Borrowing directly from the bank

More hospitals turning to banks for direct-placement borrowing

Borrowing by hospitals directly from banks got a boost after the credit crisis but ballooned last year as hospitals look to reduce exposure to potentially volatile debt. Banks loaned $1.7 billion directly to healthcare borrowers last year in bond deals that might have otherwise been sold publicly, according to data from Thomson Reuters. That volume of deals does not include another $1.2 billion borrowed in other privately negotiated deals. The combined $2.9 billion in private healthcare lending is an increase from $503 million in the prior year, the Thomson Reuters data show (See chart below).

More hospitals have embraced such deals, in which bonds are sold privately, as an alternative to financing vehicles that have proved riskier after the credit crisis, according to healthcare finance chiefs.

That was the case for the Cleveland Clinic, which borrowed $42 million from a bank last year. The deal was the system’s first direct bank placement in roughly eight years, says Chief Financial Officer Steve Glass. Officials with the Ohio system sought to limit exposure to more volatile debt deals, known as variable-rate demand bonds, by financing with a more stable alternative.

And banks appear eager to lend. RBC Capital Markets conducted its first direct placement deal in 2008 and has since purchased $1.5 billion in healthcare bonds, says Kathleen Costine, managing director of RBC Capital Markets’ healthcare finance group. Wells Fargo began to increase its direct lending roughly 2½ years ago, says Adam Joseph, a Wells Fargo Securities managing director in public finance capital strategies.

A large appetite

“I’ve never seen his much bank appetite” for direct loans to borrowers, says Mark Melio, founder of healthcare financial advisory firm Melio & Co., based in Northfield, Ill. Multiple banks compete for deals and have agreed to lend $100 million to $150 million directly to borrowers with strong credit ratings, Melio says. He says that such capacity appears to have tightened somewhat in recent months, but demand from borrowers and banks for the deals continues so far this year.

Johns Hopkins Health System borrowed directly from a bank for the first time last month.

The $53 million deal diversified the system’s debt portfolio without adding a risk common to variable-rate demand bonds, says Stuart Erdman, senior director of finance for Baltimore-based Johns Hopkins.

Variable-rate demand bonds are often backed by bank letters of credit, which act as a credit guarantee for investors. But when banks’ credit strength falters, as it has in recent years, investors grow more wary of such guarantees and interest rates might climb. Hospitals must also renew letters of credit with banks frequently—which creates the risk banks may not renew or may charge more to do so.

Erdman says Johns Hopkins, which owns six hospitals, is seeking to reduce its exposure to letters of credit.

“That’s our goal now,” he says. So when officials considered how best to refinance a loan, they looked for other options, which include fixed-rate bonds and private placement with other investors.

Banks competed aggressively for the system’s business as they made their first direct placement, he says. Johns Hopkins pursued such a deal for the first time because direct bank deals were not previously as available or as cheap.

“If they were available, they weren’t available at a good price,” Erdman says.

Three of eight banks offered bids that were less costly than letter of credit deals. Johns Hopkins ultimately closed the direct bank deal for less than a letter of credit, he says.

The direct deals aren’t without risk. Banks typically agree to deals of three, five or seven years and hospitals may be forced to refinance. “Markets change,” Erdman says. Demand from borrowers or bank appetite for direct deals could disappear in coming years.

Banks too may be looking to move away from letters of credit.

Joseph of Wells Fargo says experience during the nation’s recent financial upheaval made the direct bank deals more attractive.

Banks and borrowers developed a “shared fear” that letters of credit could change borrowing costs and demand on balance sheets overnight, he says. When investors no longer want hospital bonds, banks must honor letters of credit by buying up the debt—as was the case during the nation’s recent financial