Marquette General Hospital (MGH) is the largest hospital and the sole tertiary care provider on Michigan’s Upper Peninsula.  Between its FY2000 through FY2004, MGH had expended $74.9 million for capital assets, borrowing only $9.4 million.  Also during this period, MGH repaid $10.85 million of its outstanding debt.  As a result, its cash balances became significantly depleted.  First River Advisory was engaged in mid-2004 to devise a strategy to restore MGH’s balance sheet and to arrange financing for an $11 million expansion of MGH’s emergency department (ED).

The challenge proved to be formidable due to the convergence of several factors:

i.    no “reimbursement resolutions” had been adopted so it would not be possible to replenish cash from the proceeds of a bond issue that would finance capital assets that had already been constructed or installed;

ii.    MGH’s Series 1996D Bonds, which represented most of its outstanding debt, were not callable until April 2006, and could not be advance refunded using tax-exempt debt due to Internal Revenue Code (IRC) limitations;

iii.    the remaining average life of the Series 1996D Bonds was significantly less than the remaining useful life of the assets financed or refinance;
iv.    the Series 1996D Bond documents dated to the mid-1970s, and were archaic in many respects; and
 
v.    the only debt incurred between FY2000 – FY2004 had been HELP Loans that featured rapid repayment schedules.

In addition to financing the ED project, a principal objective was to preserve cash by financing other capital assets and maximizing the amortization period of all debt instruments to be utilized.

MGH had not utilized the public capital markets to finance new capital assets since the late 1980s.  Once the various constraints and opportunities became clear, and possible solutions began to emerge, First River Advisory recommended that informal “round-table” discussions with key governing board members be convened with two objectives:

• to educate these board members in order to promote rational decision-making; and
• to elicit their reactions to characteristics of various financing alternatives, especially their tolerance for risk

As a result of this process, First River Advisory designed the Financing Plan to minimize risk, albeit at a correspondingly greater cost.

First River Advisory’s recommended Financing Plan, as refined following additional dialogue with MGH’s Finance Committee, featured four components:

• a conventional (taxable) term loan through a bank that would defease the Series 1996D Bonds in a manner permitted by the IRC, thereby enabling MGH to issue this and other debt under a modern master trust indenture;
• a $12 million issue of variable-rate demand obligations (the Series 2004 VRDOs) that would refinance the HELP Loans at a lower cost, and finance certain capital assets identified on MGH’s FY2005 and FY2006 capital budgets;
• a $28,465,000 issue of tax-exempt long-term, fixed-rate bonds (the Series 2005 Bonds) that would finance the ED expansion project and the remaining capital assets identified on the FY2005 and FY2006 capital budgets; and
• a $37 million issue of tax-exempt bonds (the Series 2006 Bonds) for the primary purpose of refinancing the term loan.

Another feature of the Financing Plan is the expectation of issuing long-term, fixed-rate tax-exempt bonds in early 2006 to refinance the term loan (the Series 2006 Bonds).  It is expected that the Series 2006 Bonds will have the same final maturity (2019) as the Series 1996D Bonds, but all amortization will be delayed until the last five years based on a recalculation of asset useful lives in a manner permitted by Bond Counsel.  Again, due to MGH’s aversion to risk, an interest rate lock with respect to the Series 2006 Bonds was put in place in March 2005.

Once typical characteristic of financing plans developed by First River Advisory is ability to adapt to changing circumstances.  During the course of implementing MGH’s Financing Plan, MGH began to consider another $8 million facilities improvement project that would require financing.  Because of its preliminary nature and lack of certificate of need approval, this project could not be financed immediately with tax-exempt bonds.  Thus, this amount was added to the term loan.  Because this project had been deferred at the time the Series 2006 Bonds were issued, the term loan was left outstanding so that the proceeds could be used either for this or another facilities improvement project, or for general corporate purposes.

The term loan and the Series 2004 VRDOs were closed in December 2004.  The cornerstone of the implementation process was procuring the requisite bank credit facilities.  When MGH’s historical relationship bank declined to participate, First River Advisory solicited proposals from several banks.  The outcome of this process was the organization of a lending group consisting of three banks which are sharing the risk in a 50 / 30 / 20 percent ratio.  The term loan features a fixed interest rate (once again, to address the Board’s risk-aversion) without any amortization through April 2006.  The Series 2006 Bonds were issued for the primary purpose of refinancing this loan.  If, however, MGH had been precluded from the tax-exempt bond market, the term loan could have remained outstanding, although at a variable interest rate unless fixed again at the time.  If still outstanding, the term loan would have begun to amortize in December 2006 over a 13-year period.

The principal amount of the Series 2005 Bonds was increased by approximately $4 million in order to take advantage of favorable market conditions.  First River Advisory obtained a commitment for a bond insurance policy on favorable terms, including a forward commitment to insure the Series 2006 Bonds.  However, First River Advisory’s market research revealed tremendous demand for the Series 2005 Bonds on an uninsured basis, so First River Advisory recommended that the Series 2005 Bonds be marketed on the basis of their “Baa1” rating.  The disclosure of the bond insurance commitment in the Preliminary Official Statement compelled prospective investors to pay higher prices (accept lower yields) for the uninsured bonds in order to avert the application of the insurance policy.  This Series 2005 Bonds were indeed sold without the bond insurance policy at yields which evoked a significant degree of grousing among investors.

By 2006, synthetic fixed-rate structures featuring the issuance of variable-rate bonds coupled with a variable-to-fixed interest rate swap had emerged as a superior approach to fixed-rate financing.  Because First River Advisory was able to satisfy the MGH Board that the benefits of this approach outweighed its potential risks, the Board elected to proceed in this manner.  To implement this plan, First River Advisory negotiated a bond insurance policy with the bond insurer which had committed to insure the Series 2005 Bonds.  MGH issued auction-rate securities (ARS), and swapped the entire principal amount for a 3.74 percent fixed interest rate, resulting in an all-in cost of financing of approximately 4.78 percent.  This all-in cost reflected, among other factors, a $648,000 payment to terminate the interest rate lock, which still served its purpose even though the form of the Series 2006 Bonds had changed.

The utilization of bank financing to defease the Series 1996D Bonds demonstrates the value of the separation of First River Advisory’s advisory role from the sale of financial products.  When other hospitals have been confronted with similar circumstances, investment banking firms’ responses focused on complex securities transactions, frequently involving interest rate swaps or other derivative products.  In many instances, investment banking firms earn fees in connection with both the securities and the derivatives, but are not in the lending business.  While these solutions no doubt accomplished their purposes, they might not have done so as cost-effectively and as straightforwardly as the term loan.

Reference:
Mike Beckstrom, Chief Financial Officer
(906) 225-3450
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