Hospitals can effectively manage the fees associated with issuing ?tax-exempt debt and help minimize their ongoing cost of funds.


Issuing debt involves costs incurred at the time of issuance, as well as ongoing costs. Both can be managed by following certain steps.

Understanding Up-Front Costs

Up-front costs are referred to as costs of issuance (COI) and vary based on the type of tax-exempt debt offering and specific structure. These costs are generally capped per IRS rules to a total of 2 percent of par. The portion of COI that exceeds the 2 percent cannot be paid out of tax-exempt proceeds and must be paid from funds on hand.

The single largest component of COI is the fee paid to underwriters for selling the bonds to investors. This fee can be as much as half of total COI. Other COI include legal fees such as bond counsel, underwriter's counsel, and hospital counsel fees, and other fees including rating agency, bond insurance, issuer, financial adviser, and trustee fees.

Also known as underwriting spread, the fees paid to underwriters to sell bonds to the public are generally quoted in dollars per thousand dollar bond. For example, a $10 spread on a $50 million offering represents a fee of 1 percent or $500,000.

Hospital and health system finance leaders should know that underwriting spreads have steadily declined across all sectors in recent years, and particularly in healthcare (see the exhibit below). According to Thomson Reuters, the average spread for all negotiated municipal bonds was $13 in 1986. In 2013, it was down to $5. In the last five years, the average underwriting spread for hospital bonds went from $8 to $6 per bond. The drop in spreads has benefited hospitals across the entire rating spectrum.

Hospital Bond Underwriting Spreads, 2010-14
Hospital Bond Underwriting Spreads, 2010-14

The major factor behind lower underwriting spreads is supply and demand. Hospital issuance has steadily declined in the last several years, with 2014 the slowest year since 2001, in part due to the emergence of bank placements, which do not require an underwriter. Fewer deals means more competition among underwriters. As a result, hospitals are in improved positions to negotiate lower underwriting fees.

Contrary to what some underwriters say, there is not much difference in fees charged for smaller hospital deals, unless the issue size is below the $25 million mark (see the exhibit below).

Hospital Bond Underwriting Spread by Par Amount, 2010-14
Hospital Bond Underwriting Spread by Par Amount, 2010-14

Underwriting fees vary more widely in the BBB category; fees are tighter for higher-rated hospitals in the A and AA categories (see the exhibit below). This may be the result of lower-rated hospitals being less familiar with the underwriting process, more complex credit pictures requiring additional work from underwriters, and generally fewer deals involving financial advisers who could help negotiate fees. Whatever the situation, the wider range of fees creates an incentive for these hospitals to negotiate more aggressively with underwriters.

Hospital Bond Underwriting Spread Distribution, 2010-14
Hospital Bond Underwriting Spread Distribution, 2010-14

Besides underwriting fees, legal fees are the other major cost incurred at the time of issuance, including bond counsel, underwriter's counsel, and hospital counsel.

The hospital should request estimates from each counsel, preferably not to exceed a specific amount. Underwriter's counsel is typically selected by the underwriter subject to the borrower's approval, and their fee depends on whether they are in charge of assembling the Appendix A to the official statement. Appendix A provides a detailed description of the borrower including its market, utilization, and financial results, and often requires significant time and resources to draft. This should be factored into the side-by-side comparison of underwriter's counsel quotes. Bond counsel fees vary depending on the regulatory approval process, with some bond counsels unwilling to quote capped fees until the process has been more defined so they can better estimate the amount of work required.

There are also other fees, including those from the following sources:

Rating agencies. Most public offerings are rated by one or more rating agencies; a bond rating provides bondholders with an indication of the likelihood of getting repaid.

Bond insurance. Insurance guarantees debt service payment to bondholders, although its use is less common.

Issuer. The state or local government issues the bonds on behalf of the hospital as the obligor.

Financial adviser. This third-party expert advises the hospital on the financing.

While some fees may be non-negotiable, they should still be identified and estimated. For example, rating agency fees should be quoted and budgeted for based on the preliminary plan of finance and which rating agencies will be involved. Rating agencies also charge ongoing surveillance fees. The hospital CFO should discuss with the financial adviser and underwriter(s) the value of obtaining more than one rating for its bonds and whether bond insurance would be of benefit.

Related Sidebar: Case Study on Bond Underwriting Fees

Accounting for Ongoing Costs

Interest is the primary ongoing expense of a tax-exempt bond, and it is measured based on yield-the bondholder's rate of return on the bond. Hospitals sometimes fixate on up-front costs and ignore the fact that yields have a much longer lasting impact on the hospital's overall cost of debt. An underwriter's ability to achieve aggressive yields on day of pricing will affect the hospital's ongoing cost of debt for as long as the bonds are outstanding. For example, savings of 0.20 percent over 30 years can add up to close to $1 million on a $50 million offering.

The challenge is that market conditions change constantly and yields cannot be known with certainty until the deal prices.

Financial advisers are often expected to pay for their fees by negotiating lower fees from underwriters. While hospitals can reasonably expect to lower underwriting fees by running a competitive bid process, greater savings can be achieved when the financial adviser helps position the hospital in the most favorable light with rating agencies and investors, sets expectations with the underwriter early on, and closely monitors the markets and underwriter performance on the day of pricing.

Contrary to popular belief, being significantly oversubscribed is not a positive characteristic of an offering: Oversubscription simply indicates that yields were set by the underwriter at levels higher than what investors required.

Minimizing Costs

Hospital finance leaders can take these two steps to minimize costs:

Develop a preliminary plan of finance. Bringing in a financial adviser or another party early on whose sole fiduciary duty is to the hospital can help narrow down alternatives before members of the working group-which typically includes the underwriter, issuer, legal counsels, and financial adviser-are selected. At minimum, the hospital should develop a preference for whether the debt will be issued on a public or private basis, what the interest rate mode will be, and what regulatory approvals may be needed, as these factors will directly impact costs of issuance. The more specific the preliminary plan of finance, the better the organization can manage costs of issuance.

Conduct a competitive solicitation process. The most effective way to minimize costs of issuance is to request competitive quotes from the various parties considered for the financing. In the case of a public bond offering, which unlike private offerings requires an underwriter, it is highly recommended that the hospital run a competitive request for proposals process for underwriters. When it comes to underwriters, the process should be truly competitive; if the hospital gives any hints of having already made a decision, the level of interest, quality of responses, and proposed fees will all be negatively affected.

Seeking Competitive Quotes

Seeking competitive quotes for costs of issuance is always a good idea, particularly for lower investment grade hospitals that may be facing higher fees. Costs can be managed by following certain steps, but hospitals should also focus their efforts on selecting an underwriter who can price bonds at aggressive yields to minimize the ongoing cost of debt.


Pierre Bogacz is managing director and co-founder, HFA Partners, LLC, Tampa, Fla., and is a member of HFMA's Florida Chapter.

Bruce Deskin is managing director, HFA Partners, LLC, Houston, and is a member of HFMA's Texas Gulf Coast Chapter.

Publication Date: Wednesday, August 12, 2015