From electronic health records to stem-cell research, a new wave of technologies, medicine and other breakthroughs promise to transform the way hospitals and health systems deliver care over the next five to 15 years. Alternative capital arrangements are gaining in popularity because traditional financing is becoming more problematic for many institutions. Yet finding the capital to invest in these clinical advances and to improve healthcare delivery is a growing challenge for many not-for-profit healthcare providers.
As a result, an increasing number of health systems and hospitals are turning to what has traditionally been considered alternative financing, primarily tax-exempt private placements and true leases, but also options such as sale-leasebacks to monetize existing assets. While other industries regard such arrangements as mainstream financing, non-profit healthcare organizations have overwhelmingly relied on other capital sources to fund their growth, until recently.
Non-profits have traditionally obtained investment capital from four sources including: operations, philanthropy, returns on their investments and the debt market. However, many non-profit providers are losing money or are marginally profitable. At the same time, their investment returns are considerably lower than in the 1990s. Philanthropy, which generally follows the trends in the stock market, also is down.
TAX-EXEMPT PRIVATE PLACEMENTS
With the window narrowing considerably for traditional options, more non-profit providers are turning to the private markets to seek tax-exempt loans. A tax-exempt private placement is a loan between a not-for-profit or municipal borrower and a single-debt provider or a small syndicate of lending institutions. The loan terms are negotiated privately between the two entities, and the transaction can be structured either as a term note or a synthetic lease, where the lender takes a future residual position in the assets resulting in off-balance-sheet treatment for the borrower.
Tax-exempt private placements offer several advantages over publicly issued bonds. While public issues are cost efficient for large transactions, they involve numerous parties (underwriters, rating agencies, trustees, bond counsels, etc.), that can slow down the process and significantly increase the costs of issuance. In addition, they require exhaustive public disclosure, including compensation for company officers and audited financial statements.
In contrast, tax-exempt private placements offer a faster and more private way to raise capital. Because there are only two parties to the transaction, the process is streamlined and transaction fees are reduced. Also, since the lenders are knowledgeable institutional investors holding the loans for their own account, the borrower is not required to publicly disclose financial and other information that would ordinarily be required on a public deal.
PRIVATE VS. PUBLIC BOND ISSUES
Publicly issued bonds still are the best way to finance very large transactions (more than $50 million) involving longer-lived assets (with amortizations of 20 years or more). This is because the higher up-front costs to issue a public bond can be spread over a larger base and a longer period of time, minimizing the impact on the borrower's effective cost of capital. Private placements, on the other hand, make more sense for smaller projects (typically under $50 million) involving shorter-term assets, such as equipment. Although private placements can be economical for single assets (such as a $1-million MRI), a more typical scenario would be for a hospital to employ a tax-exempt private placement to finance a full year of equipment and information technology acquisitions.