FHA has a fix for tax reform’s potential hit to 501(c)(3) hospital tax-exempt financing

The Tax Cuts and Jobs Act passed by the House of Representatives on November 16 held an unwelcome surprise for non-for-profit hospitals: the elimination of tax-exempt financing for 501(c)(3) organizations, among other things.

However, the Senate markup, dated November 14, was a bit more tolerable. Below is a summary of tax reform provisions being discussed on the Hill, which could increase borrowing costs for not-for-profit hospitals, and how the FHA 242 hospital program could benefit more hospitals as a result:

Elimination of Private Activity Bonds (PABS): Hospitals have long been beneficiaries of tax-exempt private activity bonds for debt financing for capital projects and refinancing. Repealing PABs, as incorporated in the House proposal, would require 501(c)(3) hospitals to secure taxable financings instead, such as taxable bonds, bank loans, or governmental loan programs such as HUD/FHA or USDA. In general, taxable financings carry higher interest rates than analogous tax-exempt transactions because the bondholders/investors pay taxes on interest income, whereas investors in tax-exempt bonds do not. The Senate markup does not call for elimination of PABs, so it will be interesting to see if this provision remains as the legislation progresses.

Potential Effect:
A 1-2% increase in interest rates for not-for-profit hospitals starting as early as January 1, 2018.

No More Tax-Exempt Advance Refunding:
Both the House and the Senate proposals agree (for now) to eliminate the use of tax-exempt bonds to advance refund another tax-exempt bond. Presently, hospitals can refinance existing tax-exempt bonds prior to the stated call-date with the proceeds of a new tax-exempt bond issue. Refinancing via an advance refunding has been an effective tool for hospitals to take advantage of favorable market conditions and lower interest expense.

Potential Effect:
Reduces hospital’s opportunities to refinance existing debt and take advantage of the low interest rate environment.

Corporate Tax Rate Reduction:
Both the House Bill and Senate markup propose to cut the highest corporate tax rate from 35% to 20%. While good for profitable proprietary hospitals, the cut would reduce corporate demand for tax-exempt bond investment.

Potential Effect:
Tax-exempt bonds interest rates could increase significantly, given lower demand.

FHA 242 Hospital Mortgage Insurance
If these tax reform provisions are enacted, the utilization of tax-exempt bonds by hospitals could diminish or be eliminated. In the absence of an alternative, this would affect the feasibility of future projects under consideration.

Fortunately, there is such an alternative. Hospitals will still have access to affordable financing through the Federal Housing Administration’s (FHA’s) 242 hospital mortgage insurance program. This sparsely-used, but longstanding (since 1968) loan guarantee program administered by the U.S. Department of Housing and Urban Development (HUD) could be just the answer for many hospitals that would be seeking affordable debt financing for capital projects and equipment to further their mission and replace and modernize aging facilities. The FHA 242 program can also be used for hospital acquisition and refinance of existing debt, including advance refunding, through a revitalized FHA 223f program. While the FHA 242 program may not be a fit for all hospitals, it could certainly be a silver lining for hospitals in certain credit profile ranges.

FHA 242 loans are funded by taxable Ginnie Mae mortgage backed securities (GNMA MBS), which are 100% backed by the full faith and credit of the U.S government. To obtain this credit enhancement and the associated AA-rated debt, HUD charges hospitals a mortgage insurance premium for 70 basis points for construction project and 65 basis points for refinance and acquisition loans.

FHA 242 Program Highlights

• Affordable, Long-Term, Fixed-Rate, Non-Recourse Financing:
o Loan term: 25 years plus construction period

• Liberal Loan to Value (LTV) Requirement:
o 90% LTV based on replacement cost of project plus existing net book value of PPE

• Robust Taxable GNMA MBS Market
o $504B in FY 2017

• Taxable Advantage
o More flexibility to fund equipment, IT and MOBs.
o No rating agency involvement
o No ongoing disclosure requirements
o No debt service reserve fund with debt proceeds
o Reduced legal fees

• Access to Affordable Capital for Future Projects:
o FHA provides access to capital for future projects through a special supplemental loan program (Section 241)

The views, opinions and positions expressed within these guest posts are those of the author alone and do not represent those of Becker's Hospital Review/Becker's Healthcare. The accuracy, completeness and validity of any statements made within this article are not guaranteed. We accept no liability for any errors, omissions or representations. The copyright of this content belongs to the author and any liability with regards to infringement of intellectual property rights remains with them.

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