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Texas Health Resources borrowed $67.5 million each from two banks to build the 36-bed Texas Health Alliance Hospital, which will open in fall 2012.
Texas Health Resources borrowed $67.5 million each from two banks to build the 36-bed Texas Health Alliance Hospital, which will open in fall 2012.
Photo credit: Aerial Photography

Getting their appetite back

In need of capital, not-for-profit hospitals take advantage of dropping interest rates

By Melanie Evans
Posted: October 31, 2011 - 12:01 am ET

Investors last week snapped up tax-exempt bonds sold by WellStar Health System, and as they did so erased $4.2 million from the Georgia health system's interest costs.

WellStar, based in Marietta, refinanced $58 million last week while it borrowed another $75 million to expand the system's flagship hospital. The five-hospital system locked in interest rates of 4.58% even after accounting for underwriter fees that add incrementally to borrowing costs.

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“We're taking advantage of the current market,” said Jim Budzinski, executive vice president and chief financial officer of WellStar.

Borrowers such as WellStar have moved to take advantage of lower rates in recent weeks after borrowing by not-for-profit hospitals mostly steered clear of municipal bond markets this year. In September and October, hospitals and health systems have issued $4.3 billion in municipal bonds—one-quarter of the amount they issued since Jan. 1.

The amount borrowed and refinanced from municipal investors through mid-September was only 60% of the sum in the same period last year—$14 billion compared with $23.6 billion—and the smallest amount for the January-through-September period during the past decade. With two months remaining this year, hospitals have sold 215 municipal bonds compared with an average of 765 a year during the past two decades, Thomson Reuters data show.

Though activity in the municipal markets has been modest most of this year, healthcare borrowers' appetite for loans directly from banks has grown since 2010. Incentives under the 2009 economic stimulus act sparked interest in the deals, but direct bank loans continued to thrive after incentives expired last December.

“We are cash rich today,” said healthcare banker Mark Huebner, a vice president with Commerce Bank in St. Louis. Healthcare lending offers the bank a better return than other avenues to invest its cash deposits as the Federal Reserve seeks to boost the economy with low interest rates, he said. “We have it on the shelf, ready to be deployed.”

An attractive market, for now

The municipal bond markets have seen healthcare borrowers return in recent weeks. Trinity Health hastened to market in September to beat the rush.

The Novi, Mich.-based system, which has hospitals across 10 states, went to the municipal market faster than originally planned as borrowers emerged to capitalize on dropping rates, said James Bosscher, senior vice president of treasury and chief investment officer.

Trinity Health owns and manages 49 hospitals, including the recently acquired Loyola University Health System in Maywood, Ill. Trinity's latest municipal bond deal refinanced nearly $450 million, including debt acquired with Loyola's two hospitals, and borrowed another $200 million, he said. Despite volatility, recent declines in municipal bond interest rates “made refinancing even more attractive,” Bosscher said.

Trinity Health locked in rates below 5% after accounting for underwriter fees. And the system has 24 years, on average, to pay back the bonds, he said.

Nonetheless, Trinity Health also plans to borrow another $100 million directly from banks. Bosscher called the system's two planned direct bank deals “relatively attractive,” and the less-lengthy debt fits within the system's overall financing portfolio.

Demand for debt has not rebounded everywhere. In Wisconsin, not-for-profit borrowing has dropped noticeably during the past 16 months, records at the Wisconsin Health and Educational Facilities Authority show. The agency handles financing for tax-exempt healthcare and schools, though education accounts for a mere 10% of the debt.

The Wisconsin authority closes its books at the end of June, and last year borrowers sought $600 million in financing, said Larry Nines, the agency's executive director.

That's compared with $1.5 billion during the year that ended June 30, 2010, and an identical amount the prior year, he said. Even in 2008, when credit markets froze as the year ended, the authority handled

$1 billion in financing. That followed $1.3 billion in 2007.

Since July, borrowing has continued to be thin, Nines said, with bank deals as the preferred financing option.

Dealing directly with banks

Bonds sold directly to banks can reduce some of the borrowing risks that have dogged hospitals and health systems since the credit crisis, healthcare finance advisers, executives and bankers said.

Anxious investors in the municipal market have pushed interest rates upward for some healthcare bonds since the credit crisis, most notably in February 2008 when investor panic toppled a $330 billion market for certain short-term municipal bonds. Long-term rates rose in late 2010 as the supply of bonds overwhelmed demand for investors and rates remained higher on news of possible local government defaults (Feb. 14, p. 12).

Wary investors continue to demand higher interest for some bonds that carry bank cash and credit guarantees as insurance. When banks falter, interest rates on bank-backed bonds climb. And borrowers may be forced to quickly buy back bonds if investors flee altogether.

But when the bank becomes the investor, as is the case with direct bank deals, those risks are gone, said Matthew Goldreich, a managing director with Cain Brothers & Co., a healthcare investment bank. Financing terms for direct bank bonds can also significantly reduce or eliminate some interest rate uncertainty, he said.

Goldreich said most of his clients that have considered direct bank bonds have chosen the financing option because of the favorable terms.

However, dealing directly with banks has risks and limits, Goldreich and other healthcare finance professionals said.

“If you're a hospital and you're looking for long-term” financing, “you're not going to find it” with direct bank loans, said Pierre Bogacz, managing director of HFA Partners, a healthcare financial adviser.

Direct bank bonds typically must be paid back within 10 years or less, Bogacz said. Hospitals may manage borrowing costs by scheduling repayment over a longer period than the bond. But they must then refinance remaining debt once loans come due—or make a large final payment. That's a risk, he said.

Banks also limit the amount of direct bonds to avoid lending too much to any one borrower, he said. Large banks may go above $50 million, but municipal markets can handle significantly larger bond issues. And direct bank loans tend to be limited to investment-grade healthcare borrowers.

Bogacz said banks have aggressively pursued lending directly to healthcare providers this year. “This could be gone in six months,” he said. “It tends to be a herd mentality.” That's not to say banks necessarily will lose their appetite for the loans anytime soon, he added. “It hasn't happened yet.”

‘Still growing'

Huebner of Commerce Bank said the regional bank has healthcare direct bond deals lined up into 2012. Bank officials began to focus on healthcare lending within the past three or four years because of the sector's performance during the economic downturn, he said. “It's one of the few sectors in the economy that's still growing,” he said.

Commerce Bank will invest in bonds worth $10 million to $25 million, he said, and it works with other banks to loan up to $50 million.

Huebner said the loans allow Commerce Bank to earn interest on significant deposits, and the bank may gain other business from hospitals following the bond deal. Borrowers, he said, benefit from fewer fees and less disclosure than municipal bonds require. “There is only one bondholder and that's me,” Huebner said. “They're dealing with one bank and one person.”

Direct bank deals have raised concerns among credit analysts who argue disclosure on the debt is limited and investors need more information.

Standard & Poor's said last week that limited municipal market disclosure rules do not include bonds sold directly to banks. The ratings agency said borrowers should tell their municipal bondholders about additional debt from direct bank bonds, even though they are not required to do so.

Outside of Cleveland, executives with Southwest General Health Center recently finalized financing plans to replace the 316-bed hospital's emergency room and expand intensive care.

Mary Ann Freas, Southwest General's CFO, said the hospital will seek long-term bonds with a fixed interest rate to avoid too much short-term debt.

The Middleburg Heights, Ohio, hospital approved a plan last week to borrow $40 million in the municipal markets rather than borrow directly from banks. The bond will partially finance the $60 million initial phase of the hospital's project.

Freas said favorable interest rates influenced the financing decision, as did the fact that Southwest General borrowed directly from a bank in 2010. Southwest General borrowed about $17 million directly from Fifth Third Bank in 2010, and the loan must be repaid or refinanced by November 2014. Freas said she is unwilling to take on more debt with the same terms.

The long-term bond sold in municipal markets will help diversify the hospital's debt portfolio.

Texas Health Resources entered the market before rates began to climb as last year ended. The Arlington-based system borrowed enough to finance projects into 2012 before more capital will be needed, said Ron Long, executive vice president and CFO.

That allowed the 13-hospital system to stay clear of debt markets this year, the first in many years.

The right timing

Texas Health Resources has not sought capital, Long said. “We caught the market just before it escalated.”

The municipal market deal refinanced more risky short-term debt during a period of uncertainty, Long said.

But the roughly $157 million the system borrowed from investors in the municipal bond market amounted to slightly more than half of the debt Texas Health Resources added to its balance sheet about a year ago. Long said the system also borrowed $67.5 million each from two banks in direct placement deals—also a first.

The additional $135 million allowed Texas Health Resources the capital to build the 36-bed Texas Health Alliance Hospital.

Direct bank deals offered financing for seven years to a decade, longer than the three to five years required for liquidity guarantees on municipal market bonds.

The November financing added diversity to Texas Health Resources' debt portfolio while giving the system more time to ride out immediate uncertainty from shaky markets and to allow contested public policy to settle before the system must refinance, Long said. As when rafters ride through whitewater, he said, “you tie everything down.”

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