Direct placements are tax-exempt bonds sold in a limited offering to a single buyer, usually a bank.
Placements got a major boost in 2011 after a wave of bank downgrades. Hospitals and other LOC-backed variable rate debt borrowers looked for restructuring opportunities, but without credit support, options to borrow variable in the public bond markets were limited.
Faced with the prospect of losing LOC business, banks began converting VRDN’s to direct loans.
In the process, mandatory tenders were extended several years and remarketing risk was eliminated --along with most of the put risk, a positive for rating agencies.
Direct placements have since become a major factor across all sectors of public finance, with 2013 on track to be another record year.
There are several reasons why bank placements continue to be popular in the healthcare sector.
Firstly, hospitals are deferring large “bricks and mortar” projects in favor of IT and other assets with shorter lives. These projects are a good fit for direct placements, since banks are reluctant to go much past 10 years, at least in the BBB category. Traditional 30-year publicly-sold bonds remain the best option for large capital projects with longer lives.
Secondly, placements are usually priced at lower yields than public offerings, and the difference can be significant. Banks view placements as loss leaders, akin to selling sugar or milk at the local supermarket. To get a bank to do a direct placement, hospitals have to walk down the aisle and oftentimes, commit to buy more profitable services such as treasury and purchasing cards. In return, banks can offer placements at rates below what public bondholders require. The absence of a debt service reserve fund in bank placements also helps keep costs down.
Thirdly, placements are convenient. Dealing with a single bondholder eliminates the need for a bond underwriter, a rating agency, and simplifies disclosure (see our 2011 article The Pros and Cons of Bank Placements). This results in a more streamlined path to closing and a quicker turnaround. It also means that placements are more predictable since the middleman (bond underwriter) is eliminated and pricing and terms can be directly negotiated with the bank as the hospital is no longer subject to the whims of the public bond markets.
One drawback of bank placements is the impact of limited disclosure on the hospital's ability to negotiate the best deal. Unlike public bond offerings, placement documents are not required to be made public or posted on EMMA. Since terms can vary greatly from one deal to another, it’s hard for hospitals to know what to ask for. Should management push for a lower rate? a longer tender? more flexible terms?
Counting on the competitive process to get the best deal doesn’t always work. For example, we’ve seen some RFPs asking for a minimum tender of 8 years, when the hospital should have asked for 10 years or more. All banks came back with 8 years or less.
There are also regional variations in bank credit guidelines. What a bank did for a New Jersey hospital may be very different from what the bank will do in Georgia.
Given this lack of transparency, many hospitals choose to bring in a financial advisor who is familiar with placements, knows which banks will do in the hospital’s specific market, and have personal experience negotiating terms and conditions. Knowledge is power, and an experienced FA can go a long way to help the hospital obtain optimal terms.
The banks’ seemingly endless appetite for lending to healthcare providers may not last forever, and we are seeing several banks who have already starting pulling back on term and amortization. But for the time being, direct placements continue to provide hospitals with the opportunity to access cheap funds on flexible terms with minimal documentation.
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