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In an ideal world, the municipal market would develop a robust set of non-bank-reliant variable-rate alternatives. For a stretch in time, auction-rate securities provided this outlet and utilization was extraordinary. But no product currently appears on the horizon that is poised to achieve the same scale and breadth.
Windows variable-rate demand bonds (VRDBs) are a relatively new bond product that carries a long nominal maturity, prices at a spread to the weekly Securities Industry and Financial Markets Association (SIFMA) index (fixed for any investor holding period), has no daily/weekly put, and does not require bank support. If an investor elects to sell/put a holding, the remarketing agent has a 30-day "remarketing window" to sell the bond to a new investor at the current or higher spread. Or, the program agent can renegotiate a higher spread with the existing investor. If the bonds cannot be remarketed in the 30-day initial window, they enter a new six-month "financing window," during which the borrower secures alternative funding.
The product has been selectively used, with very good pricing results, by certain double A-rated healthcare credits. The question today is whether the market will expand to a broader pool of double A-rated credits and, more important, whether in coming years it will become available to single A- or even triple B-category healthcare credits.
Current Issues with Bank-Supported VRDBs
VRDBs are likely to continue to play an important role in future variable-rate offerings, but two major trends suggest potential barriers to future VRDB use by hospital borrowers-bank credit quality and regulatory shifts.
Bank credit quality. As noted earlier, bank ratings have been under stress since the credit crisis, and in the past two years, a steady deterioration in bank ratings has occurred. The primary purchasers of VRDBs-institutional money market funds-have regulatory limits on their ability to hold lower-rated paper. If bank-rating deterioration continues, money market funds may have to pare back their holdings of one or more of the major banks that is an active provider of VRDB support. Any such development would likely have a major impact on VRDB pricing and on the ability of hospitals and health systems to secure the support they need to maintain existing or new programs.
Regulatory shifts. Basel III is under development and might increase the cost a bank must charge to extend a standby bond purchase agreement (SBPA) or a line of credit (LOC). At a minimum, any such pricing increase would shift the risk/reward relationship associated with fixed-rate versus variable-rate alternatives; but within the variable rate realm, it may also shift the risk/reward relationship between different products, making some relatively more attractive than they otherwise might have been.
The exhibit provides an overview of the risks and benefits of direct bank loans versus VRDBs.
Eric A. Jordahl is a managing director and co-leader of the financial advisory practice, of Kaufman, Hall & Associates, Inc., Skokie, Ill., and a member of HFMA's First Illinois Chapter (email@example.com).
For more information, see Eric Jordahl's "Risks and Rewards of Variable-Rate Debt," hfm, May 2012
Publication Date: Tuesday, May 01, 2012