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

Principal amortization. The amortization schedule for the financing vehicle is critical to cash flow and maintenance covenants. For example, if you set up principal amortization to have a balloon in five years, you should be careful about how that balloon gets tested in the covenants. Will a $20 million loan structured to require a $1 million principal payment in each of the first four years and $16 million in year five violate a covenant that requires you to test for the maximum year of principal and interest? Most covenants use maximum annual debt service (MADS) as the basis for measuring debt service coverage in both maintenance covenants and incurrence tests. Therefore, you should minimize the difference between MAIDS and average annual debt service, not only to ensure covenant compliance, but also for cash flow reasons.

Interest-rate risk. When incurring fixed-rate debt, the borrower is insulated from most major risks, such as interest rates fluctuations, credit quality deterioration, worsening perception of the healthcare industry, changes in tax law that make tax-exempt debt less attractive, and international events that undermine a bond's marketability. Variable rate debt, characterized by periodic resets of the interest rate, expose the borrower to risk related to rising interest rates, remarketing, changes in tax law, worsening perception of the industry, and insurer down-grades. Your best course is to achieve a mix of fixed-and variable-rate debt that minimizes interest-rate risk.

Average useful life versus average maturity. Tax-exempt financing rules require that projects eligible for tax exemption be specifically delineated in the documents that support the borrowing. The weighted economic maturity of the bonds cannot currently exceed 120 percent of the weighted average project asset life to be financed. Consult bond counsel to certify the tax exempt eligibility of each project and the weighted average life of the financing.

Disclosure. Tax-exempt vehicles also will require that you provide prompt, accurate, complete, and continuing disclosure of certain financial and utilization information. To access such vehicles, you therefore will need to enter a continuing disclosure agreement delineating the content, process, recipients, and frequency with which information is disseminated.

Prepayment penalties and unwind provisions. Different financing vehicles have differing premiums or prepayment penalties associated with an early redemption date. Many nontraditional vehicles have steep prepayment penalties, directly related to the amount of work required to assemble the financing. You therefore should consider the costs of unwinding or exiting each financing arrangement--particularly with respect to OBS vehicles--as well as purchase rights and terms, walk-away options, and property appreciation.

The Best Strategy

All financing transactions occur within the context of your organization's long-term financial plan and culture. By weighing each financing option against the factors outlined in this article, you can narrow the field to the most appropriate financing alternatives. The best strategy in choosing debt vehicles is to stick to the basics, looking toward more complicated debt vehicles only if you know that they would provide measurable benefit.