CHICAGO - In the first deal of its kind, a Federal Home Loan Bank recently provided a letter of credit for a tax-exempt health care bond issue that participants said offers an attractive option for smaller issuers struggling to secure credit enhancement in the current market.

The transaction was made possible by the new authority Congress granted the banks last summer under the massive Housing and Economic Recovery Act of 2008. FHLBs previously could only provide letters of credit for tax-exempt or taxable housing deals.

Under the new law, the banks can support a wide variety of tax-exempt projects, though only for those issued after the law was enacted, on July 31, 2008. The program is currently set to expire on Dec. 31, 2010, though the deadline is expected to be extended if the program proves popular, bank officials said.

Using the new authority for the first time, in late October Columbus-based underwriter Lancaster Pollard priced a $6.9 million tax-exempt revenue bond deal backed by a direct-pay letter of credit from the triple-A rated Federal Home Loan Bank of Indianapolis. The bonds were issued on behalf of Swiss Village, a small, unrated continuing-care retirement community located in the town of Berne, Ind., with a population of 4,100.

The floating-rate deal that is remarketed weekly has captured rates in the 2% range of late. The borrower converted about 65% of the deal to a synthetic fixed-rate swap, under which Swiss Village pays 4.9%, which includes the LOC and remarketing fees, and receives Securities Industry and Financial Markets Association index rate in exchange from the counterparty.

"With the change in the credit market we're really having to get more creative with funding structures," said Steve Kennedy, Lancaster Pollard's vice president. "The Federal Home Loan Bank option is a really nice arrow to add to our quiver." Ice Miller LLP acted as bond counsel on the deal.

The law requires involvement of a local member bank, and in the case of Swiss Village, the FHLB of Indianapolis issued its letter of credit in conjunction with two local banks that posted collateral, Kennedy said.

While FHLBs are allowed to enhance a deal of any size, many issuers could be restricted by the involvement of a local member bank. For example, the Swiss Village finance team shaved about $200,000 off the transaction as the two local banks together had a maximum lending limit of $7 million, Kennedy said.

Lancaster Pollard is currently working with another Indiana-based hospital that is considering using the same structure, but this time with a syndicate of smaller banks, which would allow the financing of a larger sized deal, Kennedy said.

In addition to offering credit at a time when many issuers - especially smaller, unrated issuers - are having a difficult time securing enhancement, the FHLB letters of credit come with a 10-year renewal term, Kennedy said. Most letters of credit come with renewal terms ranging from three to seven years.

"It reduces renewal risk," Kennedy said, noting that many issuers are now facing the possibility that their credit providers will not renew letters of credit in light of the ongoing credit crunch. "Especially in this environment, when you're looking at capital funding options, it's not all about price or cost of capital, it's a lot about terms. To be able to mitigate risk that far out was a huge plus."

The annual fee for the FHLB letter of credit was less than 1%, which is split between the member banks and the FHLB of Indianapolis, Kennedy said. "Compared to other letter of credit fees, that's going to be very competitive, especially in light of the capital market today."

Since the deal was completed, Kennedy and FHLB officials have fielded a number of phone calls from interested market participants and other FHLB members.

"The information is just now getting into the marketplace," said Doug Iverson, senior vice president of marketing at FHLB of Indianapolis. "This may find a niche in the marketplace, where local financial institutions are very involved in the project that doesn't have a rating and needs the support of a triple-A or double-A rated organization that can provide credit on the front end."

Of the 12 FHLBs, 10 carry a triple-A rating, with those of Seattle and Chicago carrying ratings of AA-plus and AA, respectively, from Standard & Poor's. Moody's Investors Service rates them all Aaa. There are 8,100 federal home loan member lender banks nationally.

The deal comes as the Federal Home Loans Banks are lobbying to be allowed to provide credit enhancement on even more tax-exempt deals as well as enhance remarketing issues, not just original issues sold after the new law, Barbara Watkins, assistant general counsel for the Federal Home Loan Bank of Chicago, said in comments at a Bond Buyer conference last week.

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