How to Revisit Private Placement Debt
Healthcare organizations with private placement debt secured in the past five to seven years should evaluate their options.
Now that the tax-exempt public markets have reopened to a wide variety of borrowers, it is time to reassess how this debt compares with private placements or direct purchase bank bonds obtained in recent years. Private placements offer three potential options: keep the debt in place, refinance elsewhere, or renegotiate with the current lender.
Earlier in this decade, many healthcare organizations had difficulty accessing capital through the public credit market. High yield funds, which had previously purchased a significant amount of tax-exempt bonds for credits with less than an “A” rating, folded up shop. At that time, the private placement market stepped up to fill the void. Underwriters, or those acting as placement agents, solicited banks on behalf of borrowers to find and directly negotiate financing terms.
Private placements may have helped provide capital, but they also introduced risk to borrowers. Frequently, the structure of these private placements included an interest rate reset and shorter terms. Lenders were unsure of where the market was headed, and commercial banks, in particular, could not offer long-term fixed-rate debt. A typical structure was a five- or seven-year reset amortized over 20 to 25 years, which exposed borrowers to interest-rate risk when the rates reset and produced higher annual payments due to the shorter amortization.
Most banks were lending on an asset basis common to commercial lending practices and required by regulation instead of on a cash flow basis, which was more common in the tax-exempt bond market. The result was that banks held a significant amount of collateral to meet the asset or loan-to-value test. Furthermore, many banks were unfamiliar with the covenants required by the healthcare business model, which were not common measures of credit strength or were volatile (i.e., monthly days cash on hand).
Time to Evaluate Options
For the many healthcare organizations with private placement debt secured in the past five to seven years, the first steps in evaluating their options should be to confirm the conditions of the debt, understand whether the interest rate reset is approaching, determine whether the organization can refinance the debt, and clarify the conditions of a refinance. The loan documents also will specify whether the rate will reset on the basis of some type of index (e.g., LIBOR, prime) and a spread (i.e., your credit charge). These details will either open up or limit the following options:
- Keeping the debt in place and allowing the interest rate to reset
- Soliciting proposals from capital providers
- Negotiating and/or changing the terms with the organization’s existing lender
Keeping existing debt in place. Steep prepayment penalties or “make whole” clauses, which essentially compensate the lender for the interest they would have received if the debt had gone to term, can be economically unfeasible. On the other hand, some borrowers have highly advantageous terms. I know of one hospital, for example, that had a reset rate to the 10-year Treasury note with no spread. Knowing that the interest rate reset was forthcoming in the next six months, the hospitals looked at the volatility and current rate of the index, on which the interest rate is based. The current rate was over 5 percent and the 10-year Treasury note was at historical lows of slightly more than 1 percent. Further analysis disclosed that even under the unlikely scenario of a 3 percent increase, the 10-year Treasury note would not reset to a rate that would make refinancing advantageous. The debt stayed in place and at the rate reset this past June, so the hospital secured a 2.2 percent rate for another five years. With the new rate, the hospital chose to keep making the same payment at the previous rate to accelerate payoff of the debt.
Conducting a request for proposal process and then soliciting bids. Evaluating this option is an effective way for an organization to determine whether to stay with its existing lender or to look elsewhere. Private placements are not subject to the same reporting requirements as municipal bonds, so there is no publicly available offering statement clearly outlining their rates, terms, and fees, which makes it difficult to evaluate whether a deal is a good one. The best sources for finding comparisons are healthcare-specific investment bankers, which continue to be active in the private placement market and can access current rates and terms in the public tax-exempt bond market. When evaluating whether to refinance private placements, four points should be considered.
The first is whether the organization’s “credit strength” has improved since the financing was done. An improvement in financial performance could decrease the spread to the index and could be part of future negotiation with lenders.
The second is to check on whether bank deposits are required, whether the organization has a large number of accounts with the bank, and whether the fees are reasonable. This analysis may trigger an evaluation of banking relationships that includes determining what the organization is paying to maintain accounts and perform routine transactions, and whether separate accounts are needed to segregate funds and, if so, how many.
A third point is whether to tie the organization’s interest rate to a bank lender’s depository requirement. Interest payments may be a little higher, but relationships with local banks and the disruption of moving accounts are valid concerns.
The fourth is to understand what other debt is outstanding, and whether the rate is fixed or varying. Having a mix of variable-to-fixed rates can be helpful to lower annual interest costs and mitigate the risk of rising interest rates.
Renegotiating directly with an existing lender. This option is possible because many bank lenders will want to keep a healthcare organization’s business. They also will be willing to revisit the pre-penalty payment. However, there are limitations to the extent to which the terms of the existing tax-exempt debt may be altered without triggering a refinancing—depending on the specific terms of the debt. A refinancing is the equivalent of a new deal and all the associated costs of issuance (i.e., 2 percent). State-of-the-art private placement contracts include language that allows the borrower to change the index and/or period of the rate reset—subject to approval by the lender—while charging costs for the change, including limited legal fees. Bond attorneys specializing in private placements can best evaluate whether alterations in the loan’s terms can be made without a refinancing and to ensure that future private placements allow for such provisions.
Keep an Eye on the Trends
“Finance is fashion” and debt structures or financing products are always changing, making it necessary to regularly review market conditions. Healthcare organizations can realize savings opportunities or faster pay offs of existing debt by carefully and consistently tracking shifts in regulation and the interest-rate environment.