Diversifying Capital Sources

Bridging the Cost of Capital Gap

Tax exempt bonds have been, and will continue to be, the cornerstone of the capital structure for non-profit healthcare systems. However, credit market conditions periodically make taxable structures such as credit tenant leases or developer provided financing compelling - in spite of cost of capital differentials.

Taxable debt plays an important role by helping health systems diversify funding sources, enhance financial flexibility, manage timing of accessing capital markets, and eliminate the opportunity cost of deferring projects. We recommend that health systems maintain a strategy for leveraging all sources of capital and measure the benefits of each strategy not just by cost of capital but by incremental flexibility and diversification.

Credit Tenant Lease (CTL)

A Credit Tenant Lease is more like a bond transaction which looks to the ability of the tenant / guarantor to make periodic payments, as opposed to underwriting the type, quality, and location of real assets for credit support.

As a form of external debt, the CTL can perhaps be best characterized as a speed-to-market structure which may allow a capital project to commence prior to a healthcare system or hospital being able to procure their optimal tax-exempt structure. As a long-term financial instrument with 20 to 25-year maturities, the CTL can also be structured with prepayment options at specific points in the future. For example, a CTL could be timed to be coterminous with the completion of a tax-exempt bond issuance, closing of a philanthropic campaign, or a decision to reallocate cash from the balance sheet following the sale of non-core assets.

The CTL can be tailored to the operating objectives for a healthcare provider's real estate assets including acute care facilities, medical office buildings, and ambulatory clinics. The transaction is almost always considered on-credit and generally on-balance sheet by rating agencies and accounting firms. As such, qualifying healthcare providers must maintain an investment grade credit rating of BBB+/Baa1 or higher for optimal execution.

The opportunity cost of most delayed initiatives can be measured as foregone revenue and net income, lost investment income, project cost escalation, and preemptive competitive pressure. We believe that the inherent value of utilizing a CTL results from a healthcare provider having the ability to execute on its strategic initiatives at the optimal moment.

Often requiring only 90 days completing a transaction, a CTL can minimize the transaction costs (both economic and otherwise) of a public financing while offering additional flexibility and a more diverse capital structure.