CHICAGO — The Sarah Bush Lincoln Health System, a small A-plus-rated provider in southern Illinois, began planning a $45 million bond issue early last fall. But after months of watching interest rates climb in the public market, the hospital decided to privately place the debt with a bank.
“In my career, I’ve never done a direct placement — it’s always been a public financing,” said vice president of finance Craig Sheagren, who has worked in health care finance for more than 35 years.
“But before we could get the bond documents completed in mid-November, the market started to pull away from us,” he said. “We thought the market might respond after the first of the year but it did not, so in mid-January we began to look at the direct-purchase option.”
The result is a transaction with JPMorgan Chase that is set to close next week. The hospital expects to pay around 3.8%, according to Sheagren. Estimates of their public rates, in contrast, never fell below 6%. “It pales by comparison,” he said.
For small, lower-rated health care providers that have been forced to pay punishingly high yields on the public market over the last few years, direct bank loans can be less expensive and faster than public bond sales.
Most private placements remain under $50 million and feature relatively fast amortization rates of 15 years or less.
Private placement deals took off last year due to the federal stimulus act’s higher small-issuer limit for bank-qualified bonds.
The program allowed banks to deduct 80% of the cost of buying and carrying tax-exempt debt sold by issuers whose annual issuance is not more than $30 million, up from $10 million under then existing law. The higher limit also applied to an issue sold by a conduit if all of the borrowers qualified for it. The higher limit expired last year but Congress is considering a bill that would reinstate it through 2011 or 2012.
Some expected private placements to stop once the federal stimulus program expired, but many providers and banks remain interested, according to Michael Tym, a Chicago-based director at health care financial adviser Ponder & Co.
“As a firm, we’re still seeing a fair number of clients looking at it,” Tym said, adding that four of the five transactions he is currently working on include at least one piece of private placement. “It’s been very active.”
The market’s recent volatility has prompted many deals to continue despite the stimulus program’s expiration, said Randy Waring, managing director for tax-exempt financings at GE Capital Healthcare Financial Services.
“We were seeing a lot of it last year, and we’re still seeing the trend, because the public market has only gotten worse in the last three or four months,” Waring said.
He estimates that GE Capital offered about $500 million of tax-exempt loans to health care providers in 2010 and 2009.
In addition to often-lower interest rates, benefits to private placements of tax-exempt bonds include lower issuance costs — with no underwriter or rating agency fees — as well as no debt-service reserve fund requirements and bond covenants that are typically less restrictive.
Many banks, however, require deals to include three-, five-, and seven-year resets and a 10-year renewal, which means the issuer is facing renewal risk at some point during the life of the debt.
“The only drawback is that we’ll be faced with a renewal at 10 years, but considering that at that point there will be only five years remaining on [the debt,] we thought it was well worth the risk,” Sheagren said.
Waring noted that some private lenders like GE Capital do not require resets or renewals.
“It’s a niche product that’s not for everybody,” Waring said. “But if you’re looking for that, then it’s a great solution, especially for triple-B or lower-rated hospitals.”
