Taxable Federal Housing Administration (FHA) insurance financing is the “best financing vehicle” for borrowers with “BBB” or unrated credit profiles from a cost standpoint, says the Cain Brother’s Strategies in Capital Finance report for Fall 2011 in reference to the agency’s Section 242 program, mortgage insurance for hospitals.
Since the Department of Housing and Urban Development’s (HUD) Office of Healthcare Programs (OHP) took control of the program in 2007, it has made several improvements that led to increased utilization. From 1990 to 2000, issuance volume equalled $2.067 billion, with 34 deals. In the next ten years, through 2010, volume nearly quadrupled to $7.903 billion, and 83 deals.
“The FHA 242 program was no longer seen as an ‘insurer of last resort,’ but rather a compelling vehicle with which to access very affordable capital,” says Cain Brothers, especially since capital sources have restricted after the sub-prime mortgage crisis.
Interest in the program has increased in the past few years largely due to the program’s “favorable long-term, fixed rate, fully amortizing non-recourse structure,” Cain Brothers says, adding that borrowers are able to take renewal, interest rate, and counterparty risk off the table through FHA mortgage insurance, and that interest rate levels are currently “very favorable, particularly in the taxable funding markets.”
“Use of FHA mortgage insurance has never been more advantageous than in the current credit environment,” says the report, adding that it’s especially true for the spread between both “BBB” and unrated tax-exempt securities versus FHA-insured obligations. “The lack of alternative bond insurance providers combined with low risk tolerances on the part of tax-exempt bond investors leaves FHA-insured loans with a significant funding advantage.”
Taxable FHA-insured loans that are securitized through Ginnie Mae have another “significant” structuring advantage over uninsured taxable and tax-exempt bond structures: funding works similarly to bank construction loans, where interest during the loan is only incurred on the accumulated, monthly-drawn loan principal, “which serves to eliminate costly negative arbitrage on loan proceeds over the construction period,” Cain Brothers points out.
The report runs through cost comparisons of new construction projects for FHA 242 taxable or tax-exempt, “A” rated tax-exempt, “BBB” rated tax-exempt, and unrated tax-exempt loans, and also runs through a number of eligibility requirements that borrowers must meet in order to qualify for FHA mortgage insurance, including the ownership of the project; eligible project type (inpatient-oriented or owned by inpatient-based hospital that has an existing FHA-insured mortgage); operating margin and debt service coverage; and recent underwriting developments and trends.
“As demand for FHA insurance has increased, the credit profile of the hospitals applying to the Program has improved, because even financially healthy hospitals have fewer or less attractive financing options today,” says Cain Brothers in regards to underwriting trends. “However, meeting baseline eligibility requirements no longer assures success in obtaining insurance. Recent experience tells us that OHP is concerned with the uncertainties stemming from health care reform, and, as a result, the Office of Hospital Facilities is applying more rigorous underwriting standard.”
The report concludes that the “compelling” Section 242 program works best for stand-alone facilities and small health care systems thanks to its ability to obtain a fully amortizing, long-term fixed rate financing at very low interest rates, which outweighs many of the program’s processing challenges and less flexible operating covenants.
“Cain Brothers believes the FHA Section 242 mortgage insurance program remains the best-in-class financing vehicle for hospitals in the US right now—lowest interest rates, highest leverage, most reasonable covenant structure, and speedy application processing times,” Nick Nicholson, Managing Director at Cain Brothers, told SHN. “For hospitals with stable operating performance or new projects with a positive outlook, the benefits of the FHA 242 program can’t be beat.”
Read the full Strategies in Capital Finance report here.
Written by Alyssa Gerace