Obtaining low bond interest rates - bond offerings by healthcare firms - includes related article

Healthcare Financial Management, Nov, 1995 by Steven D. Bittel, Robbin R. Grill

CAPITAL FORMATION AND MANAGEMENT

Healthcare executives whose organizations seek major capital financing through bond offerings typically focus their attention on obtaining the lowest possible bond placement fees for the services of underwriters, legal counsel, accounting firms, and other advisors. However, far greater savings can be achieved by employing a strategic approach to securing low bond interest rates.

Healthcare organization executives increasingly are seeking better ways to secure financing for major capital projects. Although many healthcare executives may be knowledgeable about facilities planning, facilities design, and construction cost control, some may lack the expertise to make the technical financing decisions that will assure the best bond placement. Some healthcare executives may leave critical financial decisions involving bond rates to underwriters or state bond authorities that may have restricted or specialized experience or a limited market presence. These "outsiders" may not be able to obtain the most favorable bond rates.

Healthcare executives should recognize that successful bond placement is the result of an integrated approach that uses the expertise of underwriting, legal, and accounting disciplines but maintains control over the overall financing function through a well-informed management team and board of directors.

Benefits of a low interest rate

Healthcare executives may deal with major capital financing projects only once every 10 years and, consequently, may not be skilled in the nuances of bond placement. One mistake sometimes caused by this lack of experience is that executives may concentrate on the beginning phases of bond placement rather than on the result of the placement.

Executives may devote most of their efforts to negotiating with underwriters, attorneys, advisors, and certified public accountants to obtain the lowest possible bond placement fees. However, executives should not accept decisions concerning bond rates made by underwriters or state bond authorities without applying independent financial measures to the proposed bond issue or attempting to improve the positions of their organizations in the bond marketplace, thereby lowering bond interest rates.

The importance of negotiating the lowest possible upfront fees should not be minimized. Reductions in fees provide immediate, tangible, and noticeable savings. However, obtaining the best possible bond interest rates can achieve more significant savings. The following example compares the effect on the overall borrowing cost for a bond placement from negotiating a discount on fixed, upfront fees and from securing a low bond interest rate.

In this example, the face amount of 30-year bonds at an interest rate of 7 percent is $5 million. Fees for the underwriter are stated as a discount of 1.25 percent from the par value of the bond issue, or $63,000. The amount paid in legal fees is $40,000, and the amount paid for other fees is $35,000. Therefore, total amount for bond placement fees is $138,000, which represents 2.8 percent of the cost of the offering. Factoring this total into the costs for a bond with a coupon rate of 7 percent yields a true interest cost of 7.28 percent because the total is amortized over the term of the bonds.

The effect of a reduced interest rate per se will be far greater, however, than that of reduced fees. In general, every one-eighth percent movement in the interest rate of a bond increases or decreases the amount of available principal by 1.25 percent or approximately $12,500 in present value for every million of the face amount of the placement.

A $5 million placement of 30year bonds at an interest rate of 7 percent will have a semi-annual payment of $200,000. An increase in interest rate of one-eighth percent will have a semi-annual payment of $203,000, producing an annual payment increase of $5,000. The present value of increase in the semi-annual payment stream at 7 percent will be $63,000. The annual increase in relation to the face amount of the bond issue will be 1.26 percent.

Every one-eighth percent increase in the interest rate of bonds means an institution will have $12,500 less per $1 million of bonds in available proceeds for its project. In contrast, an otherwise meaningful 25 percent reduction in placement fees will reduce the total interest cost for a bond issue by only 5 or fewer basis points (.005 percent).

If, by actively marketing their organizations to bond markets, healthcare executives can secure as little as a quarter of a percent reduction in the bond interest rate, $125,000 more capital will be available for a $5 million project. A half-percent reduction in bond interest rates can result in savings similar to those that an organization can garner by imposing rigorous cost controls on construction.

A change in mindset

Healthcare executives should consider the financial aspects of the bond placement function to be as important as selecting and conducting negotiations with architects, contractors, and vendors. Executives should devote as much time to ensuring that their bonds will be presented to bond purchasers in the best possible light as they do to overseeing the details of design, development, and completion of the capital project.