Multimillion-dollar mess 

Enticed by yesterday's good market, Memorial put hospital debt on shaky ground

Remember the good years, America? Back in the time of low interest rates. Back when the economy was a bundle of de-thorned roses. Back when we modern-day Scrooges and penny-pinchers were buying Hummers and getting so high off the white-picket-fence dream that we bought into adjustable-rate mortgages without a thought of, "But, what if ..."

Those were the days, right?

In that context, it's easier to understand how Colorado Springs City Council, on behalf of its enterprise, Memorial Health System, thought it was a great idea to finance more than $270 million in hospital expansions with adjustable-rate bonds in 2002 and 2004, a move that's since cost the hospital millions.

"I think given the market at the time, and the fact that it was common practice, we definitely weren't unique," says Tracy Narvet, Memorial's interim chief financial officer. "Nobody predicted the failure of Wall Street."

Like so many home-buyers then, Memorial and its advisers didn't look for the black cloud. They saw a great deal in auction-rate securities.

Auction-rate securities are a lot like adjustable-rate mortgages. They're a way for an issuer, in this case Memorial, to take out long-term debt that acts like short-term debt. What this means when interest rates are low and the market is happy is lower interest rates. (The market gives them a better deal, knowing the issuer can always change the deal, even on a weekly basis.)

For a while, it worked. At one point, Memorial paid less than 1 percent interest. But in February, the auction-rate market crashed, and Memorial's interest rates shot to between 10.5 and 12 percent. The hospital had expected to pay between 3.5 and 4 percent interest, and the jump put Memorial $2.8 million over budget for 2008.

The market has since settled considerably (Memorial's now paying between 2 and 3.2 percent interest), but auction-rate securities are no longer popular.

"It's just like they have leprosy," says Craig Carnick, local certified financial planner and president of Carnick and Co. "It's dead, dead, dead."

What happened?

To understand why auction-rate securities went from financial cheesecake to brussels sprouts, you need to understand why investors ever wanted them. They once were considered a good place to store cash. The securities earned decent interest compared to bank accounts, money was easily accessible, and bonds were supposedly safe.

The appeal of auction-rate securities depended on people wanting them. Issuers wanted investors to battle for the auction-rate pie; competition ensured low rates. Investors wanted other investors to want the securities so they could sell shares at will, with quick access to cash.

Then nobody wanted them anymore.

"[W]hen housing took off in recent years, investment bankers stuffed the securities with the now-infamous collateralized debt obligations backed by risky mortgages," David Henry wrote for Business Week. "It worked until August, when fears of all things subprime hit investors."

The bonds' value diminished. Investors who thought bonds were safe lost money, and some sued. Interest rates for issuers shot up.

The good news is that Memorial has options, such as converting to fixed rates. But the timing is a bit off.

"It's a lousy environment to issue new bonds today," Carnick says, "... and that means you're going to have to pay high interest rates."

Despite that environment, with the advice of an independent consultant and Council approval, Memorial has begun converting its 2002 auction-rate bonds, currently $103 million, to fixed-rate. The hospital expects to pay around 4.7 percent.Councilman Jerry Heimlicher, who has a business background, trusts the decision because outside professionals have helped.

"I feel much better about that process than anything else that's going on in the hospital at this time," he says.

Councilman Randy Purvis, an attorney who teaches business at Colorado College, has a different take: "I would have been content to leave them in the auction-rate market. I think the historic average is that the interest rate in the auction-rate market is lower."

Memorial isn't abandoning the auction-rate market. For now, bonds it issued in 2004 currently $168.9 million will stay in auction rate, because the bond insurer was downgraded, so Memorial can't negotiate as low a fixed rate on those bonds.

Should somebody, say former hospital CEO Dick Eitel, apologize now for the auction-rate bonds? Purvis and Heimlicher say there's no way Memorial could've known the market would sink. Narvet notes hospital officials were cautious, sought advice from consultants, got top-rated bond insurance and even hired a firm to work on stabilizing rates.

But everything just went to hell.

Carnick concedes Memorial wasn't lured alone into the auction-rate market. Lots of municipalities and other traditionally safe borrowers were following suit. But he doesn't think that lets Memorial completely off the hook.

"It's insane to finance a long-term institution and long-term commitments with short-term commitments," Carnick says.

"It's insane. It would be like you getting a home mortgage and the interest rate changes every seven days. I don't think anybody would tell you that's a good idea."



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