Before Canada's largest acute-care teaching hospital system was permitted to sell about $190 million (U.S.) of bonds last fall, it had to convince government officials, analysts and lawyers it could carry the debt without sacrificing patient services or leaving bondholders in the lurch.
Never before had a Canadian healthcare provider raised a significant sum of money from the sale of bonds. Hospital expenditures in Canada are traditionally funded from government appropriations. But in an era of cautionary spending, management and board members of 1,000-bed Toronto Hospital, a three-hospital system, knew they'd never snag a big enough piece of the provincial tax pie to carry out the extensive rebuilding plan they had in mind. Nor could they finance the project in one fell swoop.
So system leaders turned to Scotia Capital Markets, a Toronto-based investment banking firm. Scotia led a syndicate of Canadian underwriters, which marketed the newfangled bonds to investors.
But first Toronto Hospital needed the blessing of Ontario's health and finance ministries. Government officials eventually warmed to the idea. But, as Susan Conner, then-chief financial officer of the Toronto-based system, concedes, "it did not sail through, because they were afraid of giving up control."
Conner, who now serves as vice president of development and head of the redevelopment project, called Project 2003, went through the wringer with independent financial analysts whose job is to protect bondholders' interests.
After five months of dickering and dotting of i's, the hospital launched the bonds at an annual rate of interest of 5.64%. It happened to be the fourth Thursday of November-Thanksgiving Day in the U.S. By the issue's Dec. 1, 1998, closing, Conner had plenty to be thankful for.
Institutional investors-primarily U.S. and Canadian money managers and life insurance companies-liked the deal so much that it was oversubscribed. With bond proceeds and private donations, the hospital will rebuild two of its three campuses. The five-year reconstruction plan, worth about $240 million (U.S.), entails the demolition of outdated facilities, the construction of new patient-care and research facilities, and the modernization of existing space.
The deal by Toronto Hospital, which recently changed its name to University Health Network, is considered an icebreaker of sorts. In countries where government appropriations fund healthcare, private bond issues are still rare. But international healthcare financiers expect to see more deals like this in Canada and other countries as cash-strapped governments faced with ballooning healthcare costs ease their resistance to private financing alternatives.
"To me it's a good example of how these types of transactions can be done in markets other than the United States," says Dave Johnson, a managing director with Merrill Lynch & Co. in Chicago.
In Ontario, at least, Toronto Hospital helped pave the way for other major providers to consider private financings. Now that the deal is done, Health Minister Elizabeth Witmer will entertain proposals from other providers, says Jeremy Adams, a spokesman for the health ministry.
The momentum for Project 2003 began building in May 1997. Alan Hudson, the system's president and chief executive officer, and his board realized that years of deterioration and underinvestment in the system's infrastructure were threatening to undermine the academic health science center's ability to recruit top researchers and clinicians. A facility assessment by Hellmuth, Obata & Kassabaum, an American architecture firm, confirmed their worst fears.
"We were afraid that we would not be able to compete on the world front," Conner explains. "You can't buy new equipment and technology, and put it into old buildings."
Toronto Hospital receives an annual government grant for operations, which in 1998 totaled about $270 million (U.S.). About $25 million (U.S.) more in government money was earmarked for special programs.
But as system executives contemplated an overhaul, they knew the project's capital requirements far outstripped the government's funding capabilities. Conner says few new government dollars are going to new construction.
The obvious, if not easy, solution was to issue bonds to private investors. Bond proceeds, in turn, will fund a more efficient Toronto Hospital. Nearly one-third of existing real estate holdings will be taken out of service, for example. "That's a lot of property that we're not heating, lighting or maintaining," Conner says. "And what we do have left is easier to maintain." The project is expected to free some $17 million (U.S.) annually, which will be used to pay debt service on the bonds.
Although the bonds were sold on Toronto Hospital's own credit, they carry some pretty stiff bondholder protections, at least by U.S. standards. For example, in the event of a default, bondholders would be first in line to tap the hospital's cash receipts. That excludes donations and research grants but includes virtually all other forms of cash, such as government grants for operating and capital expenditures, ancillary revenues from parking lots and retail concessions, and third-party insurance payments made on behalf of foreign patients.
Bondholders also would hold claim to any land and buildings at the time of default. Furthermore, if the system anticipated a default, it would be barred from holding a fire sale to free up cash.
"It's a nice credit hammer for us as an agency," says Paul Calder, an analyst with Toronto-based Canadian Bond Rating Service, which rated the bonds AA. "Without those elements they could not have achieved the same rating as the province (of Ontario)," he says. Dominion Bond Rating Service, Toronto, which uses a different rating scale, awarded Toronto Hospital an A.
Philip Lieberman, associate director of structured finance investment banking at Scotia Capital, says the tough covenants helped sell the deal. By obtaining ratings that matched the long-term debt ratings of the province, Toronto Hospital could finance its project at a cost of capital that made sense to government officials. If it had obtained a lower rating, its cost of capital would have been higher, it would have been unable to service the debt from savings generated through the project, and the government might not have allowed the hospital to proceed with the financing, he says.
Now that the deal is done, Conner offers advice to other hospitals. Most important, she says, have a conflict-resolution process for the parties at the bargaining table.
"A hospital has to lead the process and not be led, because there are a lot of agendas," she says. "I led it for sure because I wanted to keep the cost down and I wanted to make sure the deal was one that the hospital could live with for 25 years."