Tax-exempt hospitals, systems may find some relief through FHLB letters of credit in last week’s housing aid bill
Healthcare tax-exempt borrowers were offered an unusual bright spot by Congress last week following months of bad news: A sweeping bill to help homeowners included a provision to aid others embroiled in the housing meltdown, namely tax-exempt bond borrowers, a group that includes more than 60% of U.S. hospitals.
The law, signed by the president July 30, allows the Federal Home Loan Banks to back tax-exempt bonds with so-called letters of credit. Letters of credit, also known as credit enhancement, provide borrowers with banks’ credit strength and a pledge to cover debt payments should hospitals fail to do so.
With banks and bond insurers faltering from an overextended housing market, healthcare borrowers have been met with higher debt prices and increasingly austere lenders (July 21, p. 8). Hospitals and health systems have scrambled to contain the damage even as fresh problems added to headaches and costs. The law could ease some of that pain.
“This is very timely and very important,” said John Price, president and chief executive officer of the Federal Home Loan Bank of Pittsburgh. The banks’ backing will help secure financing for deals “which might not otherwise get done,” he said.
Hospitals and health systems often relied on bond insurance to back borrowing and score low interest rates, but have shed the coverage since February, when insurers’ exposure to risky mortgages prompted nervous investors to bolt from a once-stable, $330 billion debt market where interest rates were set at daily, weekly or monthly auctions. Anxiety spread into other healthcare debt with variable rates covered by insurance, creating further turmoil.
The disruption triggered massive restructuring among tax-exempt borrowers in a tight credit market, increasing demand for bank guarantees as an alternative to insurance, even as banks’ capacity constricted.
Proponents said the law unlocks a new source of credit enhancement. Among those that may gain: hospitals and health systems squeezed out by the current crisis, and small, rural hospitals that have been unable to obtain bond insurance or credit ratings needed to issue affordable tax-exempt bonds.
Not everyone benefits. The avenue is open only for new bond issues, which could shut out hospitals’ restructuring debt. And, the provision expires at the end of 2010, though letters of credit issued under the provision may be renewed after the law sunsets.
Advocates hope to see the law extended beyond its sunset. “We want it to be used,” said Chuck Samuels, counsel for the National Association of Health and Educational Facilities Finance Authorities. “We want to have a lot of good transactions for smaller hospitals that Wall Street and the bond insurers have ignored for years.”
The Federal Home Loan Banks typically provide low-cost loans to more than 8,000 member banks, credit unions, savings and loans and others to finance housing. Now the Federal Home Loan Banks—which carry ratings of AA or AAA—may extend their credit strength to member banks that guarantee tax-exempt bonds. The banks may prove useful in particular for rural hospitals, which also may get a boost from an effort to improve Medicare reimbursement for some noncritical-access rural hospitals (See story, p. 8).
Still, finance experts cautioned against an expectation that Federal Home Loan Bank guarantees will relax tightening credit markets for all hospitals.
Banks will scrutinize hospitals’ underlying credit strength as well as to gauge whether potential borrowers’ finances and market strength will support debt, said Kelly Arduino, director of financial advisory services for Wipfli, a Chicago accounting consulting firm. Arduino works primarily with small, rural hospital officials and capital sources to develop financing plans.
“Banks are preserving their capital for less risky endeavors,” Arduino said, a shift from less-restrictive standards that narrowed credit margins in recent years between high- and low-rated credits and lowered interest rates for the latter. “It was a little loosey-goosey for a while,” she said.
Members of the Federal Home Loan Banks will apply individual lending standards for borrowers seeking letters of credit, Federal Home Loan Bank of Pittsburgh’s Price said.
Expanding the Federal Home Loan Banks’ reach won backing from a coalition of finance, economic development and municipal groups, including the U.S. Conference of Mayors and the Securities Industry and Financial Markets Association, prior to the nation’s housing-related credit tumult. But as early tremors began to push up interest rates late last year, the idea gained proponents, including one powerful ally: the American Hospital Association.
Newton
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Mike Rock, a lobbyist for the Chicago-based AHA, said that the Federal Home Loan Banks give hospitals another option at a time when financing choices are limited and healthcare’s demand for capital is expected to climb as aging hospitals require replacement.
And Mark Newton, president and CEO of 324-bed Swedish Covenant Hospital, Chicago, called the Federal Home Loan Banks’ new authority a short-term fix for a problem that requires a more lasting solution. It’s unclear whether bond insurance will rebound, he said, yet tax-exempt bonds continue to need credit enhancement.
Swedish Covenant refinanced $100 million in auction-rate debt as variable-rate demand bonds with letters of credit, a move Newton said was possible thanks to existing bank relationships. Banks may be less likely to take on new clients, even with the Federal Home Loan Banks’ support. “There’s so much business and such a limitation on credit,” he said. He described seeking bank backing in the tightening credit market as akin to “pushing everybody out of the line while they’re all going to the same window.”
For an aging hospital in rural Dillon, Mont., the law may give officials a competitive alternative to the limited financing options already under consideration for a significant renovation or replacement for the hospital.
On any given day, 20-bed Barrett Hospital & HealthCare is host to seven patients, though the 40-year-old hospital, like others of its era, was designed for greater volume. Times have changed. Roughly three-quarters of the small hospital’s businesses now comes from patients never admitted to the hospital, said Steve Hannah, Barrett’s CEO.
“Clearly we need to do something,” Hannah said. “There’s no option here of no option.”
The improved layout and upgraded technology that come with new construction will likely attract patients and help attract doctors and nurses. Recruiting to Dillon, as is often the case for rural hospitals, can be challenging. Hannah’s latest hire, an internal medicine doctor, filled a vacancy open for two years, he said.
The population within 15 minutes of Dillon totals 7,000 but Barrett serves 10,000 scattered across Montana’s largest county. As the Beaverhead County seat, Dillon’s main attractions are three nearby rivers popular with fly fishermen and its place on the Lewis and Clark Trail. Construction won’t entice a recruit to stay, he said, but it “will get you noticed.”
Construction will hinge on what Barrett, with $17 million net revenue, can afford and its projected future demand, he said. Though plans are not yet far enough along to determine costs, Hannah said, replacing Barrett may require as much as $30 million.
Putnam
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Rural finance experts said that preliminary estimates put interest rates for Federal Home Loan Bank-guaranteed tax-exempt bonds on par with 4.5% to 5% rates for a U.S. Housing and Urban Development-insured debt program that extends strong credit ratings and lower interest rates to hospitals (March 3, p. 32). Since 1968, the federal program has insured 358 hospitals, according to the housing agency.
For Hannah, financing with a Federal Home Loan Bank offers one advantage: It keeps business local, he said. To a small community hospital, that’s a definite asset.
“We’re conservative and we’re here for the community well-being for the long-term, so everything we do has to be diligent,” Hannah said.
Charles Ervin Jr., managing director for the Red Capital Group, a division of National City Bank, applauded the increased competition that the Federal Home Loan Banks entry into tax-exempt bond credit will bring to financing for small, rural hospitals.
Lending standards for the Housing and Urban Development-backed debt may shut out some borrowers, he said, and loans and guarantees from the U.S. Department of Agriculture typically carry higher interest rates.
Larry Putnam considered tax-exempt bonds to rebuild 12-bed Phillips County Hospital in Malta, Mont., when he led the hospital a few years ago. Unable to afford the cost, the then-CEO stitched together financing from grants and loans to replace the 52-year-old hospital with a $4.5 million, hospital in 2004.
Putnam, now a consultant, said small hospitals struggle to gain access to capital markets because building budgets are relatively small and balance sheets are vulnerable to small reimbursement changes or the loss of a doctor. Malta’s hospital employs a doctor, a nurse and a physician’s assistant, he said. “The loss of any one of those three is a big deal and it definitely impacts your finances very quickly.”
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