The University of Maryland Medical System has set aside tens of millions of dollars because of complex financial transactions related to interest rates that have not paid off — yet.
The medical system cannot use those funds — $93 million at the end of March — even as it wrestles with financial pressures that have led to layoffs.
Several years ago, UMMS entered into what are known as interest rate swaps when the financing tool was popular and widely used by hospitals, municipalities and businesses looking to protect themselves against the risk of rising interest rates.
In an interest rate swap, an entity such as a hospital executes a contract with a bank to transfer that risk. In this case, the hospital system agreed to pay a bank a fixed interest rate and, in return, the bank agreed to pay a floating rate on bonds the hospital sold. In such an arrangement, if the floating rate rises, the system is protected because the bank foots the bill.
A UMMS spokeswoman called the interest rates swaps a "prudent financing option" and said they have had no impact on layoffs and other cost-cutting measures. Due to the nature of some of its swaps, UMMS must recognize their market value on its balance sheet, which is why it had $93 million set aside as collateral in March. It must add or subtract to that collateral monthly, which can pinch its cash flow.
A local labor union, pushing for better labor protections for the medical system's 5,000 workers, called the swaps a risky financial scheme and said UMMS is gambling with jobs and money that should be spent on patient care.
The union — 1199SEIU United Healthcare Workers East — is targeting the medical system even though other area hospital systems also use swaps. The Johns Hopkins Health System and MedStar Health joined as many as 500 hospitals around the country that used the financing mechanisms in the past decade.
SEIU representatives said it is targeting the University of Maryland because it gets more public financing and is in weaker financial health than other systems in the region. UMMS owns and operates 11 hospitals across the state, including the University of Maryland Medical Center, home to the Maryland Shock Trauma Center.
"They have been crying poverty to the state over the years, while executives have been giving themselves raises, and there is all this money tied up that doesn't have to be," said Vanessa Johnson, vice president at large for the union.
UMMS spokeswoman Mary Lynn Carter countered that the institution is fiscally responsible and accused the union of spreading inaccurate information.
"All financing arrangements carry some risk, but it is not accurate to characterize interest rate swaps as risky," Carver said. "Issuing variable-rate debt and interest rates swaps are designed to reduce the risk of interest rate fluctuations, not increase the risk."
The medical system believes their use was the best financing option at the time, she said.
"The cost was certainly less using variable interest rates with swaps than if we had followed traditional fixed-rate financing available at the time," Carver said.
Analysts at bond ratings agencies offer mixed views about the risks of UMMS' use of swaps.
A February report by Fitch Ratings suggested that the swaps need to be watched even as it gave UMMS an "A" rating and said its outlook was stable.
"Given market conditions, swap collateral posting requirements have been sizable and volatile," the report said. "Due to UMMS' already weak balance sheet, further demands on liquidity are of concern."
Bond rating company Moody's Investors also noted the swaps in a report released in February but didn't name them as the reason for dropping UMMS' outlook from stable to negative. Instead, Moody's report said it was more worried about how recent acquisitions, including that of St. Joseph Medical Center in Towson, would affect finances.
Sarah Vennekotter, an assistant vice president at Moody's, said that interest rate swaps can become problematic if they cause a cash crunch for a company.
"It can start to deplete cash flow if large amounts of collateral are being posted," Vennekotter said. "We do look at it as a credit factor if we see a borrower that we rate has lot of swaps or collateral posted and it comes to a point that it is so much that the cash ratio declines."
The amount of collateral that UMMS has had to set aside has diminished as interest rates have begun ticking upward.
At the end of fiscal year 2012, it had nearly $122 million reserved. That fell to $108.9 million on Dec. 31 and to $93 million as of March 31. And, Carver pointed out, that money remains the medical system's, and it earns interest on it.
When the collateral requirements fall, that reduction is recognized as income. When it rises, it reduces the system's income.
The need to post such collateral has hammered some institutions, resulting in significant losses and layoffs. South County Hospital in Wakefield, R.I., was forced to cut jobs a few years ago after it had to give $12.7 million to Merrill Lynch & Co. after a swap backfired, according to a Bloomberg News story.
Johns Hopkins Health System said in a statement it used interest rate swaps in the past to "turn variable rate debt into a more predictable fixed rate." It entered into its last swap in 2007 and said recent lower interest rates have enabled it take advantage of traditional fixed-rate financing.
Like UMMS, Hopkins is still invested in past swaps and puts aside money each quarter it can't touch in case it defaults on its swap agreement. The system posted $103 million of collateral in the third quarter of its 2013 fiscal year ended March 31.
While Hopkins has more exposure than UMMS, the union contended that Hopkins is a larger, more lucrative system that can better afford to put aside collateral. Hopkins posted operating income of $208.5 million in its 2012 fiscal year, while UMMS reported $71.7 million.
MedStar Health, which declined to comment about its use of swaps, has much less money tied up in the financing mechanisms than Hopkins or UMMS. At the end of March, the medical system had no collateral posted.
Little was known about swaps when hospitals and other companies began using them, said Jeff Bauer, an independent Chicago-based medical economist and health futurist.
Swaps were one of many risky financing tools companies used when the economy was booming, Bauer said. Many hospitals around the country lost money on the agreements when interest rates didn't rise.
"There were pretty aggressive financial decisions made over the last 10 years based on the fact that things would always be good," Bauer said.
Entities can pay to cancel swaps, but it's costly. At the end of March, UMMS could have paid $183 million to cancel its contracts, and Hopkins would have had to pay nearly $233 million. MedStar only would have had to pay $20.3 million.
Analysts said there is no rule on whether a company should take the financial hit to get out of a swap or hold onto the agreement until interest rates are more favorable.
UMMS' swaps still could pay off if interest rates rise steeply before the underlying bonds come due. The system has no plan to terminate them, Carver said.
She also insisted that the swaps did not influence cost-cutting decisions at the system, including layoffs this summer at its main campus in Baltimore. She said hospital rates, which are set by a state board in Maryland, and Medicare payments have hurt hospital revenue. Hospitals are also seeing patient volume decline as medicine moves to a model focused more on outpatient care.
"All hospitals in the state have been required to do more with less," Carver said. "Our situation is no different than most hospitals in Maryland and across the country. The goal is to provide excellent patient care while remaining efficient and financially viable."