Senior Living Business: Federal Home Loan Bank Offers LOC Option--
December 1, 2008
In late October, Lancaster Pollard financed $7 million in tax-exempt bonds enhanced by a direct-pay letter of credit (LOC) for a project being undertaken by Swiss Village, a not-for-profit CCRC located in Berne, Indiana. While that financing structure is widely used for not-for-profit senior living borrowers, this transaction was unique in that the Federal Home Loan Bank of Indianapolis (FHLBI) backed the LOC for two of its local member banks. It was the first tax-exempt health care transaction completed under a new Federal Home Loan Bank (FHLB) program that became available earlier this year.
Historically, the FHLB has provided credit enhancement in the form of LOCs for housing bonds; but under provisions of the Housing and Economic Recovery Act of 2008 (HERA), an omnibus housing bill passed by Congress and signed into law on July 30, 2008, the IRS tax code was amended to allow the FHLB to expand its use of LOCs to support qualifying non-housing tax-exempt bond issuances—one of which is tax-exempt health care.
"LOC-backed bonds trade on the credit strength of the LOC provider," explained Steven W. Kennedy, Vice President at Lancaster Pollard. "Of the 12 FHLBs located throughout the country, 10 carry AAA ratings—including FHLBI—so bonds that are enhanced by an FHLB LOC will trade with a AAA rating. That’s a primary difference when compared to the majority of LOCs provided by banks. And that added value obviously provides more comfort to investors, particularly in the current environment where we’re seeing a flight to quality in all types of paper."
In addition, a bank LOC is likely to have a term of three to five or maybe seven years, but the term for an FHLB LOC can be 10 years or more. "That’s significant," added Kennedy, "because renewal is one of the primary risks with the LOC-backed structure in general. If a bank providing the LOC decides not to extend it, the organization is forced to find a replacement LOC or restructure the bond." The Swiss Village transaction has a 10-year term with some LOC renewal provisions available, as well.
The Swiss Village project
Swiss Village, located about 35 miles south of Fort Wayne, Indiana, opened in 1968 and currently serves 350 residents and employs 340 people. Looking to expand its popular fitness program, the board of directors sought financing to augment $3.7 million in pledges raised through a fundraising campaign for construction of a wellness center that would serve both residents and members of the local community.
According to Kennedy, Lancaster Pollard had actually multi-tracked the financing from a structuring perspective and was keeping an eye on the Housing and Economic Recovery Act (HERA). "We were about two weeks away from presenting our recommendations to the board when the bill was passed by Congress," he said. "We immediate-ly began a dialogue with two non-rated community banks that were very responsive to the opportunity." In order to participate in this program, the transaction must go through a local FHLB member bank or banks.
The board and the management team of Swiss Village were ecstatic—not only about keeping the community banks involved but also because this option was significantly more cost-effective than the next-best financing arrangement. The cost of capital was significantly lower, and the overall terms of the transaction were significantly more favorable. The organization probably saved 60 to 70 basis points, according to Kennedy.
How the new FHLB program works
HERA permits FHLBs to issue LOCs to guarantee tax-exempt bonds for economic development projects (including infrastructure improvements for nursing homes and medical clinics) through December 31, 2010, without jeopardizing the tax-exempt status of the bonds. Prior to the passage of this legislation, FHLB LOCs guaranteed only taxable bonds and tax-exempt bonds for multifamily housing. In the past, bonds issued for a non-housing purpose that were enhanced by an FHLB LOC could not receive tax-exempt status.
For a local bank customer (the senior living provider) looking to issue debt using a regional FHLB’s credit rating, the local member bank or banks must apply for the LOC through the appropriate FHLB. In the Swiss Village transaction, for example, The First Bank of Berne and The Bank of Geneva applied to FHLBI, which then wrote a direct-pay LOC that guaranteed payment to the trustee that represents the investors and processes payments on behalf of the investors. The credit risk associated with the local bank’s customer (Swiss Village, in this example) remains with the local bank(s); any draws made on the LOC (by the trustee) and made by the regional FHLB are reimbursed by the local bank(s).
LOCs must be secured, as any other advance would be, and are subject to regular borrowing limits. Collateral requirements and capital stock holdings are adjusted at the time the LOC is issued. If the borrower should default, the investor has a direct-pay LOC from the FHLB and the FHLB holds collateral posted by the local bank(s).
Although terms and fees may differ among the dozen FHLBs throughout the country, terms of up to 20 years are available from FHLBI and a fee (up to 3/8%) based on the approved principal amount is payable annually on the issue date. An administrative fee is charged for each draft presented for payment under the LOC, as well.
"There are a lot of layers," said Kennedy, "but this program gives local banks an opportunity to participate in transactions in which, historically, they’ve been unable to participate. Before this legislation passed, the only way a small community bank could have been involved in a deal such as the one that Swiss Village closed would be to wrap the LOC with a large bank. The problem there is that not a lot of banks are issuing LOCs in this environment—and for those that are, the LOCs are extremely costly. The pricing on the FHLB option is very competitive and more uniform than that of a traditional bank wrap."
The new FHLB program isn’t a solution for organizations that want to borrow capital but don’t have a good credit profile. In fact, it’s quite the opposite. It’s a way for non-rated and low investment-grade hospitals and senior living providers to leverage local resources to finance capital projects that might otherwise be put on hold. Approved uses for the LOCs include facilitating residential housing finance, assisting members with asset/liability management, and providing member banks with liquidity and other funding.
Berne, Indiana, is a tiny, close-knit community (population 4,100), and Swiss Village has grown to become a rather sizeable CCRC with a focus on wellness. This new development—the wellness center—is a way for Swiss Village to provide a new facility for its residents and, at the same time, encourage participation from the greater community. "It’s a solid business venture for Swiss Village, but it’s also a way to continue to drive home community involvement," said Kennedy. The transaction also allows a portion of the bond proceeds to be used to fund renovations to the property’s assisted living facility.
"So many organizations have sound financial profiles, but their access to capital is negatively impacted by the effects of the recent global subprime lending activities in which they had no part," he added. "Swiss Village is a great example of a traditional nonprofit CCRC with a board that takes a conservative approach to the organization’s asset management and capital structure. The financial ratios are all very sound, and they’ve never come close to overleveraging their balance sheet. So it’s unfortunate that they, like a lot of others, were impacted by what’s going on in the overall economy."
Lancaster Pollard forecasts that this new FHLB program will become a popular alternative for similarly positioned borrowers, especially in small communities where senior living providers have had longstanding relationships with their local banks but are looking to the capital markets to access credit. "Community banks are small in size and don’t have high investment-grade ratings, so they are often unable to participate in the debt offering in a meaningful fashion," said Kennedy. "This new option allows a local bank to support the issuance of an FHLB LOC that trades at a lofty AAA rating."
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