use of the capital and providing adequate disclosure to potential investors regarding the credit and bond
structure.
Fixed-Rate Bonds. These bonds are the most commonly issued debt by not-for-profit hospitals and
systems, and they represent the least risky debt structure available for borrowers. Fixed-rate debt
essentially transfers all market risks to the investors and, as a result, typically represents the most costly
form of tax-exempt or taxable debt.
The interest rate paid on a fixed-rate bond does not change during its lifetime. Even though each
maturity of an issued bond may have a different interest rate, the investor purchasing the bond receives
a fixed rate of return for the entire period during which the bonds are outstanding. Fixed-rate bonds are
also considered committed capital, because as long as the hospital borrower meets its principal and
interest payment obligations on a timely basis and complies with covenant requirements, the rates and
repayment structure remain fixed until the bond matures, except at the option of the borrower.
Fixed-rate debt generally provides investors with call protection for a number of years, which means
that for a period of time (typically 10 years), the hospital borrower can not “call” or buy back the bonds
from the bondholder. At the end of the “no call” period, if interest rates have declined, the hospital
borrower might wish to call the bonds and replace them with lower interest-paying obligations through
issuance of new refunding bonds.
Variable-Rate Bonds. Variable-rate or floating-rate bonds or notes have rates that are reset daily, weekly,
or monthly. The interest rate paid by the borrower fluctuates with each rate reset based on an interest
rate index that reflects current, but changing market conditions. Variable-rate demand bonds (VRDBs),
the primary variable-rate product available to hospitals at this time, are put bonds, meaning they can be
put, or redeemed by bondholders for their full face amount on every reset date. VRDBs are considered
uncommitted capital due to this put feature and the fact that the credit enhancement and liquidity support
required to issue these bonds does not typically extend for their full life but must be renewed numerous
times during their lifetime. Put differently, VRDBs carry certain “event risks” that might create an
unexpected and accelerated repayment obligation, which could severely strain cash resources.
The biggest challenge attached to VRDBs is securing the credit and liquidity support from a highly rated
bank. This is needed to convince investors that they will be able to get out of their position at any time.
Such support typically takes the form of a direct pay letter of credit (LOC), under which the bank stands
between the hospital and investors. Smaller hospitals may have particular difficulty securing this form of
bank support from the “right” large banks, which may lead them to the direct issuance option described
later.
Historically, variable-rate debt has provided borrowers on average with lower “all-in” costs of capital
than fixed-rate debt. The all-in borrowing rate represents the total cost of capital, including interest and
fees involved with initiating and maintaining the financing. However, access to variable-rate debt through
the municipal markets has generally become limited to organizations with stronger credit ratings. This is
due both to the fact that purchasers of VRDBs are typically institutional investors with minimum rating
requirements and to the more limited appetite of the banks providing credit enhancement and liquidity.
Direct Bank Loans
Since Federal money started flowing through the Troubled Asset Relief Program in 2009, banks have
been expanding their direct loan programs to tax-exempt health care organizations. The American
Recovery and Reinvestment Act (ARRA) has also contributed to this upward lending trend. ARRA
A Guide to Financing Strategies for Hospitals
