The municipal bond markets have often been criticized for their lack of transparency, and for many borrowers, bond pricing remains a mystery. To better understand pricing, hospitals need to understand credit spreads.
Credit spread is the premium over a high quality index (most commonly, the “AAA” Municipal Market Data benchmark rate) that investors demand in return for taking on a borrower’s repayment risk.
Credit spreads vary directly based on a borrower’s credit quality, but not so much on rates — at least not in the short run– so two bonds in the same credit category that priced on different days will pay different yields, but their credit spreads ought to be close.
Being relatively impervious to changes in rates, credit spreads are handy because a hospital can use them to directly compare how well its bonds priced against other hospitals in the same rating category.
Want to publish your own articles on DistilINFO Publications?
Send us an email, we will get in touch with you.
Because credit spreads eliminate the variability due to changes in interest rates, they are often used to evaluate underwriter performance. Underwriters are expected by borrowers to sell bonds at the lowest possible yields, but they have to serve investors as well (for more on this, read MSRB: Hospital Bond Underwriter Can Be BFF, But Not FA). It’s a zero-sum game between the two and depending on who gets the better end of the deal, the resulting credit spread can be unfavorable to the hospital.
Some bond underwriters go to great lengths to make a direct comparison of credit spreads difficult for borrowers, mentioning state of issuance, tax preference, terms, butterflies flapping wings in China, etc. The fact is that while there are other factors that impact credit spreads, credit quality and underwriter performance are the most significant.
Date: September 16, 2013