The credit crunch is taking a toll on hospital expansion and renovation projects.

Hospitals are finding that it is becoming increasingly expensive to borrow the money needed to finance their building programs. That’s because the interest that hospitals must pay on the bonds they issue is increasing due to decreased demand for those instruments. Interest expense is a significant portion of the total cost of hospital expansion projects.

To secure the highest ratings for bonds, hospitals often buy bond insurance from such issuers as AMBAC and MBIA. These insurers have been in the news lately for their exposure to sub-prime market liabilities. Those high-risk deals have resulted in the lowering of bond ratings for these insurers. That, in turn, has driven up interest rates on the bonds that they insure.

Mark Huebner, vice president for health-care banking at Commerce Bank in Clayton, noted that hospitals had typically bought bond insurance as a means of raising their bond ratings and thus lowering their interest expense. But now, “since the big bond insurers are bigger credit risks themselves, some hospitals are being hit by increases in both premiums for the bond insurance product itself and increasing interest rates required to sell those bonds.” 

Hospitals have alternatives to buying bond insurance but those financial instruments are also being affected by the credit crunch. For example, hospitals can secure letters of credit from commercial banks as collateral for bonds. But those too are becoming more expensive because many banks have also been downgraded due to credit crises of their own often stemming from deterioration in the mortgage market. 

Hospitals with strong balance sheets -- often those that are part of multi-hospital systems -- have begun to self-insure the bonds they issue. This allows them to save on the insurance premium and -- if they are a strong enough credit risk -- to secure high bond ratings. The higher the rating, the lower the interest rate the hospitals will have to pay.  

“In general, most hospitals in the St. Louis area are in pretty good shape since so many are associated with multi-hospital systems and have strong credit histories and balance sheets,” Huebner said. “I am most concerned with smaller independent and rural hospitals in the outlying areas.  This is clearly a situation where those hospitals that can least afford increasing debt servicing costs are the most likely to be exposed to them.” 

Another threat on the horizon is the general interest rate environment. For most of the past year bond market indices, upon which bond interest rates are calculated have been relatively low as a result of the Federal Reserve’s low interest rate policy. If that trend is reversed, as some fear would be the case if inflation rebounds, bond interest rates would rise even further.

Hospitals can accommodate increasing interest rate expenses in a variety of ways including raising more money from donors, reducing operating costs, and increasing prices. Raising prices is only a limited option since Medicare and Medicaid, which typically constitutes about half of all patient revenue, are not subject to renegotiation. Renegotiating managed-care contracts with commercial health plans is becoming increasingly difficult as well. 

“There is no question that our interest expense is going to increase,” said John McGuire, executive vice president and chief financial officer at St. Anthony’s Medical Center in south St. Louis County. “The three options we (hospitals) have are to increase revenue, decrease costs, or accept lower income.  We are pursuing all three. Increasing revenue can be achieved not only by increasing prices and renegotiating contracts, but also by closely focusing on our mix of businesses and services and increasing volume in our profitable service lines. 

“One way we have been successful in decreasing costs is by changing our Group Purchasing Organization,” McGuire said. “The new group was able to deliver superior pricing on the supplies we need. That strategy allows us to lower costs without compromising patient care.”