• New Opportunity under Federal Housing Administration (FHA) Hospital Mortgage Insurance Program
  • February 14, 2013 | Authors: Alexander "Alex" B. Buchanan; A. Bindu Liang; Donald "Don" B. Stuart; Robert "Rob" P. Sweeter
  • Law Firm: Waller Lansden Dortch & Davis, LLP - Nashville Office
  • A new program taking effect in March provides hospitals with a new option to secure funds for financing acquisitions and refinancing debt.

    On February 5, 2013, the Office of Hospital Facilities published a new rule that will enable qualifying hospitals to finance their acquisitions and/or refinance their existing debt with FHA insurance even if the hospitals do not have FHA-insured mortgages. With this new rule, the Department of  Housing and Urban Development (HUD) has provided permanent regulatory codification of its refinancing authority,  increased the number of the hospitals that are eligible to apply for the insurance, and expanded the list of expenses that are eligible for refinancing. For qualifying hospitals, the new rule represents a unique opportunity that is further enhanced because it does not condition availability on any pre-set expenditures of funds for construction or rehabilitation. If construction or rehabilitation is contemplated, however, the rule still is available for such hospitals that successfully apply.

    The new rule will take effect on March 7, 2013.  Because the rule significantly loosens the eligibility criteria for qualifying for FHA Section 242 Hospital Mortgage Insurance Program, it is expected that the many hospitals that currently are saddled with high debt service payments will attempt to take advantage of the opportunity afforded by the new rule. Effectively, borrowers who qualify will have their debt converted to the equivalent of “AA” or “AAA” rated debt, thereby lowering their interest rates and reducing their borrowing cost.  The new rule amends the Section 242 regulations to permit refinancings for hospitals that do not have FHA-insured mortgages in place and does so without conditioning such refinancing on new construction or renovation.

    As is to be expected, the new rule is not designed to be an option for all hospitals. Instead, the rule is designed to help those hospitals that are essential for the communities in which they operate but which are saddled with unexpectedly high interest rates and do not have the opportunity to refinance in the current market environment.

    There are a number of restrictions on eligibility. Each proposed borrower will be required to demonstrate that it is a hospital with a high degree of financial strength. In general, a hospital will be ineligible if it had an average debt service coverage ratio of less than 1.25 to 1 in its three most recent audited years unless HUD determines that the hospital achieved a financial turnaround resulting in a debt service coverage ratio of at least 1.4 to 1 in its most recent year. In cases of refinancing, the hospital must have an aggregate operating margin of at least 0% when calculated from the three most recent annual audits and must have an average annual debt service coverage ratio of at least 1.4 to 1 during such time. If the borrower is refinancing pursuant to Section 223(f), HUD will use projected debt service if the above tests are not met by applying its estimate of the projected rate at the time the mortgage is expected to close in lieu of the historical rate.  In such case, the hospital will be required to demonstrate compliance with a required 1.4-to-1 coverage ratio but HUD may permit the hospital to exclude one of the three prior fiscal years from the test if one-time exceptional events substantially altered the hospital’s performance for the year proposed to be omitted. In this case, the three-year performance that will be based on the four most recent years with the unusual year omitted.

    In addition to satisfying the debt service coverage rates and operating margin tests, the hospital may show it provides an essential healthcare service to the community by submitting an analysis quantifying how the community in which it operates would suffer if the hospital were no longer in operation. Specifically, the hospital would need to document that (a) the community would suffer inadequate access to an essential service that the hospital provides, (b) there are few alternative financing vehicles and (c) three of the following seven criteria are met:

    1. the proposed refinancing would reduce the hospital’s total operating expenses by at least .25 percent;

    2. the interest rate on the proposed refinancing would be at least .5 percentage points less than the interest rate on the debt to be refinanced;

    3. the interest rate on the debt that the hospital proposes to refinance has increased by at least 1% since January 1, 2008, or is likely to increase;

    4. the hospital’s annual total debt service is in excess of 3.4% of total operating expenses;

    5. the hospital has experienced a withdrawal or expiration of its credit enhancement facility or the lender providing its credit enhancement facility has been or is about to be downgraded;

    6. the hospital is a party to bond covenants that are substantially more restrictive than the Section 242 mortgage covenants; and

    7. there are other circumstances that demonstrate the hospital’s financial performance would be materially impaired by the refinancing.

    Additional changes under the rule include  new definitions of “Capital Debt,” “Soft Costs” and the like which in context are designed to make clear that HUD has the authority to finance and refinance those costs listed which are enhanced under the new rule. Such costs  include swap termination expenses. The inclusion of swap termination payments will undoubtedly be a godsend to those hospitals stuck with underwater swaps in the wake of the financial meltdown.

    The community need information that may be provided in the hospital’s application is designed to provide HUD with the necessary information to enable it to select only those hospitals where the need for 242 mortgage insurance is compelling. While the insurance contemplated by the new rule is not likely to be available for  hospitals that are financially secure, it is a significant opportunity for the remaining hospitals that successfully avail themselves of the opportunities afforded by the rule and  that satisfy the compelling need test.