Nervous investors and the nations worsening credit crisis are again making it more expensive for not-for-profit hospitals to borrow for construction and big-ticket technology.
First came the crash in late February of a $328 billion auction market for debt that had been a stable and cheap source of capital for tax-exempt healthcare (Feb. 25, p. 6). Investors bolted from the market, unnerved by bond insurers exposure to risky mortgages, and those who stayed demanded sharply higher interest rates.
The latest trouble stems from the same source: faltering bond insurers. Ratings agencies downgraded insurers MBIA and Ambac Financial Group in June. Investors have dumped debt or demanded higher interest on so-called variable-rate demand bonds covered by either insurer. The insurance that once helped secure investors and lower interest rates has the opposite effect, said healthcare financial executives.
Its rather unprecedented, said C. Talbot Heppenstall Jr., treasurer of the University of Pittsburgh Medical Center, where interest on its MBIA-insured variable debt jumped higherto 7%than the 2% rate for similar debt without the insurance, something Heppenstall said is not supposed to happen.
The 12-hospital system moved earlier this month to jettison its insurance and instead rely on its banks credit strength to attract investors for variable debt worth $75 million. Its a small amount compared with the $450 million in debt UPMC had tied up in the auction market, which it quickly abandoned after the spring collapse. This is just a minor problem, Heppenstall said.
Similar to auctioned debt in Februarys sell-off, variable-rate demand bonds are bought and sold frequently, and interest rates rise and fall with demand. Unlike the auction debt, investors who cant sell bonds may sell back to banks the variable demand bonds caught in the latest market flight as a last resort. Many investors are doing just that, said Andy Majka, chief operating officer for financial consultants Kaufman Hall.
Funds that invest in bonds want borrowers with strong credit and enough cash with access to buy back debt quickly, he said.
Majka said that healthcare borrowers with variable-rate demand bonds now have two options to calm investors and reverse rising interest rates. Financially healthy systems with strong credit may seek to borrow on the strength of their own operations, without insurer or bank backing, but few can do so. Or not-for-profits may secure access to cash and a strong credit rating through a deal with a bank. However, the banking industrys own woes and high demand for such deals have made it an increasingly difficult and expensive route. Anything that anybody does right now is going to be a higher cost of capital, he said.
Memorial Hospital & Health System, South Bend, Ind., tried unsuccessfully to reach a deal with its investment bank for $36 million in variable-rate demand bonds insured by Ambac. Since Ambacs June downgrade, interest rates on the debt have climbed to about 7% or 8%, said Jeffrey Costello, Memorials vice president and chief financial officer.
The 325-bed hospital did find a bank to provide backing for the bonds, but at a price. Fees are at least twice what they once were, Costello said. Memorial must also shift other banking business to its new partner. Costello also scored a line of credit to buy up bonds temporarily as Memorial moves to refinance its variable-rate bonds.
Sarasota (Fla.) Memorial Health Care System started 2008 with $77 million in variable-rate demand bonds but increased that by $160 million after Februarys collapse of the auction rate market, where its interest had spiked to 11%. David Verinder, 618-bed Sarasota Memorials CFO, said the switch lowered rates until investors anxiety spread to variable-rate demand bonds. Now Verinder and Bill Woeltjen, Memorials senior manager of treasury services, are working on yet another deal to lower rates that Verinder said have climbed as high as 9% from less than 1% in April. The latest plan will drop insurance on roughly $160 million in variable-rate demand bonds, Verinder said. We dont see value in the insurance policies today, Verinder said.