By Jason Dopoulos, Ken Gould, and Steve Kennedy - Managing Directors at Lancaster Pollard
The last several years have been challenging for hospitals, as uncertainty regarding the Affordable Care Act (ACA) and a narrowing in operating profitability became the norm. In 2015, however, the three major credit rating agencies (CRAs) presented refreshingly optimistic reports, particularly for the larger providers, citing strong revenue growth, continued cost containment, greater clarity with respect to the ACA and industry trends (e.g., consolidation and technology) as reasons for the positive momentum.
In this more encouraging environment, there are a variety of financing structures a hospital can pursue to improve its fiscal outlook and better serve its patients. Below, we present three examples of hospitals that took advantage of the positive momentum and completed transactions that benefited both the hospitals and their communities.
In the first, a health care district refunded three expensive bond issues with a general obligation (GO) bond that will save the district’s taxpayers approximately $2.8 million. In the second, a health care system used a direct bank placement to fund a new construction project that resulted in an expanded campus and enhanced specialty services. Finally, we detail how a hospital used one tax-exempt bond transaction to fund an expansion, renovation and a refinance all at once, resulting in a thorough and comprehensive fiscal upgrade.
Saving Taxpayers’ Money
Formed in 1962, Sierra Kings Health Care District is a subdivision of the State of California encompassing over 230,000 acres in southeastern Fresno County. The District previously owned and operated a 49-bed acute care hospital known as Sierra Kings Hospital. In 2009, the District filed for bankruptcy and subsequently transferred the operations of the hospital to Reedley Community Hospital, an affiliate of Adventist Health System/West. The District maintained its ownership of the hospital.
To help guide them through the bankruptcy process and improve the hospital’s overall financial situation, the District hired HFS Consultants. Of chief concern, HFS sought to refund three prior bond issues that each carried a high cost of capital. The bond issues were not payable from, nor secured by, the revenues or assets of the hospital, meaning that the District’s taxpayers were paying the high debt service costs.
HFS worked with the District’s investment bank to refund the three bond issues using a $27 million general obligation (GO) bond with a 25-year term. The investment bank used a current refunder structure to refund the first two series of bonds from 2002 and 2007. For the third series of bonds from 2009, it structured an advanced refunder and established an escrow-based pay structure. In addition, HFS and the investment bank navigated issues regarding the remedial disclosure on the prior bonds and worked with bond counsel to maximize debt service savings for the District.
“This refunding resulted in a significant benefit to district taxpayers by reducing the amount of interest that would otherwise be paid under the refunding bonds,” said Sandy Haskins, managing director of HFS Consultants. “The savings, adjusted for the time value of money, approximates $2.8 million or about 11% of the bond principal. This is a very high rate compared to industry standards.”
Kennedy Health is an integrated health care delivery system that provides a full continuum of care, ranging from acute-care hospitals to a broad spectrum of outpatient and wellness programs. It owns and operates a 607-bed multi-campus system which includes three acute care hospitals in New Jersey: Cherry Hill, Stratford andWashington Township. Kennedy Health sought funding for a new construction project that would expand and improve its campus in Cherry Hill. The goal was to provide more room for state-of-the-art specialty services and allow for more open green space and improved parking options, resulting in a family-centric facility that would enhance health care access in its community.
Kennedy’s investment banker conducted a competitive bidding process with over 12 prominent funding sources. The firm ultimately put together a two-bank syndicate to finance $71 million, a strategic decision that enabled Kennedy Health to maintain multiple bank relationships.
The debt is secured by Kennedy Health’s obligated group under a master trust indenture put in place when its investment banker underwrote its last bond issue in 2012. The financing carries a 10-year term, variable rate, and no prepayment penalties, allowing Kennedy Health to retain financial flexibility as it pursues an aggressive repayment plan. Furthermore, the competitive bid process resulted in a reduction of 40 basis points in the cost of capital compared to the initial bids received.
The $71 million transaction will allow Kennedy Health to build a new medical office building, a parking garage and a lobby addition to its campus in Cherry Hill. Once complete, the Cherry Hill campus will provide enhanced specialty services, including radiology, orthopedics and cardiology. Further, the financing allows Kennedy Health to retain cash on its balance sheet which will be used to support the future development of all three of its campuses.
“The new construction project at our Cherry Hill campus is an important part of Kennedy’s continued efforts to improve our integrated health care delivery system and expand services to Cherry Hill residents and the surrounding community,” said Gary Terrinoni, Executive Vice President of Administration and Chief Financial Officer of Kennedy Health System.
One Financing, Three Objectives Achieved
Graham Hospital is a nonprofit hospital that provides inpatient, outpatient, home care and long-term care services in Canton, Illinois. It currently operates 25 private medicine/surgery beds, 13 progressive care unit (PCU) beds, five intensive care unit (ICU) beds, six obstetric care (OB) beds, 20 skilled nursing and 18 long-term care beds. Graham Hospital sought funding for multiple capital expenditures, including the renovation of its skilled nursing facility totaling $2.1 million, expansion to its physician clinic totaling $8.5 million, and a small addition and total remodeling of its five inpatient/outpatient surgery suites of $11.4 million. The hospital’s outstanding debt of $26 million was in the form of tax-exempt, variable-rate demand bonds (VRDBs) enhanced by a direct pay letter-of-credit from a regional bank. The debt was hedged by two floating-to-fixed rate swaps with two separate swap counterparties.
Graham’s investment banker conducted a competitive process that resulted in financing proposals from eight funding sources, ranging from local, regional and national banks to non-bank funds. Hospital leadership elected to proceed with the funding option that offered a blend of the lowest cost of capital and favorable terms.
The $48 million funding structure converted Graham Hospital’s letter-of-credit backed bond structure to a private placement structure, thereby eliminating letter-of-credit renewal risk and extending the term of the financing by nearly a decade. The structure also permitted the hospital to retain its existing interest rate swaps, thereby preserving the hospital’s interest rate hedge and preventing the hospital from realizing a swap termination mark-to-market payment. Finally, the structure provides funds for capital expenditures using a cost effective draw structure, minimizing interest expense to the hospital as it further upgrades its hospital facilities.
“This transaction allows Graham Hospital to continue to grow and add providers and new services,” said Robert Senneff, president and CEO of Graham Hospital. “The oncology suite will be relocated from Graham Hospital to our state-of-the-art medical office building, which will allow all of our patients who are undergoing chemotherapy treatment the advent of natural light throughout the suite. We will also complete a major remodeling of our entire 20-bed skilled unit, an addition to our inpatient/outpatient surgery floor, and a total infrastructure remodel/modernization. These projects would not have been possible without the ability to access funds at very attractive rates and terms.”
As demonstrated above, low-cost capital is available for strong hospitals looking to improve their fiscal outlook and better serve their populations. The key to success is in identifying the right funding structure for a hospitals’ specific objectives.