Understanding Financing Options for Hospitals, Health Systems

June 27, 2013

Before joining a hospital or large health system, physicians should consider their potential partner's financing strategy.

A recent Healthcare Financial Management Association publication focused on various options for procuring financing (here and here). Since not-for-profit hospitals cannot issue stock, they often turn to debt financing through the issuance of tax-exempt bonds. For-profit entities have the option of issuing stock in addition to issuing bonds - although not tax exempt - and many of the larger systems (i.e., Tenet, HCA and Community Health Systems) do so on the major exchanges such as the S&P 500.

Whether a not-for-profit or for-profit entity, third-party capital is a viable option that should not be overlooked. For physicians, who are either employees of these systems or have medical staff privileges allowing them to treat patients at that facility or health system, appreciating how the hospital or health system finances strategic facilities or objectives can play a role in how a possible joint venture between the physician and the hospital/health system is valued.

When evaluating a hospital or health system, the type of financing and debt-to-income ratio should be considered. In general, the types of entities that can issue tax-exempt debt (bonds) to not-for-profit organizations is limited. Some states limit issuance to a single authority. Other states have both local and statewide authorities, while others only have local authorities. These "authorities" typically act as liaisons between the investors and the investment banking firms. The costs associated with the issuance depend upon the issuing authority and the competition within the marketplace. In turn, this affects the bond’s yield (the return the investor expects to earn from the coupon payments and interest).

When assessing bonds, whether issued by a for-profit or not-for-profit entity, four characteristics should be considered:

1. Term to maturity;

2. Interest rate type (fixed v. variable);

3. Utilization of bond insurance; and

4. Revenue vs. general obligation bond (municipal bond specific).

[Note: General obligation are those bonds that are backed by the full faith and credit of the issuer. Revenue bonds are backed by the revenue generated by the specific project being financed through the bond issue.]

Considering these factors can help with assessing the overall financial picture of an entity.

Alternatively, third-party capital may be used. Although, not-for-profit health systems typically do not consider this option because of the entrenched dogma that using bonds is preferable based on the notions that, "[t]ax exempt debt is less expensive over the long term; ownership makes the most sense if the asset is to be used for 30 years or longer; as long as the organization has sufficient debt capacity, there is no reason not to use it; and alternative capital could implicate the organization’s balance sheet in the eyes of the credit markets." This option should be considered and may have to be contemplated if a hybrid arrangement (e.g. a joint venture between a not-for-profit and for-profit entity), such as an ambulatory care facility is being evaluated.

In sum, today’s healthcare marketplace is more dynamic than ever before. It is more important to evaluate an entity and the financing options before entering into a deal or arrangement.