Covenants. There are two basic categories of covenants—maintenance and incurrence. Maintenance
covenants are routine requirements that the borrower must meet on an annual and sometimes quarterly
basis. Examples include the liquidity covenant (i.e., days cash on hand) and the debt service coverage
ratio. Incurrence covenants are special requirements that must be met to undertake a particular action,
such as sale or disposition of property. Organizations should always seek the least restrictive covenants
possible.
Principal Amortization. The amortization schedule for the financing vehicle is critical to cash flow and
maintenance covenants.
Interest-Rate Risk. When incurring fixed-rate debt, the borrower is insulated from interest rate
fluctuations. Variable-rate debt, characterized by periodic resets of the interest rate, exposes the
borrower to risk related to changing rates. The best course is to achieve a mix of fixed-rate and
variable-rate debt that minimizes interest-rate risk.
Average Useful Life Versus Average Maturity. Tax-exempt financing rules require that projects eligible for
tax exemption be specifically delineated in the documents that support the borrowing. The weighted
economic maturity of the bonds cannot currently exceed 120 percent of the weighted average project
asset life to be financed. Organizations should check with bond counsel to certify the tax-exempt
eligibility of each project and the weighted average life of the financing.
Disclosure Requirements. Tax-exempt vehicles require organizations to provide prompt, accurate,
complete, and continuing disclosure of certain financial and utilization information.
Prepayment Penalties and Unwind Provisions. Different financing vehicles have differing premiums or
prepayment penalties associated with an early redemption date.
Selection Principles
By weighing each financing option against these 11 factors, organizations can narrow the field of options
to the most appropriate financing alternatives. The best strategy in choosing a financing structure is to
stick to the basics, looking toward more complicated vehicles only if they would provide known and
measurable benefits. Complex financing vehicles may carry greater risk or terms that could limit an
organization’s current and future flexibility.
In a changing environment, flexibility of selected options is critical, but so is a fundamental understanding
of the underlying benefits and risks of each instrument. One rule of thumb applies in all cases: If a
hospital’s financial leaders and the board members on its finance committee don’t understand and
cannot explain the financing approach, the hospital should not pursue it.
Take Aways To choose the right capital markets financing vehicle(s) for the hospital, many factors should be weighed, including issuance costs, all-in borrowing rate, covenants, interest rate risk, and other factors. Flexibility of selected options is critical, but so is a fundamental understanding of the underlying benefits and risks of each instrument. If a hospital’s financial leaders and the board members on its finance committee don’t understand and cannot explain the financing approach, the hospital should not pursue it. Action Items
1. Evaluate each debt instrument using the 11 criteria outlined in this section. 2. Ensure that the debt vehicle selected provides as much flexibility as possible and involves the lowest overall cost and risk level, given the hospital’s overall asset and liability portfolios. 3. Stick to the basics: Don’t select debt products that the hospital’s financial leaders and the board members on its finance committee don’t understand.
A Guide to Financing Strategies for Hospitals
