HUD 242: It's No Housing Tax Credit, But It's Helpful for Some Hospitals' Debts

I'm currently in the market for a house and let me assure you that the Obama housing tax credit, which ends at the end of April, is creating quite a buying frenzy in my home state of Massachusetts. I read last week that home sales nationwide surged 27% in March; my husband and I can tell you first hand how true that is—we were outbid for a house in the midst of this recession. Still, I suspect that after April 30 this little boom will fall flat and people will return to their senses about what you really should pay for a house.

Having too much debt is precisely why so many people are selling their homes to begin with. With no way to financially dig themselves out from under the weight of their mortgages, many people had to offload their homes to avoid bankruptcy and foreclosure. Many healthcare facilities found themselves in the business equivalent of these circumstances. They had too much in variable rate bond debt and were left holding the empty money bag when the economy tanked. This misstep in risk assessment affected their credit ratings, which in turn made refinancing their debt out of variable rate bonds difficult (which is an understatement)—as lenders now viewed them as riskier. It was a terrible circle to be caught in, but like the housing tax credit, the government did realize they needed to intervene on their behalf.

So, in 2009 the U.S. Department of Housing and Urban Development Section 242 Program (which has been around since 1968) amended its program to offer hospitals an alternative to traditional bank refinancing. The government adjusted the regulation to allow "hospitals to refinance existing loans, without requiring such refinancing to take place only in conjunction with the expenditure of funds for construction or renovation," which was the existing programs original requirement.

"When the credit markets became more restrictive, the lower-rated and non-rated hospitals didn't have good access to capital. The HUD 242 refinance option was initially to fill that void. Now that the credit markets have improved quite a bit and facilities are back to being rated BBB or better, many hospitals have reasonable access to capital. But there is a lot of applicability of this program for non-investment grade, quality hospitals," says Tom Green, CEO at Lancaster Pollard, a Columbus, OH-based healthcare financial advisory company.

Last year, Section 242 of this HUD program was updated (section 223 (f)) to include using the mortgage insurance program to refinance capital debt—which was previously not allowed unless 20% of the project proposed was new money. Once that was lifted, it opened the funding source for hospitals to refinance their variable bond debt.

"This program really opens up the funding option to facilities trying to replace letter of credit financing or bond insurance financing," says Green. "Initially there was a great deal of interest in this program but when hospitals saw the criteria for approval they found they didn't meet the initial criteria."

Recognizing that the eligibility criteria might be off putting, in January of this year the Federal Housing Authority decided to make section 223 (f) permanent, publishing a proposed rule that would regulate the refinancing of capital debt. The comment period for that regulation ended March 30, and now the regulation is awaiting final adoption—there is no word on when the process might be completed officially, though the program is active in the meantime. The final regulation is expected to relax eligibility requirements to allow more hospitals to refinance. Click here to read the new eligibility requirements.

There are additional benefits of using Section 242 (though the speed with which the application is processed isn't among them; it takes months):

• the cost of the credit enhancement does not fluctuate with the markets
• the non-recourse pricing can be appealing to independent hospitals that may seek to affiliate in the future
• the non-recourse price appeals to large systems that want to create a separate financing structure for related hospitals of any size

Traditionally Section 242 has been a low volume program, however, with the relaxing of the criteria that may change somewhat (though not quite to the degree of the housing tax credit frenzy I'm dealing with). "If you've got a hospital that's needed in a community but struggling financially, this program could be a good fit. But it isn't going to result in hundreds of hospitals being refinanced by this program," says Green.

Here are a few more HUD Section 242 details:

• Purpose: To help hospitals access affordable financing for capital projects—including new construction, refinancing, and modernization, remodeling, equipment and expansion.
• Eligibility: Acute care hospitals with no more than 50% of patient days attributable to the following services: chronic convalescence and rest, drug and alcoholic, epileptic, nervous and mental, mental deficiency, and tuberculosis. For Critical Access Hospitals this restriction does not apply. If your state has a Certificate of Need process, a CON must be issued or pending.
  • You must grant the FHA-insured lender a first mortgage on the entire hospital, including property, plant, equipment, and receivables. (Note: Exceptions may include leased equipment, off-site property, capital associated with affiliations, etc.)
  •  
  • You must be willing to make monthly payments into a Mortgage Reserve Fund that will build to a balance equal to two years of debt service after ten years.
  • Over the last three full fiscal years, the hospital's average operating margin must have been equal to or greater than 0.00 and the average debt service coverage ratio equal to or greater than 1.25.
• Funding amount: Loan-to-value may not exceed 90%. Maximum loan term is 25 years. One-time fees total 0.8% of loan amount. Fixed annual premium is 0.5% of remaining balance. FHA insures 99% of the loan amount.
• Application process: Long; the first step of the application process is for HUD to perform a preliminary review of the hospital and the proposed project with information provided by the hospital and mortgage lender.

By now a good majority of hospitals with variable-rate bond debt have refinanced their way to higher ground, but not everyone has done it. Moreover, being aware that these types of programs are available to your facility could help keep hospitals out of trouble in the future. Of course the key to success all together is not to over leverage your facility—which is why you won't see me overpaying for a house even though the tax credit is about to expire.