c apital f unding a n overview of the funding process presented by: ross sinclaire & associates...

CAPITAL FUNDINGAN OVERVIEW OF THE FUNDING PROCESS

Presented by:Ross Sinclaire & Associates

July 25, 2013

Kentucky HFMA Summer Institute

Ross, Sinclaire & Associates, LLC

TABLE OF CONTENTSIntroductionInterest RatesRecent DevelopmentsCapital Funding SourcesTypical Bond StructureFixed Payer Swap OverviewWhat is a Bond Rating?Why are Ratings Important to Issuers?Why are Ratings Important to Investors?Who Issues Bond Ratings?Rating Agency ScalesInvestment Grade BondsSpeculative Grade BondsRating Distribution

Rating Medians

Rating Ratio DefinitionsChart of Borrowing CostsRating ProcessHow Do Rating Agencies evaluateIssuers?What Information is Used inDetermining a Bond Rating?How Long Does a Rating Last?How to Improve Your Bond RatingDo I Need a Bond Rating?Typical Steps in a TransactionFinancing ParticipantsContact Information


Introduction

This presentation is meant to accomplish the following items:

• Provide an overview of the current economic environment

• Establish an understanding of various financing mechanisms available to healthcare providers

• Provide basic outline for the decision making process required to obtain the lowest cost of capital and the optimal capital structure

1


Interest RatesBond Buyer 20 Year General Obligation Bond Weekly Index – 20 Year History

2


Interest Rates(Continued)

Bond Buyer 25 Year Revenue Bond Weekly Index – 20 Year History

3



Ten Year Treasury Rate – Six Month History

4



5



SIFMA Municipal Swap Index Yield – 10 Year History

6


City of Detroit - Bankruptcy• Market Reaction – Rates generally unchanged since bankruptcy had long

been expected.• City Ramifications – Yields of future debt expected to increase if access to

capital markets is possible.

Ratings Downgrades• Moody’s Investor’s Service has issued many downgrades in the recent

weeks, including the City of Chicago• Reasons include more stringent analysis as well as the weakened economy.

Economic Comeback• Dow Jones Industrial Average, S&P 500 and NASDAQ at recent highs.• Federal reserve may pare back their quantitative easing policy.• Unemployment rate lower, though still historically high.

Recent Developments

7


Debt Limit• House speaker John Boehner indicated a clash with the White House and

Senate over raising the US debt ceiling.• Senate leadership and White House signaled that anything outside of a

clean increase will not be accepted.

Home Prices• US home prices increased 7.3% in year through May.• Real estate pricing rising with employment.• Limited supply and increases mortgage rates may be slowing growth.

Quantitative Easing to slow in September• Ben Bernanke will trim the Fed’s monthly bond buying by $20 billion to

$65 billion in September.• Fed to begin to moderate the pace of bond buying near year end.

Recent Developments

8


Capital Funding Sources

• Gifts – can include gifts from individuals or corporations, community gifts or grants.

• Capitalized Leases – can be used for many items including equipment and technology

• Long-Term Debt (Bonds) – can include both tax-exempt and taxable obligations, bank loans, fixed and variable rate obligations, and private placements.

9


Capital Funding Sources - GiftsPros

• Extremely cost effective

• Not required to pay back funds

• No reporting requirements

• No issuing process

Cons

• Highly unreliable

• Susceptible to economic shifts

• Highly competitive

10


Capital Funding Sources – Capital LeasesPros

• Low issuance cost

• Ease of issue process

• Little to no reporting requirements

• Ease of access

Cons

• Only available for certain items

• Relative high interest cost

• Little structure flexibility

11


Capital Funding Sources – BondsPros

• Flexible Structure

• Relative low interest cost

• Most projects eligible

Cons

• Issuing process can be cumbersome

• Reporting requirements

• Increases entity debt

12


Bank Loans, Private Placements & Bank-Qualified Bonds

Bank Loans

• Commercial Bank Loans in the form of real estate or equipment term loans.

• Available from local and national banks.

• Interest rates can be fixed or variable rate.

• Typically banks will only finance for a limited period, usually up to 10 years.

Private Placements

• Tax-Exempt bonds can be placed with local or national banks.

• Can be sold to one or several banks.

• Offering documents distributed only to interested parties.

• Financing terms can vary.

Bank-Qualified Bonds

• Available to issuers that issue less than $10 million in one year.

• Banks can deduct 80% of purchase and carry cost.

• Issue must be designated bank-qualified.

• Offering documents distributed similar to non-bank-qualified bonds.

13


Bank Loans, Private Placements & Bank-Qualified Bonds(continued)Issuance Soars do to expiring letter of credits.

14


Fixed Payer Swap Overview• Synthetic fixed rate debt is an

alternative to traditional fixed rate debt.

• Issuer receives floating and pays fixed against floating rate note.

• Swap can also be executed today with the rate protection to begin at some point in the future (“Forward Starting Swap”).

• Forward Starting Swap allows the client to take advantage of currently low variable rates while having interest rate protection in the future.

Issuer Bank

Bonds

Issuer pays floating rate plus loan spread

Issuer receives floating rate index

from the Bank

Issuer pays fixed rate to the Bank

When these indices don’t

match, the issuer is not perfectly

hedged.

15


Typical Bond Structure

Typical Bond Structure

Credit-Enhanced

Letter of Credit

Bond Insurance USDA

Unenhanced

Rated Non-Rated

16


Typical Bond Structure – Credit Enhanced• Letter of Credit • Provides issuer with rating of letter provider• Typically cost prohibitive• Difficult to obtain

• Bond Insurance • Provides issuer with rating of insurance provider• Possibly not cost effective• Few Insurers left to utilize

• USDA• Loan through the department of agriculture• Guaranteed by federal government agency• Difficult to obtain

17


Typical Bond Structure – Credit Enhanced(continued)

Letter of Credit • Provider has obligation to make principal and interest payments in the

event the borrower is unable to make payments.• Cost is generally derived from credit profile of issuer.• Issued for limited terms, typically 3-5 years, and can be renewed.• Low supply of banks willing to issue new letter of credits.

AmountRank Firm ($000,000) Issues

1 Wells Fargo Bank 240.2 42 JPMorgan Chase Bank 189.1 23 Citibank 145.0 24 Bank of America 101.3 55 Bank of New York Mellon 63.6 16 Northern Trust Company 17.0 17 BMO Bancorp 11.8 18 Aliant Bank 9.3 19 East West Bank 7.2 1

10 CoBank ACB 4.8 1

Source: Bond Buyer - 07/15/13

Top Letter-of Credit ProvidersFirst Half of 2013

18



Bond Insurance• Credit enhancement that guarantees investors will be paid even if the

issuer cannot make it’s principal and interest payments.• Cost is determined and be part of the initial bond sale.• Historically common, recently insurance providers have been scarce.

AmountRank Firm ($000,000) Issues

1 Assured Guaranty Municipal 3,393.3 2712 Build America Mutual 2,126.1 2903 Berkshire Hathaway Assurance 106.9 1

Source: Bond Buyer - 07/15/13

Top Bond InsurersFirst Half of 2013

19


FHA Section 242 Mortgage Insurance• Must work with FHA-approved lenders.• Program is available to fund new facilities, acquisitions and/or the

renovation and updating of current facilities.• Enables issuers to borrow with AAA or AA bond ratings.• FHA insured loans are non-recourse - the loans are backed solely by the

borrower’s real estate and other assets.• Interest rates are fixed up to a 25 year term.• May borrow up to 90% of the value of the project.• Issuer must be an acute care hospital that derives less than half of

revenues from non-core services.• Three year average operating margin must be positive and must have

debt coverage ratio of at lease 1.25 for the last three years. • 242/223 program allows the refinance for existing bonds.

• Re-activated in 2013, allowing for 100% refinancings to be possible.• Must meet minimum eligibility requirements.• Debt service coverage must be 1.40 for the last four years.


20


Typical Bond Structure – Unenhanced• Rated• One or more rating agencies perform a through analysis of

the issuing entity and assign a rating• Higher ratings allow for lower rates • Ratings process can be difficult and time intensive

• Non-Rated • No rating agency involved• May require higher interest rates• Possibly preferred if expected rating determined not cost

effective• May make market access difficult

21


Typical Bond Structure – Unenhanced(continued)

• May be utilized by both investment grade and non-investment grade issuers.

• Sold on the credit profile and characteristics of the borrowing entity.

• Collateral typically provided in the form of a pledge of the organization’s revenues and a lien on trustee-held reserves – including a debt service reserve fund.

• May also require a first mortgage and lien on real estate assets as well as additional security and covenants.

22


What is a Bond Rating?

• A Bond Rating is an independent assessment or opinion of the ability of an issuer to honor their financial obligation to make interest and principal payments.

• It is associated with purchase and holding a particular bond.

• It assesses relative credit risk.

• Ratings indicate likelihood that the obligation will be paid.

• In essence, a local government's bond rating is the government equivalent of your personal credit score or credit rating.

• The higher the rating means the less likely an issuer will default.

23


Why are Ratings Important to Issuers?

• They are independent verification of their credit worthiness.

• They allow the issuers to “tell their story.”

• They are a marketing tool that can be used to attract investors.

• The higher the rating, the lower their borrowing costs.

• Provide potential investors with an unbiased opinion regarding their ability to meet obligations.

Higher Rating = Lower Cost

24


Why are Ratings Important to Investors?

• Investors rely on ratings as an indicator of the risk of default for a particular bond investment.

• The ratings influence the price and the yield of a bond both in the primary and secondary market.

• The rating provides investors with a comparative ranking between bonds that would otherwise be impractical or impossible for them to get with their own resources.

25


Who Issues Bond Ratings?

Moody’s Investors Services1909 – John Moody published a book of Railroad Investments that included concise analysis of their relative investment quality.

Standard & Poor’s Corporation1860 – Henry Varnum Poor began supplying European investors with financial with financial information on their holdings in the developing infrastructure of America.

Fitch Ratings1913 – John Knowles Fitch published “Fitch Bond Book” and other books on financial markets. Fitch is credited with introducing the AAA through D rating system now used.

26


Rating Agency Scales Credit Ratings

Moody's S & P Fitch

Highest Quality

Credit Ratin

g Levels

Credit Ratin

g Levels

Aaa AAA AAA

High Grade / High Quality

Aa1 AA+ AA+

Aa2 AA AA

Aa3 AA- AA-

Upper Medium Grade

A1 A+ A+

A2 A A

A3 A- A-

Minimum Investment Grade

Baa1 BBB+ BBB+

Baa2 BBB BBB

Baa3 BBB- BBB-

Speculative Grade

Ba1 BB+ BB+

Ba2 BB BB

Ba3 BB- BB-

B1 B+ B+

B2 B B

B3 B- B-

Highly Speculative Grade Caa (1,2 or 3) or Ca CCC (+,-) CC or C CCC (+,-) CC or C

Imminent default or in default C SD or D RD or D27


Investment Grade BondsHighest Grade – AAA These bonds are judged to be of the best quality. They carry the smallest degree of risk. Interest payments are protected by an exceptionally stable margin and principal is secure. The issuer’s capacity to meet its financial obligation on the bond is extremely strong.

High Grade – AA These bonds are judged to be of high quality by all standards. Margins of protection may not be as large as in AAA securities. The issuer’s capacity to meet its financial obligation on the bond is very strong.

Upper Medium Grade – A These bonds possess many favorable investment attributes. Factors giving security to principal and interest are considered adequate. Although these bonds are somewhat more susceptible to the adverse effects of changing economic conditions, the issuer’s capacity to meet its financial obligations is strong.

Medium Grade – BBB The bonds lack outstanding investment characteristics and have speculative characteristics as well. Adverse economic conditions are more likely to lead to a weakened capacity of the issuer to meet its financial commitment.

28


Speculative Grade Bonds

Distinctly Speculative Grades - BB & B The future of these bonds cannot be considered as well assured. These bonds face exposure to adverse business or economic conditions which could lead to an issuer’s inadequate capacity to meet its financial commitment.

Predominately Speculative Grades - CCC and belowThese bonds are of poor standing. Such issues may be in default, or there may be elements of danger with respect to principal or interest. These bonds are vulnerable to nonpayment, and are dependent upon favorable economic conditions for the issuer to meet its financial commitment.

29


Rating Distribution

*Information from Standard and Poor’s Rating Service

8%

43%39%

10%

Stand Alone Hospital Rating Distribution by Category 2012

AAABBBSpeculative-Grade

30


Rating Medians

*Information from Standard and Poor’s Rating Service

Health Care Stand-AloneSystem Medians Hospital Medians

'BBB' 'BBB'

Operations MediansSalaries & Benefits/Net Patient Revenue 51.0 51.0Bad Debt Expense/Net Patient Revenue 4.4 6.1Maximum Annual Debt Service Coverage 2.7 2.9Debt Burden 3.0 3.3EBIDA Margin 9.7 10.2Operating Margin 1.2 1.8Excess Margin 3.2 2.9

Balance Sheet MediansDays' Cash on Hand 124.7 132.6Cushion Ratio 11.3 10.1Cash Flow/Total Liabilities 9.5 14.6Average Age of Plant (Years) 12.3 11.0

31


Rating Ratio Definitions

Unrestricted Cash and InvestmentsDaily Cash Operating Expenses

Unrestricted Cash and Investments(Long-Term Debt - Current Liabilities)

Current Assets Current Liabilities

(Total Op. Revenues - Total Op. Exp)Total Operating Revenues

(Op Revs - Op Exp + Int Exp + Dep&Amort)(Total Op Revenues - Non-Op Revenues)

(Op Revs - Op Exp + Non-op Rev, Int Exp, D&A)Max Annual Debt Service

Days Cash on Hand

Cash to Debt

Current Ratio

Operating Margin

Cash Flow (EBIDA) Margin

Debt Service Coverage

32


Chart of Borrowing Costs

Scenario A Scenario B Scenario C Scenario D Scenario E

Issue Size $10,000,000 $10,000,000 $10,000,000 $10,000,000 $10,000,000

Bond Rating AAA AA A BBB BB

Interest Rate 3.0% 3.5% 4.0% 5.0% 6.0%

Repayment Period 30 Years 30 Years 30 Years 30 Years 30 Years

Payment per Year $510,000 $542,500 $578,000 $650,000 $726,500

Total over 30 Years $15,300,000 $16,275,000 $17,340,000 $19,500,000 $21,795,000

Difference from 5% --- $975,000 $2,040,000 $4,200,000 $6,495,000

33


Rating Process

• Bond Issuer requests that a rating company determine a rating.

• Financial Advisor & Bond Counsel submit financial plan draft legal documents for review.

• Rating Company forms an analytical team that:o Gathers information sufficient to evaluate risk to investors who might

own or buy a given securityo Develops a conclusion in committee on the appropriate rating

• The Rating Committee then issues a rating decision based on the report of the analytical team.

• The new rating then is monitored over time and adjusted as appropriate to reflect changes in the probability the issuer will default.

34


How Do Rating Agencies evaluateIssuers?

Finances Debt Position

Economy Management

Bond Rating

35


How Do Rating Agencies EvaluateIssuers? (continued)

Debt PositionFinances

• Financial Operating History

o 3-5 years of audits

o Significant deviations

o General trends

• Stable revenue streams

• Expenditure Items

• Liquidity

• Financial feasibility of project

• Utilization and payor mix

• Budget vs. actual

• Debt Burden

• Debt service as a % of budget

• Amortization schedule

• Future borrowing plans and capital

needs

• Variable rate exposure

• Operating procedures

• Profitability

36


How Do Rating Agencies EvaluateIssuers? (continued)

ManagementEconomy

• Growth trends

• General population

• Diversity of employers and taxpayers

• Proximity to ancillary services

• Competing facilities

• Socio-economic indicators

o Wealth indices

o Demographics

o Unemployment rates

• Long-term planning & predictability

o Strategic planning

o Financial & budgetary policies

• Growth management

o Balancing operating & capital needs

o Cost estimate accuracy

• Continuity

• Community support

• Physical plant conditions

37


What Information is Used inDetermining a Bond Rating?

• Publicly available data including past official statements and financial statements.• Fiscal policies and procedures utilized by the issuers including budget processes.

• Market data, e.g., bond yield trends, trading volume, data on bond price spreads.

• Economic data from industry groups, associations or bodies.

• Data from agencies, such as central banks or regulators.

• Books or articles from academic sources, financial journals, news reports.

• Discussions with expert sources in industry, government, or academia.

• Data that may come from meeting or conversations with the debt issuer including

local property assessments, population and other local information.

38


How Long Does a Rating Last?

• A Bond Rating can last until the final maturity of the bonds rated or until such bonds are refunded or called.

• An initial rating on a bond issue is subject to change if the rating agency deems necessary.

• Rating agencies may withdraw ratings due to insufficient information or other issues with the status of the bonds including default situations.

• Each new bond issue must be rated even if other bonds issued by the issuer have been rated.

• Issuers are not required in any way to obtain a rating from a certain agency or multiple agencies.

39


How to Improve Your Bond Rating

• Establish “rainy day” and budget stabilization reserves – memorialize these practices with written policies.

• Review economic and revenue trends to identify potential budget problems and take corrective action as needed.

• Prioritize spending and establish contingency plans for budget shortfalls.

• Develop a formal capital improvement program and a debt affordability model.

• Incorporate pay-as-go financing in capital plans and operating budgets.

40


How to Improve Your Bond Rating (continued)

• Anticipate the impact of capital and operating budgets in a multiyear financial forecast.

• Establish benchmarks and priorities through workshops.

• Establish and maintain effective management systems & financial controls.

• Consider the affordability of actions and plans before they become a part of the budget.

• Have a well-defined and coordinated economic development strategy.

41


Do I Need a Bond Rating?

Does your capital plan call for long term bond issuance?

Would a bond rating be economically beneficial?

What is your estimated or current bond rating?

See us to help answer these questions and any others

If deemed appropriate we will complete a benchmark ratings

analysis & provide other insight regarding possible ratings.

42


Typical Steps in a Transaction• Evaluate capital needs and financing source.

• Assemble financing teamo Includes financial advisor and/or underwriter, bond counsel and others mentioned

previously.

• Develop a financing plan and scheduleo Type of sale

Negotiated, Competitive, Private Placement or Bond Pool o Structure

Source of repayment Amortization Schedule Serial vs. term bonds Bond covenants Credit Enhanced vs. Unenhanced

43


Typical Steps in a Transaction (continued)

• Draft documentso Authorizing resolutions/ordinanceso Feasibility studieso Trust Indentures/Agreementso Notices to bondholders/insurance companies/trusteeo Preliminary Official Statemento Preliminary Blue Sky

• Due Diligence o Compliance with Rule 15c2-12

• Marketing

44


Underwriter – Dealer which purchases a new issue of municipal securities for resale

Trustee/Paying Agent/Registrar – Financial institution which acts in a fiduciary capacity for the benefit of bondholders in enforcing the terms of the bonds and responsible for transmitting payments to bondholders and maintaining records of the registered owners of the bonds

Insurer – Company which provides credit enhancement (for example, guaranteeing payment of principal and interest on the bonds

Financing ParticipantsIssuer/Borrower – A state, political subdivision, agency, or authority that borrows money through the sale of bonds or notes

Bond Counsel – Attorneys retained by the issuer/borrower to give an expert and objective legal opinion with respect to the validity of bonds and other subjects, particularly the federal income tax treatment of interest on the bonds

Financial Advisor – Consultant who advises an issuer/borrower on matters pertinent to an issue, such as structure, timing, marketing, fairness of pricing, terms, and bond ratings

45


Financing Participants (continued)

Credit Enhancer – Bond insurer, commercial bank, or other financial institution issuing an insurance policy or a supporting letter of credit in order to improve an issue’s credit rating

Liquidity Provider – Commercial bank or other financial institution entering into a standby bond purchase agreement or issuing a standby letter of credit in order to improve an issue’s credit rating

Rating Agency – Organization which provides publicly available ratings of the credit qualities of securities

Issuer’s Counsel – Attorneys representing the issuer

Disclosure Counsel – Attorneys serving as the principal drafters of an issuer’s disclosure document

Underwriter’s Counsel – Attorneys representing the underwriter in connection with the purchase of a new issuer of municipal securities

46


Contact InformationRoss, Sinclaire & Associates325 W. Main Street, Suite 300Lexington, KY 40507

Toll Free: 800-255-0795Fax: 859-381-1357

Joe Lakofka – [email protected]

Dwight Salsbury – [email protected]

Bryan Skinner – [email protected]

47

c apital f unding a n overview of the funding process presented by: ross sinclaire & associates...

Documents

ross sinclaire associates

bond ratings

rates bond buyer

information slide

pace of bond

year history

llc introduction

year revenue bond weekly