Banks are buying not-for-profit hospital and health system bonds as healthcare borrowers continue to exit more risky financing.
Direct deals between banks and tax-exempt borrowers have emerged as an alternative to bonds sold in short-term markets, said healthcare finance insiders. Behind the shift are tax benefits for banks and some relief for borrowers from uncertainty that has nagged the short-term-debt market for variable-rate demand bonds for the past two years.
Gundersen Lutheran Health System, based in La Crosse, Wis., recently sold $88 million in variable-rate bonds to a bank. The debt was previously sold to investors with bank backing that was set to expire during next year’s rush to renew guarantees, known as letters of credit.
Daryl Applebury, chief of corporate ventures, partnerships and investments for Gundersen Lutheran, said the direct bank deal eliminates the risk that Gundersen Lutheran would be unable to renew a letter of credit or that the bank backing its bonds would falter but allows the system to hold onto favorable short-term interest rates.
Stress on hospital and health system balance sheets grew after a surge in variable-rate demand bond deals spurred by the 2008 credit crisis. Borrowers caught in the collapse of one short-term tax-exempt market raced to refinance the debt with the variable-rate demand bond alternative.
But the refinanced bonds came with their own risks. Banks typically guarantee the variable-rate demand bonds, which can be resold as often as daily or weekly. Bank distress has left borrowers exposed to the risk that jittery investors will demand higher interest rates or refuse to buy the bonds at all. And demand for banks to renew their guarantees, which often expire after a few years, is expected to swell next year as borrowers that entered the market in 2008 seek to renew their backing.
Andrew Majka, chief operating officer for Kaufman, Hall & Associates, a healthcare financial adviser, said borrowers have entered into direct bank deals with similar prices and terms to letters of credit.
Beloit (Wis.) Health System is preparing to pull $38.5 million from the variable-rate demand market for sale to a bank, said Bill Groeper, vice president and chief financial officer. The 118-bed Beloit Memorial Hospital is also seeking to reduce its risk from possible bank distress, he said.
But hospitals that strike deals directly with banks do not escape risk entirely. The deals are typically short term, from three years to seven years, though the bonds are often actually long-term debt to be paid back over a longer period of time. Borrowers must find new financing when the bank deal ends, but risk finding it more costly or less accessible.
The deals executed by Gundersen Lutheran and Beloit are Wisconsin’s first two direct-bank deals too big to qualify for a popular tax break provision in the 2009 American Recovery and Reinvestment Act, said Larry Nines, executive director for the Wisconsin Health and Educational Facilities Authority. The stimulus law provision allows banks to double-dip on tax breaks through December for bonds sold by tax-exempt borrowers that issue less than $30 million per year.
Banks also may take advantage of another economic stimulus tax break provision for tax-exempt bond deals larger than $30 million that expires in December and had bolstered banks’ appetite for municipal bonds, said John Cheney, managing director at Ponder & Co, a healthcare financial adviser.
But Cheney said he believes banks won’t stop direct deals with hospitals and health systems once the provisions run out. Banks have capacity to lend but private companies are not borrowing, he said. Banks can deduct income from tax-exempt bonds; that’s not the case for fees on letters of credit. Meanwhile, borrowers, too, have reasons to consider direct-bank deals. Mutual-fund investors unhappy with low yields have made a steady and worrying exit from money market funds that buy the variable-rate demand bonds.
