NEW YORK – Uncertainties related to the subprime mortgage crisis and the financial health of investment banking firms continue to create a borrowing crisis for some healthcare organizations.
As a result, the normally efficient auction-rate bond market has turned into a shop of horrors for some issuers. The lack of buyers for auction-rate bonds has left sellers unable to sell bonds. Some bond covenants contain provisions with high fail-safe interest rates that issuers must pay if sellers can’t unload bonds.
A variety of not-for-profit issuers, including healthcare organizations, have been stung by the auction-rate bond crisis in the last two months. Providers are now paying more in interest costs and rethinking borrowing strategies, experts say.
“There’s been no change in the underlying credit strength of the borrowers,” said Randy Waring, hospital market leader for GE Healthcare Financial Services. “It’s just a supply-and-demand phenomenon. Rates that were (about 3 percent) back in January were up in the high sixes (in mid-March).”
Auction-rate securities have been used in healthcare since 1984, Waring said. Interest rates on the securities are set through dutch auctions, typically every 28 or 35 days. Under a dutch auction, bidders submit what they are willing to pay, and the auction agent selects the bid that will result in the lowest interest rate for the issuer.
Because the rates on the bonds are re-established regularly, issuers can achieve a better rate on the bonds than they could with a fixed-rate, long-term bond, said John Bibby, a bond lawyer with Jones Day, a law firm with a large practice in healthcare. The bonds typically carry bond insurance, giving the bonds a high credit rating.
That is, until recently, when bond insurers have run into problems because they backed some of the collateralized debt obligations for mortgage bonds. Because high foreclosure rates increase the likelihood that bond insurers will have to step in and back the bonds, credit rating agencies have lowered ratings on insurers. That particularly affected investments in the vehicles by money market or other funds that are required to put money in short-term investments that have high credit ratings.
While the markets have stabilized, CFOs are looking to alternatives to auction-rate securities, Bibby said.
“They’re trying to move into something more traditional,” he said. “Clients are trying to convert to traditional fixed-rate bonds, and some are trying to attach letters of credit to them to shore up liquidity concerns.”
Waring said some healthcare customers are moving to variable-rate demand bonds, which have a “liquidity provider” who will assume ownership of the bonds if buyers don’t come forward to bid on bonds when they come up for auction.
“The auction rate product is broken, and it will stay broken for a while,” he said. “CFOs are very preoccupied with solving their auction-rate problems. They have put projects on the back burner, like capital projects, until then.”