Low interest rates in the taxable markets are luring not-for-profit health systems away from tax-exempt bonds, where tax breaks for investors typically translate into cheaper debt for borrowers but are subject to greater restrictions on the use of capital, more oversight and higher fees.
Tax-exempt bonds must be used for tax-exempt purposes for as long as borrowers are paying back investors. For any project financed with tax-exempt debt, such as building construction, borrowers must limit its use for taxable purposes to 5%, and hospitals and health systems face oversight of tax-exempt bonds by the Internal Revenue Service. Taxable purposes could include medical office space for private-practice physicians or outsourcing a pharmacy to a for-profit company.
“Given where absolute yields are, the advantage to tax exemption is very narrow right now,” Pierre Bogacz, a managing director with capital consulting firm HFA Partners, said in an e-mail.
Zuckerman said Dignity Health's upcoming deal will also introduce the system to taxable investors. As the system seeks to diversify its services, it will look for additional for-profit deals requiring taxable financing, she said.
North Shore-Long Island Jewish borrowed for the first time from investors in the taxable public market in mid-September and paid slightly more than what the New York system might have in tax-exempt markets, said Robert Shapiro, senior vice president and chief financial officer.
The system, based in Great Neck, N.Y., borrowed $135 million for 30 years with an interest rate of 4.92%, once fees were included. That's compared to the 4.47% tax-exempt rate, which also included fees, he said.
Shapiro said the system was also attracted to the taxable market's more limited regulations and likewise sought to gain access to a more diverse group of investors. “That's what it cost us for flexibility and a new base of investors,” Shapiro said. “It's worth every penny.”
North Shore-LIJ will use the funds to pay for initiatives under way to manage population health.
The Mayo Clinic in Rochester, Minn., issued its first public taxable bond deal in August for $300 million that will be used for operating needs and capital. The deal was issued at rates comparable to the tax-exempt market.
Taxable deals can also be issued more quickly and with less hassle than tax-exempt bonds, healthcare finance executives said.