A capital idea bonds and nontraditional financing options: increasing capital demands are prompting cash—strapped hospitals to take a closer look at bond offerings and nontraditional sources of capital

Healthcare Financial Management, May, 2004 by Therese L. Wareham

Private placements. Private placements--which take the form of bonds, notes, loans, or leases--can be taxable or tax-exempt and can carry fixed or variable rates. Private placements differ from other bond offerings in that they require no public disclosure of information about the borrower, and the debt is offered to a limited universe of lenders--typically banks, leasing or equipment companies, insurance companies, or other large institutions. Applicable rules require certain legal opinions and investment letters from the lenders. Private placements are typically quicker to implement because there are fewer regulatory hurdles. However, the investors usually demand a higher rate of return, potentially tighter covenants, and a shorter amortization period than in a public offering.

Nontraditional Offerings

Up through the 1990s, healthcare executives relied almost exclusively on not-for-profit tax-exempt financing. Now, they have many more financing options to choose from, including receivables financing, off-balance-sheet (OBS) options, real estate investment trusts (REITs), and subordinated securities. Although these options can be taxable or tax-exempt, most are taxable because of the hurdles for tax exemption. Healthcare providers typically access them if they have no other options or want to preserve their debt capacity for traditional vehicles. These financing forms are sometimes used to finance stand alone assets that are off site or not required for an organization's core business.

Receivable financing. With reduced payment to providers, liquidity has become an issue requiring securitized funding mechanisms. Receivables financing is one such mechanism that could be characterized as "an option of last resort." It involves the sale or transfer of a n organization's accounts receivables and the securing of financing against such receivables. Typically, commercial paper is issued and the administrative requirements are extensive. The seller (the hospital in this case) has limited recourse, must meet the requirements of financial accounting standards, and must qualify for OBS treatment of the receivables financing.

OBS options. Historically, U.S. healthcare providers have viewed hard assets as something to be owned and, thus, have significant equity tied up in bricks, mortar, and equipment. With increasingly fight capital markets and credit challenges, however, they may wish to consider OBS financing of real estate or equipment as a way to finance capital needs. OBS financing structures, such as operating leases, sale/ leasebacks, synthetic leases, and joint ventures or master leases, effectively let s 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.

Although in essence all of the four basic methods of OBS financing involve an operating lease, each has subtle distinctions and separate accounting treatments, and each offers different trade-offs, such as higher control with less walk-away ability versus less control with easier walk-away ability. Getting accountants involved ca fly is the best strategy.