Should My Health System Issue Bonds to Raise Capital? A Complete Guide for health systems looking to access capital, and the many options to consider. Third party equity, traditional bank financing, and federal loans such as PFA funds are all options that health systems might consider.
However, one popular option is the issuance of bonds.
Large health systems such as CommonSpirit and United Health have recently been featured in the news for issuing massive bond sales, in some instances valuing billions of dollars. As a healthcare provider, it is crucial to have adequate funding to provide quality care to patients. But before deciding whether to issue bonds, it is essential to understand what they are and how they work.
What Are Bonds?
Bonds are debt instruments that organizations issue to raise capital. When an organization issues bonds, it essentially borrows money from investors who buy the bonds. The organization then pays interest on the bonds to the investors until the bond’s maturity date, when the organization repays the principal amount of the bond.
Should Health Systems Issue Bonds?
Issuing bonds can be an effective way for health systems to raise capital. Because the healthcare industry tends to be both competitive and rapidly changing as the needs of patients evolve, health systems require a significant amount of capital to fund the latest medical technologies, build new facilities, and expand existing facilities. By issuing bonds, healthcare providers can raise a significant amount of capital upfront, and then pay it back over time with interest.
Issuing bonds also provides health systems with access to a broader range of investors. The bond market is typically larger and more diverse than the stock market, which provides a more extensive pool of investors to tap into.
However, issuing bonds can be a lengthy, cumbersome, and legally intensive process. If a health system is looking to generate less than $50 million in capital, it may be much easier and more convenient to access capital from a developer.
Benefits of Using a Developer as Third-Party Capital
Before deciding whether to issue bonds, it is necessary to consider all of the options available for raising capital. Especially when capital goals are small to moderate in value, developers often have the advantage over issuing bonds in the following areas:
Timing: Developer’s capital may be more readily available than bond funding, which can take time to arrange. Developers may be more willing to invest in a health system project upfront, whereas bond funding requires a lengthy process of credit rating, underwriting, and issuing.
Flexibility: Developer’s capital may offer greater flexibility than bond financing. A developer may be more willing to negotiate the terms of the investment, such as repayment schedules and interest rates, based on the specific needs of the health system project. On the other hand, bond financing may come with stricter terms and conditions that are less flexible.
Risk: Developer’s capital may involve less risk for the health system than bond financing. A developer may assume some of the risk associated with the project, such as construction delays, cost overruns, and market fluctuations. This can provide the health system with greater financial stability and reduce the risk of default on bond payments.
Control: Developer’s capital may allow the health system to retain more control over the project. A developer may be willing to work closely with the health system to ensure that the project meets its specific needs and goals. In contrast, bond financing may come with more oversight and requirements that can limit the health system’s ability to make decisions about the project.
If your health system does decide to issue bonds, there are multiple important factors to consider before starting the process.
What Types of Bonds Can Health Systems Issue?
Health systems can issue several types of bonds, including:
General Obligation Bonds: These bonds are backed by the full faith and credit of the healthcare provider, meaning that the healthcare provider promises to use its taxing power to repay the bondholders if it cannot repay the bonds from other sources.
Revenue Bonds: These bonds are backed by the revenue generated by the healthcare provider’s operations. Revenue bonds are typically used to finance capital projects that are expected to generate revenue, such as building a new hospital.
Private Activity Bonds: These bonds are issued by healthcare providers but are exempt from federal income tax. Private activity bonds can only be used to finance specific types of projects, such as building affordable housing or developing infrastructure in low-income areas.
What Are the Risks of Issuing Bonds?
Issuing bonds does come with some risks. The primary risk is that if a health system fails to generate enough revenue to repay the bonds, it could default on its debt. This could lead to a downgrade in the health system’s credit rating and an increase in the cost of borrowing in the future.
Another risk is interest rate risk. If interest rates rise after the bonds have been issued, it could be more challenging to refinance the debt in the future.
You Want to Issue Bonds- Now What?
Issuing bonds is a complex process that involves several steps. Here are the general steps that a healthcare system would follow to issue bonds:
- Determine the Need for Capital: The healthcare system must determine how much capital it needs and what the funds will be used for, such as building new facilities, purchasing medical equipment, or funding research projects.
- Determine the Type of Bonds to Issue: The healthcare system must determine the type of bonds to issue, such as general obligation bonds, revenue bonds, or private activity bonds. The type of bonds issued will depend on the healthcare system’s needs and financial situation.
- Develop a Plan of Finance: The healthcare system must develop a plan of finance that outlines how it will repay the bonds, including the interest rate and the length of the bond’s maturity.
- Select an Underwriter: The healthcare system must select an underwriter to manage the bond issuance. The underwriter is responsible for marketing the bonds to potential investors, setting the interest rate, and managing the bond issuance process.
- Obtain Credit Ratings: The healthcare system must obtain credit ratings from rating agencies, such as Standard & Poor’s or Moody’s, to determine the creditworthiness of the healthcare system and the bonds being issued.
- Prepare the Offering Statement: The healthcare system must prepare an offering statement, also known as a prospectus, that provides information about the bonds, the healthcare system, and the risks associated with investing in the bonds.
- Market the Bonds: The underwriter will market the bonds to potential investors, such as institutional investors, mutual funds, and individual investors.
- Price the Bonds: Once the bonds are marketed, the underwriter will determine the final price of the bonds based on market demand and other factors.
- Close the Bond Issuance: After the bonds are priced, the healthcare system will close the bond issuance and receive the proceeds from the bond sale.
- Repay the Bonds: The healthcare system will repay the bonds according to the plan of finance developed during the bond issuance process.
Overall, issuing bonds requires careful planning, financial expertise, and legal compliance to ensure that the healthcare system can raise the necessary capital while minimizing risks and costs.
Key Takeaways
Issuing bonds can be an effective way for health systems to raise capital. However, it is necessary to carefully consider the risks and benefits before issuing bonds. If possible, it might be more beneficial to access third-party capital from an alternative source such as a real estate development firm. Regardless of their choice, health systems should work with financial advisors to determine the most appropriate method of capital to access, to ensure that the terms of the transaction are favorable to both the healthcare provider and the lender.
