Issuing tax-exempt debt isn't simple anymore. Just ask William Price, chief financial officer of Owensboro (Ky.) Mercy Health System.
As the only hospital in town, Owensboro Mercy is among the lucky healthcare institutions that have managed to remain profitable and liquid despite industry struggles. Nevertheless, it faced complications leading up to its bond deal in June, its first debt issuance in five years.
"They've really gotten exotic and complicated, vs. the simple fixed-rate issues we used to do," Price says.
The 347-bed hospital, which is financing a new emergency room, women's center and parking structure, was one of the largest issuers of tax-exempt healthcare debt in this year's second quarter (See chart). Pent-up demand for capital drove 97 bond issues in the quarter totaling $4.96 billion, up from 74 issues worth $4.17 billion in the year-ago quarter. Last year was the slowest for tax-exempt healthcare bonds since 1995.
Hospitals returning to the market after several years are finding a vast new menu of options, such as interest-rate swaps, which are exchanges of fixed-rate debt for variable-rate debt, or vice versa. Lately, the rising cost of bank letters of credit has made it less economical to issue variable-rate bonds. To get cheaper variable rates, some hospitals have begun to swap their fixed-rate bonds for floating-rate debt with a so-called "swap provider," such as a bank.
In fact, swaps virtually didn't exist in tax-exempt healthcare financing a few years ago. B.C. Ziegler & Co., which advises hospitals on swap transactions, estimates that swaps of fixed-rate debt to floating rates are now outpacing traditional variable-rate debt financing by more than four times. However, statistics are difficult to obtain because swaps, unlike bond issues, are private.
Owensboro Mercy decided on a swap after it was told that the letter of credit on its variable-rate debt might not be renewed at an economical rate. By immediately exchanging 35% of its new fixed-rate bonds for floating-rate debt with its investment bank, Salomon Smith Barney, the hospital shaved 40 basis points from its interest on $70 million of debt. Using a swap rather than a variable-rate bond issue eliminated the need for a bank letter of credit.
One drawback is that swaps can complicate audits because accounting rules require them to be valued every 90 days and recognized as gains or losses on the balance sheet, according to financial advisers. Changes in interest rates and tax rates can affect the value of swap.
Financial advisory firms report an increase in business as a result of swaps. Swaps are "difficult to analyze and they're more difficult to price" than simple bond transactions, says Gerry Fiorina, executive vice president of Chicago-based Ponder &. Co., the firm Owensboro Mercy hired as its financial adviser for the deal. Price says it was helpful to have an independent adviser sort through the options and explain the transaction to the hospital's board.