Welcome to the Fall 2007 edition of The Capital Issue. This edition features an overview of letters of credit, an enhancement that can be very appealing for borrowers across the credit profile continuum. We also cover borrowing options for weaker hospital credits, and review recent activity in the senior living markets. This season's Nonprofit Minute focuses on a hot topic for nonprofit borrowers - alternative investments. Of note, this is the time of year when affordable housing developers who are considering using tax credits should start the financing process, as Ginger McGuire writes in the affordable housing section.
As always, we welcome your suggestions for content. Additionally, we are considering offering The Capital Issue as a hard copy newsletter.
Thomas R. Green, CEO
A letter of credit issued by a commercial bank is an irrevocable obligation to make bond payments if a borrower cannot. With that support, a borrowing organization can issue bonds backed by the bank’s credit strength. This credit enhancement can make borrowing more affordable for organizations that wish to issue bonds, but have limited credit strength, putting other forms of enhanced or unenhanced bonds out of their grasp.
This fall, credit rating agency Standard & Poor’s issued a report expressing concern over the credit risks of nonprofit health care providers with speculative-grade ratings. While few small hospitals carry actual credit ratings, many would be considered speculative-grade (BB+ or lower) if they did. The overall commentary on the perceived risk in these potential borrowers serves as a reminder of the importance of understanding a hospital’s complete credit profile, as well as the various financing options available to weaker credits.
Tax-exempt bond volume in the nonprofit senior living sector was up 41 percent during 2006, to almost $6 billion. Much of this growing stream of capital funded new construction and substantial rehabilitation projects, further upgrading and expanding the country’s senior living stock, which now totals an estimated 57,840 facilities. Over the past few months, however, senior living stakeholders have been forced to re-examine the sector’s future growth prospects as the economy digests the current subprime mortgage meltdown. Is the current housing slump going to affect senior housing development?
The U.S. Department of Agriculture’s Rural Development Office of Multi-Family Housing estimates that 4,250 Section 515 affordable rural housing properties “will physically deteriorate to the point of being unsafe or unsanitary within the next few years.” They further estimate the injection of capital required to preserve these 85,000 units at as much as $3.2 billion for portfolio-wide rehabilitation; accommodating merely the most distressed would still cost $850 million.
Now more than ever, institutional investors are being urged to allocate funds to alternative investments. The conventional wisdom is that this kind of portfolio diversification will improve future returns, since returns from these non-publicly-traded investments are not correlated with those of conventional asset classes. While it is true that in many cases, asset classes within the alternative investment universe have significantly outperformed equities and fixed income without obvious evidence of increased risk, it is also true that there is no free lunch: Investments promising outsized returns are always associated with significant risks that may or may not be appropriate. The key to deciding whether to make an allocation to an alternative investment asset class is a strong understanding of what is available and of the nonprofit organization’s ability to understand the product.