The House Republicans’ draft tax-reform legislation threatens the financial health of not-for-profit hospitals and health systems. To the surprise of industry analysts, the November 2, 2017, draft included provisions that would significantly raise the cost of capital and limit financing options for 501(c)(3) hospitals and health systems after December 31, 2017:
- Eliminating the ability of 501(c)(3) hospitals and health systems to issue tax-exempt bonds (Private Activity Bonds, or PABs)
- Eliminating the ability of municipal issuers to advance refund bonds
For hospitals and health systems already struggling to fund important current and future capital projects, these provisions represent a potentially detrimental challenge.
Hospitals and health systems have voiced a number of pressing questions about the legislation:
- Is our current debt affected?
- How would this effect debt restructuring?
- How would we handle future financing?
- How would this affect initiatives such as capital structure integration as part of a merger?
It is too early to say with certainty whether these provisions will be in the final tax-reform bill, or whether the final bill will pass at all. The next several days will bring the House's mark-up of the draft legislation and the Senate’s version of tax reform, which will provide a clearer sense of the ultimate legislation. However, these provisions may well survive and certainly suggest the vulnerability of not-for-profit providers in an environment of rising federal spending coupled with a desire to provide tax relief.
Given the unexpectedness of these provisions and the fluid nature of the legislative process, identifying the right approach can be a moving target. Below is the best information Kaufman Hall has been able to gather to date about the proposed legislation’s effects on clients’ current capital structures as well as options for protecting the tax-exempt status of existing bonds and loans for as long as possible. We also discuss certain methods now in development for issuing new tax-exempt bonds on a private basis prior to the December 31, 2017 deadline that can subsequently be converted to a public tax-exempt fixed rate bond.
Accelerating Current Bond Issues into 2017
Not-for-profit clients already in the process of issuing bonds that can close before December 31, 2017 are moving aggressively to do so. This involves a flurry of activity related to document development, rating updates, issuer and borrower approvals, proper disclosure and due diligence, and marketing/sales for the bonds. However, this is viewed as a risk-reducing strategy to lock in tax-exempt financing before the proposed December 31 deadline. The current sentiment shared by market participants, including investment bankers and tax-exempt investors, is that while this may create a glut of supply in the public market, it will likely be met with sufficient demand on the part of investors eager to purchase what may be the last of healthcare bonds issued on a tax-exempt basis.
Preserving Tax-Exempt Status on Outstanding Bonds: Qualified Tender Bonds
Based on our conversation with leading national and regional bond and tax counsel law firms, if a bond qualifies as a qualified tender bond and has sufficient multi-modal language, that bond stands the best chance of avoiding a tax reissuance in the future. Ultimately, it will be bond and tax counsel that provide an opinion on this point. Although we can try to anticipate all of the flexibility we may need in the future, we are likely to face tax-related issues with various variable rate products in the future.
Existing Direct Purchases, Variable Rate Demand Bonds, and Tax-Exempt CP Programs
We are encouraging clients to consider modifying existing direct purchases and variable rate demand bonds before the end of the year so that they qualify as qualified tender bonds. We are also encouraging clients to consider extending bank commitments on existing direct purchases so as to prolong the tax-exempt status of existing direct purchase bonds and loans for as long as possible. Care should also be taken to provide for a replacement index to LIBOR if or when changes are made to these documents. It may also be advisable to convert existing tax-exempt commercial paper programs to another mode if possible. These actions may well require a reissuance for tax purposes and issuer involvement between now and December 31. The goal will be to allow for future renewals of existing direct purchase loans or mode conversion between appropriate modes without loss of tax-exempt status by avoiding reissuance in the future. Bond/ tax counsel should provide guidance on what specific changes should be made.
Accelerating Future New Money Needs
A number clients are evaluating the use of privately placed tax-exempt bridge loans issued before the end of the year using multimodal bond documents which qualify as qualified tender bonds. Properly structured, the bridge loan could be converted to another mode (fixed rate or any other) on a tax-exempt basis in the future so long as the mode change can all be accomplished within the four corners of the documents. This approach would buy borrowers the time to prepare public disclosure documents after the first of the year. Additionally, borrowers could repay any unspent proceeds during the bridge loan period of time if it turns out that the borrower elects to finance an amount less than originally thought. The mechanics of conversion to other modes would need to be spelled out entirely, such as principal amortization, call provisions, and the use of serial and term bonds. This would limit the flexibility to make any adjustments during mode conversion to meet market demands. For example, you may designate certain maturities as serial and term bonds now only to find out later that those maturities would be better marketed differently with no ability to change them. Careful review is required at the outset to make sure that the bond documents are properly structured so as to provide maximum flexibility.
Accelerating Advance Refunding
Coupling new money needs with advance refunding opportunities may also be possible. Although the arbitrage yield would be difficult to determine during the escrow period, some hospitals are evaluating the potential application of this approach to advance refunding opportunities. Otherwise, under the proposed legislation, advance refunding opportunities will only be allowed taxably after December 31, 2017.
What Should We Do Next?
These actions require adaption and analysis to determine the best approach for each client. However, the following are imperative:
- Education on relevant issues will require ongoing attention
- Involvement with bond and tax counsel will be essential to review existing documents and/or confirm the course of action for current or proposed debt issues
- Conversations are advisable with credit banks to discuss modification of existing documents and extension of existing direct purchase maturities
- New credit for bridge-to-permanent structures may be important that accelerate new money and potential advance refunding opportunities originally intended for 2018
- Given the magnitude of these issues and the potential time constraints, please contact your Kaufman Hall financial advisor or firstname.lastname@example.org for assistance with these important matters
Time is of the essence since our ability to accomplish these actions may be severely limited after December 31, 2017.
Kaufman Hall will provide more information and insight as the legislative process moves forward. Visit our Tax Reform page for additional insights and resources. Please also contact your Kaufman Hall financial advisor or write to email@example.com to discuss the specifics of your capital structure needs.