Sales of not-for-profit hospitals to investor-owned chains will become easier to complete as a growing number of large tax-exempt bond issues include special redemption provisions.
These change-in-use provisions have been dubbed the "Columbia clause" by analysts because of investor-owned Columbia/HCA Healthcare Corp.'s proclivity for acquiring not-for-profit hospitals. When the tax-exempt hospitals are acquired by Columbia or by any other tax-paying company, an expensive and time-consuming process begins to retire the tax-exempt facility's bonds.
While several experts told MODERN HEALTHCARE*no Columbia clause has been triggered yet, they say it's only a matter of time. Some 735 hospitals were involved in mergers and acquisitions last year, a 9% increase from 1994 (Dec. 18-25, 1995, p. 43).
Under the typical Columbia clause in the bond documents, hospitals tell potential investors about the circumstances in which the bonds may be redeemed, or bought back, before they mature in 30 years. The provisions also remove premium penalties for early calls, which can amount to 2% to 3% above the face value of the bonds, experts said (See graphic).
"We've been seeing this for the past one to two years," said Nessy Shems, a municipal bond analyst with John Nuveen & Co. in Chicago. "Hospitals defease their bonds early for many reasons. This is another reason that is becoming very popular, given all the mergers and acquisitions and the position of the IRS."
From 1993 to 1995, the Internal Revenue Service issued several procedural statements and private-letter rulings that were an attempt to give tax-exempt issuers-including not-for-profit multihospital healthcare systems-more flexibility to retire the bonds before the generally accepted 10-year minimum outlined in offering statements.
One IRS guideline stated that issuers could defease their bonds to their earliest call date, which is 10 years, an IRS spokeswoman said. Under defeasement, issuers place into escrow an amount of money sufficient to pay debt service and principal. Bondholders then receive semi-annual payments through the escrow accounts until the bonds are called, or redeemed.
Another IRS guideline stated that if not-for-profit hospitals want to retire bonds before five years, investors must be presented with a tender offer, which is a more costly step than defeasement, experts said. A tender is a process in which investors are offered an amount of money greater than they would have received over the life of the bonds.
In effect, the IRS rulings prompted many investment bankers to advise clients to insert a "Columbia clause" into their bond documents. The clause would allow bonds to be redeemed in the instance of a sale, lease or joint venture with a for-profit company involving a facility that had received tax-exempt bond proceeds.
"Prior to (special redemption provisions), hospitals selling to for-profits either had to get private-letter rulings from the IRS or had to conduct tender offers (for the tax-exempt bonds)," said Steve Renn, first vice president in the healthcare group at AMBAC Indemnity Corp., a New York-based bond insurer. "(Tender offers) can be very expensive because you have to negotiate the sale of the bonds with investors."
One example of how long it can take hospitals to get private-letter rulings from the IRS is the 1994 sale of Medical Center Hospital in Punta Gorda, Fla., to for-profit Health Management Associates, Naples, Fla. Medical Center Hospital had been owned by Adventist Health System/Sunbelt. Because Sunbelt didn't have a Columbia clause in its tax-exempt bonds, the not-for-profit system was forced to request a ruling from the IRS.
The IRS review lasted nine months. In its ruling, the agency ultimately allowed Sunbelt to defease its tax-exempt bonds and complete the deal with HMA (Dec. 19-26, 1994, p. 32).
By adding a Columbia clause, tax-exempt issuers benefit in three primary ways.
Hundreds of thousands of dollars in early bond redemption penalties can be saved. The total savings depends on the amount of the bonds and the special provisions for early retirement of the bonds.
Three to six months can be shaved off closing dates of deals by avoiding the time-consuming process of obtaining private-letter rulings from the IRS. The IRS' blessing is optional, but many bond investors want the assurance they don't have to pay income taxes after the bonds are redeemed.
Maximum operational flexibility is achieved, allowing healthcare systems to make deals that quickly respond to changing markets.
While St. Louis-based SSM Health Care System hasn't invoked the provisions in its bond issues, Elizabeth Alhand, SSM's senior vice president of finance, said their inclusion gives the system flexibility to more quickly adapt to market changes and develop regional delivery systems with partners that may include taxable companies.
In 1995, SSM added the provision to a $49.7 million bond issue. "We don't want legal documents to preclude us from pursuing the right strategic choices," Alhand said.
The flexibility the clause provides, however, cost SSM more money to sell the bonds. "Our yield (interest paid to investors) was a little higher, but flexibility is important," Alhand said.
Howard Levenson, a healthcare tax partner in the Washington office of Ernst & Young, agreed. "Putting the clause in bond documents can increase the cost of borrowing," he said. "It's a negotiated cost. The question is do you take the hit on the front end for the benefit of being able to engage in a transaction at the end?"
Not all systems have to pay higher yields to sell bonds with the special redemption provisions, said Constance J. Schmidt, vice president of finance at BJC Health System in St. Louis.
"We didn't incur any additional costs to get additional flexibility," Schmidt said. In BJC's past two refinancings, a
$330 million issue in 1993 and a
$176 million issue in 1994, the system added "extraordinary optional redemption provisions" to the bond documents, Schmidt said. "Because of all the talk about major healthcare reform, nobody knew what was going to happen with the delivery and financing systems."
In addition to sales of a facility, change-in-use redemption provisions cover instances in which the not-for-profit system closes a hospital or converts it to non-acute-care uses. Issuers also may choose to redeem the bonds if the hospital or healthcare facility becomes involved in a joint venture with a taxable company.
Special provisions in bond documents also allow management to call the bonds if a determination is made that it's economically unfeasible to operate the healthcare facility.
"Investors want the Columbia clause so they aren't at risk (for taxes) when the bonds are paid off early," said James Blake, an investment banker with Smith Barney in Chicago.