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Some Swaps Sweet, Some Still Sour

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While some credit default swaps may yet prove worthwhile at maturity, that financing tactic has been costly and embarrassing to some.

A string of reports from credit rating agencies shows that hospitals continue to suffer amid the economic downturn. From downgrades in the business prospects of smaller hospitals to the massive losses of up to 50% in the investment portfolios of even the best-known academic medical centers, hospitals are reworking budgets and restricting spending.

Some large medical centers and health systems, after dealing with refinancing out of complicated credit default swap contracts they used to synthesize fixed rate debt, faced a double whammy when their investment portfolios tanked late last year, disrupting building plans and financial stability.

That doesn't mean that all hospitals and health systems regret their decision to enter the swap market, however.

Michael D. Rowe, chief financial officer at Sisters of Charity of Leavenworth Health System, a nine-hospital system in Lenexa, KS, has three synthetic fixed-rate bond issues in the market. He says if the borrower plans to hold the swaps until maturity, they still represent a very good financing deal.

"They are working as they were designed, and we intend to hold them to maturity," he says.

"They have lost money currently but we don't get too concerned about the mark-to-market implications. So long as a hospital can leave the swaps alone and is not concerned about the fluctuations in market value from time to time, then swaps can still be an effective way to get things done."

He does caution, however, that current swap costs are not attractive, and "I would advise staying out of the bond market and swap markets if one can avoid them."

Depending on the type of deal, in certain circumstances swaps that turned out sour have put huge pressure on hospital balance sheets, says Brad Spielman, vice president at the San Francisco office of Moody's Investors Service.

It's easy to say people were mistaken for doing this, but even for folks who had to unwind their swaps, they actually still saved money in net on the lower payments over that 10- or 20-year period, says Spielman.

"It's hard to say that even entering into these was a mistake," he says. "In a lot of circumstances, they're still ending up better off and it was an appropriate debt structure given their credit quality."

Maybe so, but the pain now is acute as some hospitals have had to reach into their investment portfolios to post collateral following degradation in the swap market, and sell at disadvantageous prices if they were unable to refinance.

Even if they were able to wriggle free of the swaps-based financing, many hospitals are now financially weaker across the board, as patient volumes have dropped in concert with investment portfolios and as hospitals have returned to more traditional sources of financing, such as fixed-rate bonds and funding absolutely necessary projects with cash, for example. Delaying or canceling big capital projects has also come into vogue.

"You can't really deny that for a lot of these organizations, swap financing has become a political embarrassment," he says. "The market has turned much more conservative."

Philip Betbeze

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