The complex financial arrangements that recently caused huge paper losses at Maryland's largest hospitals have been commonly used for years to protect them against big interest rate increases when they sell bonds to pay for construction projects and the like.
But volatile and highly unusual market conditions, including some of the steepest interest rate declines on record, quickly turned these supposed hedges into huge liabilities late last year.
On Thursday, the Maryland Hospital Association said 34 hospitals had total losses of $466 million in the fourth quarter of 2008. Many of the losses can be traced to these deals known as interest rate swaps. Health care operations, while being squeezed, are still in the black overall.
These reversals came at a time hospitals are suffering major losses from investments, people are putting off elective surgeries and others are unable to pay for treatment. "Many organizations find themselves ill prepared for the sudden drain on liquidity that swap liabilities can cause," according to a report by Moody's Investors Service's health care policy team last month.
"Interest rate swap" is one of many exotic financial terms that have gone Main Street in recent months as the economic crisis has spread from Wall Street. Hospitals aren't the only ones using these arrangements, which are common among not-for-profit borrowers. For the most part, institutions using them are not gambling, several experts said.
Simply put, a hospital, in this case, makes a financial contract with some other party to protect itself in case interest rate increases drive up the costs on variable-rate bonds it sells to investors. It promises to pay the other party a fixed rate of interest in exchange for getting a variable rate back. So if rates rise, the hospital's increased income from its part of the swap offsets the higher interest it has to pay on its bonds, and perhaps generates a gain.
But when interest rates plummeted last year in response to the recession, the hospitals were left paying far higher fixed rates on the swap contracts than they were getting back in variable rates.
In some cases, the contracts lost so much value that the hospitals were forced to quickly post cash for collateral.
"They're not speculative transactions - these were very mainstream, well-accepted mechanisms for funding legitimate capital projects," said Brad E. Spielman, a Moody's senior analyst. But, he added, "these are very extraordinary times. Where we are is off the charts in terms of what was expected" when hospitals signed these deals.
