In a move that could provide a timely refinancing opportunity, the federal government has opened up its hospital mortgage insurance program to be used for straight refinances. The relevance of this new option, however, has been tempered by the high eligibility thresholds it requires hospitals to meet.
During the current public comment period, hospital advocates nationwide are pushing for more relaxed standards so the program can be a more viable resource to reduce interest rates, eliminate restrictive debt covenants, exit troubled banking relationships or resolve other credit market-related concerns through refinancing.
Government-insured mortgages have historically provided some of the most affordable capital and reasonable terms. Many hospitals have found themselves suddenly needing to restructure their debt because of bank downgrades, increases in letter of credit fees, or the unavailability of credit from banks.
These same market factors have altered the landscape of financing options. Credit enhancement through bond insurance is nearly nonexistent: Only one AAA-rated bond insurer remains that will consider insuring hospitals, and the hospital must be very strong (investment grade) to qualify for the bond insurance enhancement.
The cost of a government-guaranteed mortgage, however, is non-risk-based, making it accessible to hospitals of all sizes, and to both exceptional and average credit profiles. The cost of obtaining Department of Housing and Urban Development mortgage insurance is half a percent annually irrespective of the hospital’s underlying credit characteristics. The debt is non-recourse, fixed-rate, and it can be rated AAA with a term of up to 25 years after construction is complete.
But until July, hospitals could not refinance through HUD unless 20 percent of the loan was used for new construction or renovation. For many hospitals, this often eliminated HUD mortgage insurance at the same time credit markets tightened and made other refinancing options scarcer.
As of July 1, however, HUD has eliminated the 20 percent new money requirement for its Section 242 mortgage insurance program. The new straight-refinance program will be known as Section 242/223(f).
The challenge now comes in the form of the new and more rigorous financial thresholds that must be met to refinance, which, surprisingly, are more restrictive than the requirements of FHA 242 mortgage insurance for new construction.
The Section 242/223(f) program requires a three-year Operating Margin ratio of 0.33 percent, contrasted with the Operating Margin of zero percent required for new construction. Refinancing also requires a Debt Service Coverage ratio of 1.8 in the last three years, as opposed to 1.25 for new construction projects.
Further, eligibility requires that the hospital have experienced an increase in its interest rate of at least 1 percent since January 2008, or is currently facing an “imminent” increase. This last requirement has prompted questions about whether the FHA 242/223(f) program can be used to refinance any fixed-rate debt, if an increase in the letter of credit fees constitutes an increase in rate, or if anticipated letter of credit fees are “imminent.”
The Section 242/223(f) requirements will be finalized by a HUD rule, which was published in September and is followed by a 60-day public comment period, after which time any changes will be finalized and the new HUD rule will be published.
In the meantime, mortgage insurance commitments can be issued, bonds can be sold and loan closings can take place under the authority of the July 1 notice.
Thomas R. Green is CEO of Lancaster Pollard, a provider of debt financing and financial advisory services to hospitals and healthcare providers nationwide. He can be reached at tgreen@lancasterpollard.com.