Capital markets, which have been relatively stable over the last several years, have begun a slow but consistent rise in interest rates. This means healthcare organizations should prepare for a higher cost of capital.
The outlook becomes confusing, however, because of “recent significant policy developments” from the current congress and administration, notes the author of a recent article in hfm Magazine.
“The policy changes, coupled with the dynamic of new players entering the healthcare business, suggest that over the long term the healthcare industry can expect to see new debt structures, new sources, and eventually, new metrics for monitoring and assessing the credit strength of an organization.” (“Healthcare Capital Markets Outlook: Short-Term Opportunities Versus Long-Term Uncertainty,” hfm Magazine, May 2018)
Some of the changes will result from the new tax law, others from volatility in the debt and equity markets and changing investors’ perceptions. Nontraditional healthcare organizations entering the healthcare market also will have an impact.
Although some minor changes in the status quo for borrowing will occur in 2018 going into 2019, healthcare borrowers can expect to see more radical changes with the ongoing effects of tax reform and the further influx of nontraditional players changing the healthcare business landscape, the author noted.
Today, both large and highly rated multihospital systems and urban medical centers, and smaller community and rural hospitals that may be below investment grade or unrated by the major credit rating agencies are experiencing favorable market conditions. However, as policy changes begin to bring about shifts in the cost and availability of capital, the likely future effects of the Tax Cuts and Jobs Act (TCJA) and the Federal Open Market Committee’s (FOMC) recent motions in shaping the new normal are worth considering.
The Federal Reserve already has made one interest-rate hike in 2018, and another two are expected this year. So the cost of capital has increased and can be expected to increase further.
It’s more difficult to predict the impact of the reduced corporate tax rate on tax-exempt providers. The benefit of tax-exempt debt for hospitals is that the bondholder does not pay taxes on the interest received and, in exchange, accepts a lower interest rate. Note that the relationship between the interest rate and the benefit to the borrower has roughly corresponded to the corporate tax rate.
However, with the drop in the corporate tax rate under the TCJA from 35 percent to 20 percent, the benefit of avoiding taxes is reduced, and “if this relationship holds, tax-exempt institutions will see a significant increase in capital costs.” (“Healthcare Capital Markets Outlook: Short-Term Opportunities Versus Long-Term Uncertainty,” hfm Magazine, May 2018)
Hospitals and systems should consider changes likely to occur with their tax-exempt direct placement debt. Direct placement refers to debt purchased by a single bank or other investor. The loan documents usually have a clause that notes that a change in the corporate tax rate will trigger an interest rate increase or, in some arrangements, an automatic reissuance of the debt.
“Few paid attention to such clauses in years past,” the author noted. (“Healthcare Capital Markets Outlook: Short-Term Opportunities Versus Long-Term Uncertainty,” hfm Magazine, May 2018)
In the first quarter 2018, many borrowers received notification that their interest rate would increase by amounts ranging from 0.25 percent to 1 percent. For organizations that are potentially subject to such increases, or that have debt clauses that require reissuances, it may be time to renegotiate the capital structure and gain greater flexibility for managing changes in interest rates, the author wrote.
The author concluded, “It is generally believed that, for the near term, average long-term tax-exempt bond fixed rates will continue to range between 4.25 percent and 5 percent. Over the long term, however, the new corporate tax rate will drive the cost of tax-exempt debt further upward. How much and when remain to be seen.” (“Healthcare Capital Markets Outlook: Short-Term Opportunities Versus Long-Term Uncertainty,” hfm Magazine, May 2018)
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