August 10, 2005
Up through the early 1990s, not-for-profit healthcare executives relied almost exclusively on tax-exempt financing, and some leaders still may not be aware of the full range of financing options that can help them secure the funding necessary to fulfill their missions.
Therefore, a discussion of nontraditional debt offerings is included in the latest report in the Financing the Future II series, which examines strategies for optimal capital structure management. The report was developed by HFMA in partnership with GE Commercial Finance Healthcare Financial Services and Kaufman, Hall & Associates, Inc.
Types of Nontraditional Debt Offerings
Off-balance-sheet (OBS) options. OBS financing structures, such as operating leases, sale/leasebacks, synthetic leases, and joint ventures or master leases, effectively let a hospital "own" and use an asset that is technically owned by a third-party investor. As such, neither the asset nor the liability is recorded on the hospital's or lessee's balance sheet.
Not every venture lends itself to OBS financing, nor does every healthcare entity have access to all these types of financing. Moreover, the extent to which the capital markets view OBS financing as debt depends on whether the assets financed are strategic or ancillary to the core business and the overall magnitude of OBS exposure. Healthcare financial leaders should carefully weigh whether a project lends itself to OBS financing against the trade-offs among the balance sheet benefits, income statement effects, and any potential loss of control over the asset.
Real estate investment trusts (REITs). An REIT is an entity whose primary activity is to purchase a portfolio of real estate assets, such as hospitals, nursing homes, or medical office buildings, and lease the property to one or more operators. REIT investors earn their return through lease payments and the eventual sale of trust properties. They typically are interested in high performing properties that do not need to be directly owned by a healthcare entity. REITs permit healthcare organizations to obtain cash for real property, reduce overall cost of development transactions, achieve OBS financing, and under certain circumstances, maintain control of facilities and property.
Participating bond transactions (PBTs). Used to finance projects in other industries for more than 20 years, participating bonds have recently been introduced in healthcare finance as an alternative to equity joint ventures for not-for-profit and public hospitals. PBTs are now being used to structure hospital/physician transactions involving new debt for facilities or refinance existing hospital debt.
"PBTs enable the sponsoring hospital to preserve a higher percentage of operating income, retain ownership of all assets and operations, preserve the low cost operating environment of a tax-exempt charity, and greatly reduce the regulatory risks associated with hospital/physician transactions," notes Robert H. Rosenfield, partner of McDermott Will & Emery. "They align incentives for physician and hospital financial performance. Bond performance can also be linked to non-financial indicators, such as improvement in quality of patient care and patient satisfaction. PBTs can be used to create investment opportunities in any facility that could be structured as a joint venture, such as ambulatory surgery centers and imaging centers, and can also be used with existing facilities. They do not involve an advance refunding," adds Rosenfield.
Receivables financing. With reduced payments to providers, liquidity has become an issue requiring securitized funding mechanisms. Receivables financing is one such mechanism that can be considered by hospitals in tight liquidity situations. It involves the sale or pledging of an organization's accounts receivables and the securing of financing against such receivables.
Private placements. Private placement arrangements may be useful for debt for smaller capital needs or in between major bond issues. This type of financing involves a lender who will both underwrite and hold a bond issue. Although the coupon rate paid on this type of financing is usually higher than that paid in the bond market, the transaction costs are typically much lower, resulting in "all-in" rates that can be comparable to those found in the bond market for some borrowers.
How to Choose?
The variety of nontraditional debt offerings and their associated risks can be daunting. Randy Fuller, hospital segment manager for GE Commercial Finance Healthcare Financial Services, recommends that organizations start with a blank page and first establish risk parameters given their position in the marketplace, financial performance, and credit rating. From that base they can identify available options and assess each option's ability to meet capital structure needs.
SOURCE:
Strategies for Effective Capital Structure Management, the second report in HFMA's Financing the Future II series. This article also contains excerpts from "A Capital Idea: Bonds and Nontraditional Financing Options," by Therese Wareham, May 2004 issue of hfm.
Additional Resources
- Financing the Future web site
If you have questions or comments about HFMA Wants You to Know, contact editor Laura Noble.
HFMA Wants You to Know ISSN: 1540-0697. Volume IV, Issue 15. Copyright 2005, Healthcare Financial Management Association. All rights reserved.