Kentucky Hospital Bonds: Searching for Opportunity amid Turmoil


During the third quarter of 2013, in an unsettled national municipal bond market environment, hospital bonds saw an increase in selling pressure precipitated by uncertainty surrounding the roll-out of the Affordable Care Act. During that same time period, the United States Department of Justice filed a lawsuit against King’s Daughters Medical Center in Ashland, Kentucky for purportedly submitting false claims to Medicare – bringing further scrutiny to the sector in the state of Kentucky. The hospital charged-off over $40 million in the third quarter due to the impending settlement, and national ratings services consequently downgraded approximately $240 million of King’s Daughters debt. S&P lowered their rating from A+ to A, Moody’s downgraded from A1 to A2, and Fitch later downgraded the debt from A+ to A in the first quarter of 2014.

In September 2013, the portfolio manager of Aquila Churchill Tax-Free Fund of Kentucky saw value in the hospital sector and began to increase the Fund’s exposure to hospital bonds, including King’s Daughters, based on an increase in the secondary supply of bonds with attractive yields and lower duration. The Fund’s hospital revenue bond sector weighting increased by 1% from September 30, 2013 to May 31, 2014 and the portfolio’s overall maturity and duration were reduced, partly due to the additions.

As of May 30, 2014 the Barclays Municipal Index showed hospital bonds as the second best performing sector year-to-date, just behind IDR/PCR1. According to Barclays research, no hospital or hospital system rated higher than A has ever defaulted. Investors are exercising caution with the sector due to healthcare reform, but the implementation of business changes is expected to take years, during which time historically weaker credits may be acquired by stronger operators.

Although we have found relative value in the hospital sector over the past few quarters, we believe that on-going monitoring of hospital credit quality will be very important as the effects of the Affordable Care Act take hold. As with all of the Fund’s holdings, our local portfolio management will continuously monitor the hospital credits in the course of conducting credit research.

For a full list of Aquila Churchill Tax-Free Fund of Kentucky’s most recent quarter-end holdings click here.


1 industrial development revenue/pollution control revenue

The Barclays Municipal Bond Index is an unmanaged index considered representative of the universe of the tax-exempt bond market. Performance of an index does not reflect management fees and expenses which are reflected in Fund performance. An investment cannot be made directly in an index.

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