Last December, we discussed how corporate income tax reform may cause the yields paid by hospitals on tax exempt borrowings to increase.
The concern was --and remains-- that lower corporate tax rates will make tax exempt yields less attractive to corporate investors relative to taxable yields.
Bank placements should be affected the most, because commercial banks face higher effective tax rates than other corporate buyers.
Recent placement documents have yield maintenance language giving banks the right to adjust rates to make up for changes in profitability due to changes in corporate tax rates. This language is separate from other adjustments that compensate lenders if the debt loses its tax-exempt status or the borrower is downgraded.
It may be too early to tell, but so far, it looks like lenders are taking a case by case approach to adjusting yields.
Most local banks, historically less active in direct placements, have not asked for higher rates. Regional and super regional banks seem to base their decision on what other business can be expected from each borrower. Loans are often used as door openers to get other, more profitable business such as cash management or purchasing cards. The more other business banks get, the more reluctant they are to raise rates.
The handful of institutional lenders who compete with commercial banks on placements demand little or no other business, so they have not raised rates on existing facilities.
For some lenders, the muted response may also be due to struggling with the variety of deductions and carryforwards they have to take into account in order to determine the impact of tax reform on the taxable equivalent yield of tax exempt loans. The impact on each bank will vary as a function of effective tax rate, which last year averaged close to 30%.
For hospitals and other not for profit borrowers, no news from banks is good news. Hospitals that need more certainty can ask for a waiver of any yield maintenance language and see what banks come back with. Whether the bank invokes their option under the language or not, the fact that the bank can may trigger a tax re-issuance for tax purposes, which requires filing a new 8038 form, so hospitals should consult with tax counsel.
Going forward, we expect to see higher rates on new placements, particularly if banks aren't competing with public bondholders in lower tax brackets or retail investors unaffected by corporate tax reform.
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