Jeremy Peppas

Everywhere you look, new healthcare facilities are springing up and others are being renovated. The total cost of all that new construction in Arkansas is estimated to be in the $600 million range. So the question becomes, how do hospitals pay for all this new construction?

One place to get money is, obviously, a bank. Hospitals borrow money just like anyone else who wants to add a garage or a family room to their house.

The more common route, though, is a bond. They are much like loans, but they have some tax advantages for not-for-profit hospitals.

Paul Phillips, an investment banker with Crews and Associates in Little Rock, helps healthcare facilities around Arkansas and the South get into the capital bond market. “Once the decision is made to issue tax-exempt debt, obviously it has to be for capital improvement,” Phillips said. “For the most part, you’re talking about a 60-day process from preparing the documents to marketing, and we have to sell the bonds to the investors.” The documents are thick and detailed, and Phillips showed as evidence a 201-page prospectus generated for Washington Regional Medical Center in Fayetteville.

“We create a document like this, and we distribute it to investors,” Phillips explained. “That’s one of the reasons we were hired, to find buyers. So the investor has all this information about the hospital made available to them and, including in this case, the bond rating.”

Washington Regional’s Standard & Poor’s rating was BBB. The best rating is AAA, and some places cannot be rated.

Phillips gave an example: “I’m not going to get an investment grade rating on the smaller facilities around here.”

A search of the Standard & Poor’s Web site showed that a BBB rating is fairly typical for hospitals in Arkansas.

Concerning the prospectus, the information ranged from the demographics of Washington County to quorum court members, along with incredibly detailed financial information on the hospital. Nothing was omitted.

“The offering document describes the legal structure of the transaction, it describes the legal structure of the hospital and it has a snapshot of the financials,” he pointed out. “You have sophisticated investors out there and it is our job to go sell it and get it done at the most aggressive interest rate we can do, so the hospital is afforded the lowest cost of borrowing. And clearly the tax-exempt market is going to give you access to that lower cost of borrowing.”

All that information is for the investors and is partly done to assuage any misgivings, since hospitals are considered to be a bit of a gamble.

“They are viewed to have an inherently higher degree of risk,” Phillips said, “simply because you have a lot of risk factors that come into play, and one of those is governmental reimbursement; you can’t predict that one and negotiating the contracts with third-party payers. The other thing is competition. You see the physician clinics popping up here and there, and that business is really targeted towards some of the more profitable areas.”

But with risk comes reward.

“Inherently, healthcare is a higher degree of risk than a university transaction,” Phillips said. “But it carries a little bit of a higher yield for the investor than some of your more traditional products.”

And that is appealing.

“There’s sophisticated investors that like healthcare products because they come with a little higher yield and they understand the risks,” Phillips added. “But you can find individuals and institutional investors who’ll say they don’t talk healthcare.”

So who buys these kinds of bonds?

“I’m dealing with large mutual funds, tax-exempt mutual funds, insurance companies, money managers,” Phillips said. “The sophisticated type of investors. But in some cases, like that one (pointing to the Washington Regional prospectus) you’ll have some local participation as well. You’ll have people up there who know that hospital, who use that hospital and they know it isn’t a risk.”

Phillips said the size of the transaction is a pretty good indicator of where the investor is going to come from: “$10 million or less, you pretty much market that in the boundaries of the state you are operating in. That isn’t always the case, but that’s a pretty good rule of thumb.”

On the larger transactions, Phillips said the investors come from “pretty much anywhere and everywhere.”

One such large transaction was Washington Regional. The hospital issued two bonds: a construction bond of $25 million to expand and renovate the facility, and $84.3 million of refunding bonds to be used to refinance debt.

The prospectus lays out how the money will be spent literally to the penny, with $24,552,410.28 to be spent on the construction fund. Another $218,339.72 will be for the costs of issuance, while $55,555.56 will go to the debt service fund. Those working the calculator will note that the money doesn’t total up to $25 million, but instead to $24,826,305.56. So why the difference in the two amounts? Some very complicated accounting that deals with the net original discount and the accrued interest knocks down the total from $25 million.

The complexity is something that Phillips always has on his mind.

“I have to be careful at times and not assume that everyone is versed in the terminology of the industry,” he said. “Forms 8038s and other tax issues … part of the job is to be a good communicator and make it simple to understand. But you have some really sharp CFOs out there. People who have been doing it for a living and they have a pretty good understanding of what is going on.


March 2007