Can Bank Qualified Debt Rescue Expiring LOC's?

HFA Partners  |  August 6, 2011

Renewing letters of credit is probably the #1 concern with healthcare providers right now. Banks are making renewals unpleasant for existing customers below the “A” category, and few are offering LOCs to new customers. For anyone wanting to keep variable rate on the books, it’s not too late to look for alternatives. One option is the Bank Qualified or “BQ” program expanded last year.

 



Renewing letters of credit is probably the #1 concern with healthcare providers right now. Banks are making renewals unpleasant for existing customers below the “A” category, and few are offering LOCs to new customers. For anyone wanting to keep variable rate on the books, it’s not too late to look for alternatives. One option is the Bank Qualified or “BQ” program expanded last year.

Keeping a reasonable portion of liabilities in variable rate mode makes economic sense: the SIFMA index averaged 2.8% over the last 20 years. It was only 0.3% last week. The problem is that VRDOs require an LOC, which now costs a bundle, if it can be found at all. To make matters worse, a record number of LOCs are coming due in the next few months and may flood available bank capacity, forcing banks to be even more picky.

As an alternative to VRDOs, BQ bonds are not only cheaper and quicker to sell, they do not require any credit enhancement. BQ bonds are privately placed with a single bondholder (the bank), no underwriter, no remarketing agent, no offering document, no weekly “put”, and best of all, no LOC. The bank takes on credit risk by holding the bonds directly rather than providing an LOC.

BQ bonds were not much of an option for most borrowers until recently. The Tax Reform Act of 1986 did allow commercial banks to deduct 80% of the cost of buying and carrying tax-exempt debt, but issuers were capped at $10 million per year, which excluded all but the smallest players. The 2009 stimulus law increased the cap to $30 million and applied it to the borrower instead of the issuer. With a much larger universe of eligible borrowers, banks seized on the opportunity to offer BQ bonds as an alternative to LOCs. About 6,000 BQ deals were completed in 2009 for a total of $33 billion, more than twice the 2008 pre-stimulus volumes.

BQ bonds pay a coupon based on a percentage of Libor plus a spread ranging from 100 to 200 basis points, which, combined with lower issuance costs, can result in an attractive “all-in” rate. Because most of the interest is tax deductible, the coupon is also attractive to the bank. For borrowers looking to synthetically fix, BQ Libor coupons can be swapped using a percentage of Libor swap, eliminating the basis risk found when attempting to hedge traditional SIFMA-based coupons.

One drawback of the BQ program is the $30 million cap, which keeps larger borrowers away, although a $60 million issue can be split across two calendar years.

Since BQ bonds are privately placed, terms may vary significantly from one bank to another. Before making a decision, we advise clients to do a full side-by-side comparison with their existing or proposed VRDO terms. BQ bonds are inherently less liquid than VRDOs, so if their “put” feature is exercised (typically set 3 to 5 year out), a new bank must be found or the bonds may have to be refunded, although some BQ documents allow for a mode change instead. Also, borrowers should keep in mind that as with LOCs, banks offering BQ debt will want to be considered for non-credit products such as core deposits, purchasing cards, etc. We recommend borrowers take a diversified "portfolio" approach to banking relationships and factor the costs associated with any changes into their evaluation.

The BQ cap is scheduled to revert back to $10 million at the end of this year. Assuming the bill to permanently extend the program makes it, we expect that Bank Qualified debt will continue to be a viable option for many healthcare borrowers concerned about the availability of credit enhancement and their own LOC renewal prospects.



This material is intended for general information purposes only and does not constitute legal advice. For legal issues, readers should consult legal counsel. To discuss this article or municipal advisory services, email info@hfapartners.com or call 888-699-4830. HFA Partners, LLC is an Independent Registered Municipal Advisor registered with the Securities and Exchange Commission (SEC) and the Municipal Securities Rulemaking Board (MSRB) under the Dodd-Frank Act of 2010.
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