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