For 32 years California's Cal-Mortgage program has been the bond insurer of last resort for the state's healthcare facilities, backing risky projects that commercial guarantors refuse to touch. Its clientele has primarily consisted of nonrated or speculative-grade borrowers that otherwise couldn't access capital.
Now, Cal-Mortgage is changing some of its policies in an effort to attract stronger credits. The changes are meant to reduce the program's risk by broadening its portfolio, but they also could help the state's healthcare industry at a critical time.
Demand for capital is expected to grow by hundreds of millions of dollars annually in the next few years as hospitals in California strive to meet new seismic-safety standards. Meanwhile, access to capital has tightened in the past two years, and traditional bond insurers essentially have turned away all but the top-rated healthcare credits.
Cal-Mortgage, which is the only state-sponsored loan insurance program for healthcare, is run by the California Office of Statewide Health Planning and Development. As of March 31, Cal-Mortgage backed 176 insured loans for healthcare projects worth $986.5 million, but its total capacity was $3 billion. Cal-Mortgage's financial strength ratings are derived from the long-term ratings of the state of California, which currently stand at A+ from Standard & Poor's and AA from Fitch.
For the first time in its history, Cal-Mortgage this year implemented a new pricing structure, making changes designed to attract and keep medium- and higher-grade credits. John Woodward, a managing director in the San Francisco office of UBS PaineWebber who serves on an informal advisory group for Cal-Mortgage, says the program also plans to relax covenant restrictions for stronger borrowers and it might even extend its support to variable-rate debt, as well as fixed-rate offerings.
"They're making themselves much more user-friendly and that's very welcome because we've had many hospitals that have had downgrades, and access to capital is strained," says Steven Hollis, a principal in the San Francisco office of Cain Brothers.
As of Jan. 1, Cal-Mortgage charges a one-time premium of up to 3% of the bond issue, payable at closing, vs. a previous annual premium of .5% on the balance of the loan. In the past, some borrowers used Cal-Mortgage to finance needed but risky projects and dropped out when their balance sheets improved. "We were particularly disturbed that better-quality credits were leaving the program," says Dale Flournoy, deputy director of Cal-Mortgage.
Upfront payments, which are used by commercial bond insurers, tend to discourage borrowers from leaving the program when their credit becomes stronger, Flournoy says.
Another key change was made in March, when Cal-Mortgage implemented discounted premiums for borrowers that receive an underlying credit rating from one of the three ratings agencies, S&P, Moody's Investors Service or Fitch. The discounts could help attract hospitals of medium-grade credit, with ratings that are just above speculative, such as BB or BBB, says Lisa Zuckerman, an analyst with S&P.
Under the new structure, premiums are as low as 0.8% of the debt amount for a borrower with an AA+ rating, compared with the full premium of 3%. A hospital with a BBB rating would pay 1.85%.
Woodward says Cal-Mortgage insurance now saves medium-grade credits about 100 basis points-or 1 percentage point-off their interest rates, which amounts to about $200,000 per year in lower payments on $25 million of debt. The savings are much greater for lower-rated credits, he adds.
So far one hospital, 107-bed El Centro (Calif.) Regional Medical Center, has taken advantage of the discounted rate structure. El Centro obtained bond insurance at a discounted rate of 2.7%, based on its BB rating from S&P. The hospital's $39.3 million financing will fund an expansion and renovation that will bring the facility into compliance with seismic-safety standards, says David Selman, the hospital's administrator and chief executive officer. Selman says without Cal-Mortgage the hospital would have had a difficult time finding affordable capital. "Overall, Cal-Mortgage offered an excellent financing alternative in the face of some industry challenges," Selman says.
Coincidentally, Cal-Mortgage's efforts to broaden its appeal come just as an insurance program run by the Federal Housing Administration has been trying to drum up business in the state. The FHA has not financed a project in California since the state eliminated its certificate-of-need law in 1987. A CON had been required for FHA financing. Although the FHA recently changed its rules (March 5, p. 36), investment bankers say they expect Cal-Mortgage insurance to be more popular with the state's hospitals than the FHA's program because it requires less red tape. "I think it would be very difficult for FHA to get a foothold here without some advantage either in terms of the covenants or rates," Woodward says.
Still, Cal-Mortgage continues to pose obstacles that commercial insurers do not. For example, Cal-Mortgage rules disallow hospitals from sharing a mortgage with other lenders, which means borrowers might have to refinance outstanding debt when issuing new bonds backed by Cal-Mortgage, Hollis says.
In addition, it has yet to be seen just what types of projects will pass muster. Cal-Mortgage will be under pressure not to stray from its mission of supporting projects for underserved areas, particularly rural hospitals.
Sharon Avery, executive director of the Rural Healthcare Center at the California Healthcare Association, which represents hospitals, doesn't fault Cal-Mortgage for its "reasonable business planning." But she adds, "I'm just hoping the state will stand behind them and keep them as a guarantor of last resort. If they act like any other guarantor, why should they be there?"