In A Nutshell...
- Money market funds are the largest buyers of VRDO's and require minimum LOC ratings
- If Bank of America is downgraded, its LOC ratings will no longer meet money market fund requirements
- There are several options for hospitals including other banks and structures
- Hospitals should identify their options early.
FOR AN UPDATE, READ RELATED ARTICLE: What Moody\'s Bank Downgrades Mean for Hospitals.
Tax-exempt variable rate demand obligations (VRDO) are typically backed by a letter of credit (LOC) and sold to money market funds. These funds are regulated by the SEC Investment Company Act of 1940 Rule 2a-7 which requires 95% of their portfolio to be held in “first tier” securities with short-term ratings of A-1 by S&P, P-1 by Moody, and F1 by Fitch, with a 5% allowance for “second tier” securities rated A-2/P-2/F2.
Bank of America, N.A. is currently rated A-1/P-1/F1. If the bank is downgraded by any of the rating agencies, its LOC will fall into the second tier and most money market funds will put the bonds back to the remarketing agent on the following Wednesday. If the remarketing agent is unsuccessful in finding another buyer, it will draw on the LOC and the hospital will then face a higher “default” rate and a much shorter amortization.
Some hospitals expect that if downgraded, Bank of America will work with borrowers to lower the default rate, stretch out the amortization, or even convert the LOC-backed bonds into a bank direct placement. In fact, the bank may not be able –or willing– to do so for all borrowers.
Short of taking a “wait and see” approach or paying off the bonds, the options available in a downgrade scenario require some time to implement, so hospitals ought to evaluate as soon as possible:
- Get a substitute LOC
- Refinance with a bank direct placement
- Refinance with a public offering
Many hospitals who proactively manage their capital structure have already restructured VRDO’s and are no longer exposed to downgrade risk. The others ought to discuss options with their financial advisor so that a plan can be put in place ahead of a potential downgrade.
In the capital markets, the best defense is always a good offense.
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