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2001-11-19 Special Meeting NEW HANOVER COUNTY BOARD OF COMMISSIONERSBOOK 28 MEETING WITH NEW HANOVER REGIONAL MEDICAL CENTERPAGE 899 NOVEMBER 19, 2001 ASSEMBLY The New Hanover County Board of Commissioners held a Work Session with New Hanover Regional Medical Center on Monday, November 19, 2001, at 2:30 P.M. in the Assembly Room of the New Hanover County Courthouse, 24 North Third Street, Wilmington, NC. Members of the Board present were Chairman Ted Davis, Jr; Vice-Chairman Robert G. Greer; Commissioner Julia Boseman; Commissioner William A. Caster; Commissioner Nancy H. Pritchett; County Manager, Allen O’Neal; County Attorney, Wanda M. Copley; and Deputy Clerk to the Board, Teresa P. Elmore. Chairman Davis called the Work Session to order and stated the purpose of the meeting was to hear a presentation by New Hanover Regional Medical Center (NHRMC) concerning the interest rate swap agreement being considered by the Board of Trustees. Commissioner Caster said the Board of Trustees and the Finance Committee had been discussing the issue of the bond swap mechanism for eighteen months. He found it extremely confusing and thought the Board could benefit from a work session on the issue. The Board of Trustees has voted to accept the product as a means to make money for the hospital, which is doing extremely well compared to other hospitals in the region and the nation. Dr. Bill Atkinson, President of New Hanover Regional Medical Center, spoke of working on the issue for more than thirty-six months. It was first discussed when they were working on general bond issues and he became aware that Duke University and Carolinas Health Care of Charlotte were considering the program. It is a fairly new concept in health care and some governmental and semi- governmental areas around the country. The hospital tries to stay aware of opportunities that help to stabilize the health care industry. NHRMC is in a positive position in regards to its assets. Usually they are very conservative in the way they have treated the assets of the institution, including economic decisions, but they do not want to reject an opportunity just because it is a new idea. They have considered the risks and dangers and believe they are approaching the program relatively conservatively. He introduced Tom Bradshaw from Salomon Smith Barney’s Raleigh Office and Greg Usry from Salomon Smith Barney’s New York Office. NHRMC has worked with Mr. Usry on general bond issues. He also introduced Kathleen Gormley, Chief Financial Officer, and Judy O’Neill from Public Affairs saying they would be glad to respond to any questions from the Commissioners. Tom Bradshaw stated that he had been involved with the hospital since working on the purchase of Cape Fear Memorial Hospital. While working on bond financing arrangements, they evaluated the hospital’s very attractive low fixed rate debt. The bond program is the beginning part of this comprehensive financial program. Greg Usry, head of Salomon Financial Products Program, spoke on the proposed concept for the hospital’s financial program. He said he suggested this concept to the hospital because of its strength on the balance sheet. The proposed financial product is not driven by a single product opportunity but rather taking the situation as it stands with the particular client and evaluating its strength. Given the hospital’s low long-term fixed rate debt and its strong asset base, they recommended the interest swap concept to the hospital. The NHRMC’s active investment in U.S. Treasury and Agencies and other short-term securities was also a factor. Mr. Usry showed a chart giving the relative mix of debt for other hospital systems. He said rating agencies are generally comfortable with hospitals and health care institutions when 15% to 40% of their debt is in variable rate securities. This is driven solely by the strength of their asset base and their ability to address any risk of short-term interest rates increasing. In this peer group, most have variable rate liabilities between 15% and 50%. Mr. Usry explained that an interest rate swap or an interest rate exchange agreement does not involve the issuance of debt nor does it change the way the hospital invests its money. It is a NEW HANOVER COUNTY BOARD OF COMMISSIONERSBOOK 28 MEETING WITH NEW HANOVER REGIONAL MEDICAL CENTERPAGE 900 NOVEMBER 19, 2001 contractual arrangement that provides for the exchange of two interest rates. One of those interest rates is fixed, and that is the rate that is paid from Salomon Smith Barney to NHRMC. And one of those interest rates floats, changing every week based upon short-term tax exempt interest rates. That would be the rate NHRMC would pay to Salomon Smith Barney. The contract does not involve the issuance or re-issuance or re-financing of the hospital debt. In fact, it does not do anything to preclude the hospital’s re-funding or restructuring its debt or its assets in any way. He explained that in the current market environment, for a period of ten years, Salomon Smith Barney (SSB) would pay NHRMC the market’s fixed rate of 3.70%, and the hospital would pay a floating interest rate based on a weekly tax-exempt floating rate, which is currently 1.67%. At the end of every six month period, those two payments would be netted against one another, and the hospital would either receive a payment or make a payment. In the current market, the payment to the hospital would be the difference between the 3.70% and the current market floating rate of 1.67% and would result in a net payment to the hospital of between $700,000- $800,000. The fundamental risk is that short-term interest rates rise over time. In the current market environment, NHRMC would receive significant financial gain from the transaction. It is clearly a risk that short-term interest rates can and probably will rise over time. The intention of the program is not to undertake a single transaction, but rather, as interest rates rise or fall, NHRMC has the ability to restructure the contract in a way that preserves their gain. As rates rise, the term of the contract is extended. Two to three years ago, SSB recommended a fifteen or twenty year contract based on the high interest rates at that time. The current market environment calls for an agreement between five and ten years because interest rates have fallen. SSB purposely shortened the term of the contract because of the low rates and the expectation that rates will rise in the future. In the second part of the transaction, the hospital will probably enter into a transaction to hedge a portion of that floating-rate risk. In other words, to mitigate a portion of the cost as rates rise they will bear the brunt of the loss. Although this may be a new concept for some, it is a market that is used by corporations, home loan banks, insurance companies, state and local governments, not-for-profit hospitals, and public universities. In the current market, SSB has executed a little over $12 billion in transactions for their clients in the last two years. It is a very sizeable market and a number of recognizable institutions have undertaken similar programs. Vice-Chairman Greer asked what percentage of the debt ratio SSB was recommending for the hospital. Kathleen Gormley, NHRMC Financial Officer, responded that out of the $200 million outstanding debt, the hospital intends on having 25% or $50 million of variable type debt. The $200 million debt will stay as it is, but NHRMC would contract for a portion of the debt variable. Having a 25% variable and 75% fixed rate is a conservative position, which the Board of Trustees supported. Chairman Davis asked County Finance Director Bruce Shell to comment on the proposed program. Finance Director Shell commented that NHRMC has $200 million worth of debt and SSB wants a separate contract for $50 million. SSB will pay NHRMC 3.7%, a fixed rate amount, and NHRMC will pay SSB 1.7%, which is the current variable rate. The hospital receives the difference between what NHRMC receives and what it pays. They would benefit at 2% of $50 million or $1 million per year. In essence, SSB is willing to take the risk on the variable rates staying low. In the event the rates start to climb, SSB gets some of the money back from the rate adjustment in getting a second swap. It is extremely complicated, but the fixed rate on the $200 million at 5.15% does not change. The arrangement allows a separate contract with the hospital receiving more money than paying out. In the event of variable rates going up, they are banking on short-term investments for NEW HANOVER COUNTY BOARD OF COMMISSIONERSBOOK 28 MEETING WITH NEW HANOVER REGIONAL MEDICAL CENTERPAGE 901 NOVEMBER 19, 2001 the interest income to rise. If this arrangement starts to get a little tight, then they are banking on their investment income going up to help compensate for it. Director Shell stated that NHRMC has looked at the program very closely and they are comfortable with the arrangement. It is an acceptable risk. Chairman Davis asked, other than the $1 million profit, what other aspects of the plan are positive. Finance Director Shell responded that the plan primarily improves NHRMC’s bottom line. Organizations like to have a certain percentage of variable debt to match their investment income. Having a good low rate on their debt, he would tend to think the primary focus was on trying to improve the bottom line. The hospital has an average rate of 5.15% for the entire $200 million of debt. In his discussions with Ms. Gormley, Mr. Bradshaw, and Mr. Usry, they have been receptive to his comments and point of view on the issues. Vice-Chairman Greer asked how long a period of time a contract generally is. Mr. Usry responded that the contracts can be entered into for short or long periods, from six- eight months to forty years. As in buying bonds, the longer the term, the higher the return. There is a balance between the length of the contract and the relative risk. Currently, SSB’s recommendation is between five and ten years in term, whereas two years ago, when rates were significantly higher than now, the recommendation would have been between fifteen and twenty years in term. Ms. Gormley asked Finance Director Shell if he were comfortable with the terms. Finance Director Shell said he is satisfied with the business standpoint of the issues and the fact that the hospital is comfortable with the risk they are taking. He pointed out that if the short- term rates were to rise, Mr. Usry has implied that the contract could be reconstruct to roll into another arrangement. From his conservative point of view, he would not like that much exposure and he suggested a lower percentage of money in the contract and to link the earnings to the debt in order to pay down the debt. Ms. Gormley has been very careful to keep a certain percentage of short-term investments and has some flexibility when rates turn. They are watching their cash flow and maintaining their investments to support it. Chairman Davis asked if he thought the 25% was acceptable amount. Finance Director Shell said it is for NHRMC, but for him it would have to be lower. He felt that 25% was sufficient. In response to questions from Chairman Davis on the down side of this type investment, Director Shell said as the rates go up, the investor would be paying more. Once the rates start rising, it would be cost prohibitive to get out of the contract. The investment program is a long-term decision in the sense that if rates rise, the hospital would have to stay the course of at least the original contract. Mr. Usry explained that if NHRMC had been in the program two years ago when they first began talking about it, the fixed rate for 10 years was probably close to 4-1/4% to 4-1/2%. They would be paying the floating rate today at 1.67%. The benefit to the hospital would be 260 basis points or 2.5% on $50 million, which would be about $1.5 to $1.75 million per year. The economic downfall has had a positive benefit for anyone who did it a year or two ago because they were paying a short-term floating rate which tends to decline as the economy has difficulty. Finance Director Shell informed the Board that the County could not legally participate in this type investment program. However, NHRMC is structured as a non-profit corporation and is eligible for the program. Chairman Davis cautioned that when dealing with public funds, the County wants to make NEW HANOVER COUNTY BOARD OF COMMISSIONERSBOOK 28 MEETING WITH NEW HANOVER REGIONAL MEDICAL CENTERPAGE 902 NOVEMBER 19, 2001 sure it’s the right thing for the hospital and that they do not lose money on the deal. Commissioner Pritchett asked if assets are pledged against the hospital’s existing debt. Finance Director Shell responded that the hospital has issued revenue bonds and pledged revenues from the hospital corporation. Their balance sheet shows $200 million in liabilities in long- term debt for an average of 22 years. NHRMC will depend on SSB to know the market and the best contract arrangement for the hospital. Before rates dropped, they were thinking maybe 15 years, then 10 years, and now they are thinking 25 and 10 because rates may go up sooner than they previously thought. Chairman Davis spoke on the importance of trusting the people appointed to the Board of Trustees and the hospital staff in making the best decisions for the public and the hospital. However, he felt the hospital should not go with more than the proposed 25% investment. President Atkinson responded that the staff and Board of Trustees were conservative in nature. They had seen that hospitals like Forsythe Memorial in Winston Salem (the largest hospital in the State), Presbyterian in Charlotte, Charlotte Memorial and other large systems in the State, were investing with similar programs. They have not rushed into the program, but in fact have been looking at it for three years. The hospital needs to look at every option within reasonable risk to help pay the bills. He felt his responsible role would be to bring the matter to the Board of Trustees as an option. The trustees will make decisions based on the facts as presented to the Commissioners. Chairman Davis expressed appreciation to Dr. Atkinson for the informative presentation. He adjourned the meeting at 3:10 P.M. Respectfully submitted, Teresa P. Elmore Deputy Clerk to the Board