refinancing are not alternatives. This rolling term or renewal risk will likely represent the most significant
issue in the structure and must be managed closely.
Direct loan covenants may be more stringent than with traditional fixed-rate municipal bond financings.
Banks may request certain covenants that differ from those in the organization’s Master Trust Indenture
(MTI), such as higher ratios (often, specifically, the debt service coverage ratio). Terms generally can be
negotiated in order to try to align the loan as closely as possible with the organization’s MTI.
Rates. Taxable variable-rate loans are typically priced at a spread to one-month London Interbank
Offered Rate (LIBOR), which reflects taxable interest rates. Rates and spreads to LIBOR that are
offered will be highly dependent upon a hospital’s credit, the hospital-bank relationship, and the term of
the facility. Banks are offering lower rates and spreads to hospitals with established relationships—again,
to keep the hospital’s business.
If the loan is tax exempt, either the one-month LIBOR base rate is multiplied by a percentage
representing the bank’s “tax factor” (at this point, in the 64 to 74 percent range) plus a spread, or the
loan is priced at a spread to the Securities Industry and Financial Markets Association (SIFMA) index.
For hospitals of all sizes and levels of capital access, direct loans can offer a useful tool to obtain floating-rate exposure without certain of the risks attached to public market structures. The direct loan
structure creates rollover/renewal risk at maturity but does not create public market pricing exposure
to the bank’s credit or week-to-week put risk. The spread to the benchmark index is purely based on
the hospital’s credit. Importantly, there is no deviation in that spread if the bank’s rating deteriorates
during the loan period.
“Drawable” Option. Bank-issued loans can be set up as tax-exempt drawable loans, which can offer cost
savings to hospital borrowers funding new construction projects. Normally when borrowing in the
public market, hospitals raise all of the needed capital in a single offering and then put the money in a
construction or project fund that is reinvested. Due to market conditions at this point in time, hospitals
may be borrowing at a capital cost in excess of 5 percent, for example, but receiving only 0.5 percent
interest on the reinvested funds. This “negative arbitrage” can represent a significant amount of money
over a multiyear construction program.
With drawable tax-exempt loans, the conduit issuer issues the whole amount, but the bank allows the
hospital borrower to draw on the loan, as needed. The fee for this flexibility might be 25 basis points on
the undrawn balance, but this approach effectively limits the hospital’s negative arbitrage to the bank’s
“unused” fee. During construction periods that extend over multiple years, it may be cheaper for a
hospital to use a drawable direct bank loan than it would be to issue VRDBs. Clearly the question is
how the reductions in negative arbitrage compare to the incremental fee; in some situations, the savings
could be attractive.
The tax-related issues that must be addressed are considerable, but surmountable, so direct bank loans
represent an important form of variable-rate debt for hospitals and health systems. Certain banks are
aggressively marketing such loans in order to build their presence in the health care market. Because
public disclosure is not required for bank loans, it is impossible to gauge the actual number of
transactions, but the volume nationwide is likely significant. Loans are being offered to organizations
across the credit spectrum, including some unrated hospitals. Increased competition among banks for
the tax-exempt business is boosting the attractiveness of loan offerings.
A Guide to Financing Strategies for Hospitals
