Opportunities Abound: Health Care Tax-Exempt Capital Markets Update

In an increasingly regulated health care industry with its fair share of challenges, organizations are always on the lookout for opportunities to access low-cost capital to improve and/or expand their facilities.

Over the past decade, we have gone through one of the nation’s worst financial crises, revamped our health insurance system, and watched the massive silver tsunami of seniors in need of care steadily approach. Although the implications of these developments for operating hospitals and senior housing facilities continue to evolve, the impact on the capital markets has created a number of opportunities. Foremost is a historically low interest rate environment and a change in the types of bond structures available for financing. For nonprofits that have maintained strong credit profiles, these changes offer opportunities to save significant interest expense, as well as craft covenants and terms that better fit the future of their organizations.

Historic Times

The biggest impact of the financial crisis has been a paradigm shift in global economic growth expectations, and as a result interest rate levels that continue to set new record lows. It began with the Federal Reserve taking short-term interest rates to near zero in an attempt to flood the markets with low-cost funds. While the United States has demonstrated growth the past several years, much of the rest of the world has continued to face a combination of financial challenges. Although the Fed began raising short-term rates in 2016, the capital markets have actually seen the 10-year U.S. Treasury hit a new all-time low in July 2016.

While the low interest rates are wreaking havoc on investors that rely on fixed income, for capital intensive businesses the borrowing opportunities are excellent. Refinancing numbers are a good indication of this and nonprofit hospitals and seniors housing and care providers have reacted accordingly. While in 2008, health care bond issues involving some form of refinancing totaled approximately 54% of the volume, in 2015 it reached 74% of total volume. It’s not surprising considering that the Bond Buyer Revenue Index, a leading industry benchmark for tax-exempt levels, has fallen to nearly three-percent, a 44% drop compared to the 2008 average for the index.

Options Changing

While interest rates are published and continually updated, less visible are the changes that continue to impact investors in health care related tax-exempt bonds. Perhaps the best example is letter-of-credit (LOC) and bond insured structures that have become practically extinct due to changing banking regulations that significantly increased their costs. For comparison, in 2008 $22.4 billion of nonprofit health care issuance involved a LOC or bond insurance. In 2015, that market was only a fraction of its previous size, with volume of approximately $268 million (Figure 1).


More surprising is the downward trend in overall issuance. Despite robust demand for construction and refinancing, the Bond Buyer’s volume statistics for health care issuance remains a fraction of pre-crisis levels. Figure 2 compares average issuance from 2004 to 2006 as compared to 2013 to 2015. The total volume is down nearly 20%.


So where are hospitals and senior housing organizations getting their funds? The answer is the rise of private placement structures with commercial banks and other institutional investors. Rather than pursuing bond ratings and/or LOCs and issuing bonds through offering statements, organizations are directly placing mortgages and debt. Benefits of the structure have included:

  • Opportunities for variable rates, as well as up to 20-year fixed rates
  • Less cumbersome issuance and ongoing compliance
  • Ability to avoid unnecessary debt service reserves and structure draw-down construction loans; this feature alone has the potential to save a project several million dollars

Commercial banks in particular need to fill the revenue hole that was provided by LOCs. As a result, the same health care teams that underwrote the LOCs are now spearheading lending through the private placement structures.

Access to Capital

In 2016 and 2017, we will continue to see the implementation of finance reform laws intended to curtail the excesses and mistakes of the mid-2000’s. A prime example of this is the new regulations governing high volatility commercial real estate (HVCRE) that went into effect recently. The HVCRE rules require lenders to assign a higher risk weighting to loans for the acquisition, development or construction of commercial real estate. For hospitals and senior housing organizations, it reinforces the need to maintain a strong credit profile and prudent capital strategy.

Commercial banks, as well as other investors, routinely review both quantitative and qualitative factors when assessing an organization’s credit strength. A borrower’s ability to repay debt will place them in a broad credit range, depending on several financial yardsticks. More qualitative measures then refine that credit range and place an organization within a more specific context that includes leadership and ongoing strategic viability.

Financial ratios that demonstrate financial performance are used in quantitative analyses. These ratios can be generally grouped into three categories: capital structure, liquidity, and profitability. The following ratios tend to be relied upon most frequently when assessing creditworthiness:

  • Debt service coverage
  • Days cash on hand
  • Operating margin
  • Debt to capitalization
  • Cash to debt

A credit assessment that considers only quantitative financial ratios, however, is inadequate. Thorough credit analysis should go well beyond the organization’s financial statements. Qualitative factors such as management, local economic factors, demographic changes, competition, and technological capabilities are important aspects of the credit profile. Particular attention will be given to board members’ involvement and independence as well as management’s experience and proven skill sets.

Ignorance of any of these factors can produce an incomplete analysis of an organization’s credit profile and financial options. For example, an organization with strong financial ratios located in a highly competitive or struggling metropolitan area may find accessing capital more difficult than its financial ratios suggest. Conversely, a well-articulated qualitative analysis of an organization’s market position or area demographics may allow it to access capital at a lower cost than its quantitative profile might suggest.

Green Country Village

An excellent recent example of an organization’s leadership using the current environment to their advantage is Green Country Village Seniors Housing Community, located in Bartlesville, Oklahoma. During the early 2000s, the community experienced financial difficulties which necessitated a restructuring of its debt at the beginning of 2005. Although Green Country Village retained its independence, its interest rate on the restructured debt was significantly higher and required several cash escrows. As such, it sought to refinance its debt into a more cost-effective structure as soon as possible.

Ultimately, they settled on a privately placed $6.7 million tax-exempt note with a regional bank. The final fixed interest rate was below 4% and generated more than $70,000 a year in annual savings. In addition, because the final negotiated terms included no cash escrows, approximately $250,000 was released at closing to Green Country Village.

However, this would not have been possible had Green Country not taken significant steps to strengthen its credit profile and underlying financial infrastructure. Key successes included achieving a stable operating income as well as the implementation of the fiscal discipline necessary to build cash reserves from its profits.

Path Ahead

Green Country Village provides an example of how staying aware of market conditions can produce tangible results in an organization’s bottom line. During a time of many cost pressures – IT requirements and nurse shortages to name just two – its critical for management to be cognizant of an opportunity to realize expense savings and cost-effectively fund positive present value capital projects. There is a very real window of opportunity for organizations with high-interest rate debt that will be callable, and for those with project opportunities in the near future. As the markets change, staying aware of market conditions and potential opportunities will be of paramount importance for health care providers, allowing them to best position their facilities financially in both the near- and long-term.

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