authority to charge taxes to their customers to pay bondholders. Instead, they rely on their regular income from hospital admissions, drug supplies, and other incomes. A significant portion of the revenues comes from reimbursements from commercial insurers and government-backed health insurance programs such as Medicare and Medicaid.
The revenue is used to meet the hospital operating costs and pay bondholders from the remainder of their revenues. Hospital revenue bonds that rely on government-funded programs such as Medicare and Medicaid carry a higher risk due to the uncertainty surrounding changes to health insurance laws.
Taxation of Hospital Revenue Bond
Investors who earn interest income from hospital revenue bonds enjoy tax exemption from federal income taxes. Interest income from hospital revenue bonds may also be exempted from state income taxes for revenues earned within the state. Interest income on revenue bonds issued in other states may still be taxable. Corporate taxpayers may choose to include interest income from tax-exempt hospital revenue bonds in its income computation in favor of an alternative minimum tax and other special taxes.
In 2017, there was a tax proposal that was presented to the U.S. Congress that would prevent hospitals from issuing tax-exempt bonds. If the proposal were passed, most hospitals would’ve been forced to seek alternative funding sources since investors would shy away from hospital revenue bonds.
The legislation would make it expensive for hospitals to borrow money, and it would hamper their efforts to build new hospital structures and expand or upgrade existing facilities. The proposed legislation was strongly objected to by large hospitals and nursing facilities, and the proposal was finally dropped.
General Obligation Bonds vs. Revenue Bonds
These are the two main types of municipal bonds – general obligation bonds and revenue bonds. They are issued to finance key income-generating projects, such as airports, hospitals, and toll roads. The main difference between the two types of bonds is the source of revenue used to make interest and principal payments to bondholders.
General Obligation Bonds
General obligations bonds are bonds that are not attached to a specific project, and the issuer may use different income pools to repay the interest and principal to bondholders. The issuer can use multiple sources of revenue, such as tax money, internal fees, and new security issuance, to make interest and principal payments to bondholders.
If the main source of funds is insufficient, the issuer can use other revenue sources to bridge the revenue shortfall. It makes general obligation bonds relatively safer than revenue bonds.
Revenue bonds are bonds that are attached to a specific project whose income is used to pay interest and principal to bondholders. A state agency may issue revenue bonds to investors, and the money raised is used to finance the construction, renovation, or upgrading of a project. Once the project is complete and is generating revenues, the revenues earned are used to pay interest and principal on the bond to the investors.
If the revenue generated is insufficient to pay bondholders, the project does not have an alternative source of revenue to pay investors. It increases the default risk of revenue bonds, and they typically carry a higher risk than general obligation bonds. Revenue bonds are used to finance key projects, such as housing projects, airports, hospitals, toll roads, and bridges.
CFI is the official provider of the global Capital Markets & Securities Analyst (CMSA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:\