Garden City Hospital (GCH) is an osteopathic community teaching hospital located in the Wayne County suburbs west of Detroit. GCH is one of the few remaining independent hospitals in the Detroit metropolitan area. Though GCH’s financial condition had improved in recent years, its outstanding Series 1998A Bonds were rated Ba1 by Moody’s Investors Service, one notch below investment-grade. GCH’s recent profitability had been sound, but it had not been able to grow its financial reserves due to the magnitude of its annual debt repayments, its investment in capital assets in excess of its depreciation expense, the funding of its frozen defined-benefit pension plan in excess of requirements, and its support of a subsidiary which operates physician practices. Because of GCH’s weak liquidity position (approximately 73 days’ cash on hand at the end of its FY2006), it would be essential for First River Advisory to design a financing plan which avoided further erosion of GCH’s cash.

As a practice, financing plans developed by First River Advisory are never isolated to only a particular project. First River Advisory routinely considers the “big picture” to ensure that:

1. its clients can take advantage of opportunities to realize other objectives, including those relating to prudent balance sheet management; and
2. constraints and other negative factors to which its clients are subject can be alleviated.

The evolution of GCH’s financing plan followed this paradigm. While the structure of the Series 2007A Bonds never deviated significantly from that which was envisioned at the outset, GCH took advantage of unprecedented favorable market conditions to increase the scope of the financing substantially.

The cornerstone of this financing was a $16.5 million surgery facilities replacement to be housed in a new building addition. This project was designed to replace obsolete surgical suites and address capacity constraints. Because of the long useful life of these assets (over 35 years), the first incarnation of the financing plan called for a deferral of the repayment of this project’s associated debt until 2018, after the full repayment of GCH’s Series 1998A Bonds. This strategy also aided in the preservation of GCH’s cash.

During the course of designing the financing plan, First River Advisory pointed out to GCH’s management and governing board certain issues associated with its existing bank-related debt. GCH had issued $11,150,000 of tax-exempt variable-rate demand bonds (VRDBs) in 1996 (the Series 1996 VRDBs) to finance an expansion and renovation of its emergency department. In 1997, GCH issued $6 million of taxable notes (the Series 1997 Notes) to refinance the debt relating to its medical office building. Both the Series 1996 VRDBs and the Series 1997 Notes were backed by letters of credit (LOCs) from a bank. The 30-year amortization period of the Series 1996 VRDBs was linked to the long useful life of the financed assets. However, the LOC bank required that the Series 1996 VRDBs be fully repaid by 2009, only twelve years after the assets had been placed in service. Because GCH was nearing the end of that timetable, its last few annual repayments were each well over $1 million. The bank required that the Series 1997 Notes be fully amortized by 2012, approximately 21 years after the asset, a brand-new building, had been placed in service. Thus, GCH faced the repayment of nearly $3 million over the next six years. In addition to these accelerated repayment schedules, other bank-related issues included:

1. the bank’s imposition of financial ratios and other covenants which were not required by the holders of GCH’s Series 1998A Bonds (nor would be required by investors in the Series 2007A Bonds);
2. difficulties in obtaining waivers from the bank of GCH’s non-compliance with respect to certain financial ratios during GCH’s “lean” years;
3. the bank’s substantial increase of its annual LOC fee (to as much as 2.00 percent) as “punishment” for such non-compliance; and
4. the continual need to renew the LOCs.

GCH management observed that obtaining waivers of non-compliance from the Series 1998A Bondholders was much less problematic. After the bank exhibited no interest in extending the amortization periods, GCH incorporated the prepayment of the Series 1996 VRDBs and the Series 1997 Notes into its financing plan. The principal amount of the Series 2007A Bonds was increased by approximately $4 million to refund the Series 1996 VRDBs, and GCH used its own financial resources to prepay the remaining $3 million of Series 1997 Notes.

First River Advisory also suggested to GCH that the near-ideal market conditions presented an opportunity to address other facility deficiencies and capital asset replacements which had been deferred during GCH’s period of weak financial performance. GCH opted to finance $8.3 million of improvements to its HVAC systems and other facility infrastructure to resolve long-standing efficiency and regulatory issues, and $1.8 million of beds and patient room furnishings to keep pace with the amenities at its competitors’ facilities. GCH also financed $3.7 million of routine capital expenditures in order to restore its cash balances which had been depleted with the prepayment of the Series 1997 Notes. In total, the original project cost of $16.5 million nearly doubled, to $30.2 million, without any additional compensation to First River Advisory. The composite useful life of all assets financed was still long enough the enable GCH to preserve the original structure of deferring all repayments on the Series 2007A Bonds until 2018.

The final element of the Series 2007A Bond issue was the advance refunding of a portion of the Series 1998A Bonds. Because a portion of the Series 1998A Bonds had advance refunded an earlier bond issue, only some could now be advance refunded. First River Advisory collaborated with the investment banking firm selected to underwrite the Series 2007A Bonds to distinguish which Series 1998A Bonds could be advance refunded, and to demonstrate to tax counsel compliance with applicable regulations. While net present value savings were meager, repayment of those Series 2007A Bonds earmarked for this advance refunding was also deferred until 2018, yet another strategy designed to enable GCH to build its liquidity.

First River Advisory played its typically active role in the marketing of the Series 2007A Bonds. Knowing that the issues plaguing the automobile manufacturing industry would be negative investment characteristics, First River Advisory addressed them head-on in Appendix A to the Official Statement.

First River Advisory conducted extensive research into the automobile manufacturers’ production plans and found that only two manufacturing facilities in or near (within reasonable commuting distance) GCH’s market area were scheduled for down-sizing, but that substantial investments had been and were being made in several other plants.

Through close examination of available data, First River Advisory found that the unemployment rate in an area which approximates GCH’s primary market area had been consistently less than County, State and even national averages, indicating that layoffs in the automobile industry had not affected this area adversely.

First River Advisory actively participated in site visits and conference calls with investment analysts to ensure that their concerns were addressed. To ensure aggressive marketing of the Series 2007A Bonds, the underwriter agreed to a plan which featured:

• a “rich” initial pricing which was intended to drive away many of the investors which were satisfied with GCH’s credit quality and investment merits;
• a determination to allot Series 2007A Bonds to even a single investor offering to pay a higher price (accept a lower yield); and
• favorable treatment with respect to allotments for Series 1998A Bondholders which had “stuck with” GCH during its lean years.

As a result, the Series 2007A Bonds were sold at a yield of 4.99 percent. Other key characteristics are summarized in the table below.

GCH’s Series 2007A Bonds were notable in several respects:

• The approximately five percent yield established a new benchmark for “high-yield” hospital revenue bonds.
• The wide acceptance among investors demonstrated that an independent community hospital operating in a competitive urban environment in an unfavorable economic climate still has access to capital on favorable terms.
• First River Advisory estimated that the yield on GCH’s Series 2007A Bonds was only 50 to 60 basis points greater than the yield at which top-rated hospital systems could borrow. GCH management estimated that the differential in annual interest expense would have been equivalent to its “tax” for corporate overhead if GCH were to join a system. As a result, GCH was able to retain its independence without cost.
• As a result of the deferral of principal repayments until 2018 and the favorable yield, maximum annual debt service was actually reduced by over $1.4 million or nearly 28 percent, despite increasing GCH’s overall debt by $30.7 million.

• As has been the case with many clients, First River Advisory had become the organization’s “institutional memory” with respect to its debt because of changes among executives. GCH’s Chief Financial Officer who had managed all of the previous bond issues had left the organization years ago, so First River Advisory assumed the additional responsibility of educating the Chief Executive Officer, who had not been directly involved in the past. A new Chief Financial Officer, who had no prior capital financing experience, joined GCH just before circulating the Preliminary Official Statement. First River Advisory had to bring him up to speed quickly so that decisions could be made quickly and in an informed manner.
• First River Advisory assisted GCH amend its Certificate of Need (CON) for the surgery facilities replacement to reflect more realistic project costs and the ultimate financing plan. First River Advisory also guided GCH in assembling the CON waiver request so that all of the projects which were added to the financing plan could be financed by the Series 2007A Bonds.
• First River Advisory obtained consents from a majority of the Series 1998A Bondholders to eliminate financial covenants which had been required by the bank.
• In managing the implementation of a financing plan, First River Advisory does not tolerate poor performance by members of the financing team. When the trustee for the prior bond issues failed to cooperate on a timely basis, First River Advisory solicited a proposal from another trustee, and shepherded the transition from the old trustee to the new trustee.
• In 1997, GCH had entered into a Debt Service Deposit Agreement (DSDA) with a financial institution whereby it received a lump sum payment in return for granting the financial institution the right to invest its monthly payments on its then-outstanding Series 1991 Bonds. The DSDA was extended to the Series 1998A Bonds in return for another lump sum payment. First River Advisory evaluated five alternatives for the disposition of the DSDA, and arranged for an amended DSDA to reflect the alternative selected by GCH.

First River Advisory customarily charges an all-inclusive flat fee for its financial advisory services, thereby assuming the risk of complications. Even though these extraordinary services were required to “get the job done” properly, First River Advisory’s fee remained the same as originally contracted.

Reference:
Gary Ley, President and Chief Executive Officer
(734) 458-4421
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