At a time when national banks are loath to lend, borrowers are turning to a recently-created financing option that lets smaller local banks participate in debt structures usually available only from much larger institutions.

Non-rated and low-investment grade hospitals, senior housing and care providers and others are leveraging local bank resources to finance projects that might otherwise be put on hold.

Congressional legislation opened up this opportunity in June 2008. It allowed Federal Home Loan Bank (FHLB) letters of credit (LOCs) to be used in conjunction with tax-exempt local bank financing commitments, resulting in a financing solution on par with what can be offered by the country’s strongest investment-grade rated banks, and enabling non-rated borrowers to issue bonds with the high FHLB ratings, most of which are AAA.

The change came just before the near-collapse of the capital markets in fall 2008, when larger banks that had more exposure to sub-prime mortgages stopped lending to all but the highest-rated borrowers.

Swiss Village, a continuing care retirement community in Berne, Ind., was the first to utilize this structure. Lancaster Pollard financed the new wellness center and renovations to the senior living campus’ assisted living facilities through tax-exempt bonds enhanced by a $7.0 million direct-pay LOC from the Federal Home Loan Bank of Indianapolis. The FHLB LOC is ultimately supported by two local banks, neither of which has an independent credit rating. Wrapping the local banks’ LOCs with the Federal Home Loan Bank LOC provided a higher credit rating, and thus a lower interest rate for Swiss Village.

With the financial markets in turmoil, obtaining this level of credit enhancement (which reduces the cost of borrowing) could have been very costly: The large, investment-grade rated banks that typically offer letters of credit were, and are, experiencing historic financial challenges.

And because the majority of local banks do not maintain investment-grade ratings, they typically could not provide borrowers this type of credit enhancement unless a larger national bank also participated.

Community banks’, borrowers’ and underwriters’ awareness of the FHLB LOC option has been slowly improving, helped by education sessions put on by the FHLBs. Several FHLBs have held education sessions to introduce the product to member banks.

Some of the responsibility for taking advantage of this option, however, still falls to the borrower and its financial advisor or investment banker, as knowledge distributed to bank leaders through webinars may take some time to make it through the system to lending officers working directly with borrowers.

The FHLB LOC wrap is a viable option for small-to-medium-sized projects, but it will be limited by the local banks’ capacity to lend. Some smaller banks cannot take on too much exposure to one particular borrower, making loans of over $15 million or so more difficult for one bank to handle on its own. In the case of a larger project, however, the borrower has the option to involve multiple local banks, so long as the banks are willing to take a parity security position in the collateral.

Congressional permission for the FHLBs to credit-enhanced new tax-exempt non-housing bonds expires Dec. 31, 2010, though LOCs put in place before that time will be able to be renewed down the road. Efforts are under way to request permission to continue the product for new enhancements after Dec. 31, 2010.

Despite the yet-to-thaw markets, demand for healthcare and seniors housing capital remains strong, and providers cannot always wait for optimal market conditions.

Steven W. Kennedy is a vice president with Lancaster Pollard, a provider of debt financing and investment advisory services to hospitals and healthcare providers nationwide. He can be reached at skennedy@lancasterpollard.com.