The Health Care M&A Monthly: Novel Renovation, Novel Financing - Home Restructures Debt, Finances a Project, and Saves Money

You’ve heard of the Main Street Concept, a design and decor that makes a facility appear to be a little community with streets and houses. The Good Samaritan Home in Evansville, Indiana, has gone a step further, personalizing the concept to Evansville in the 1940s — the hometown and the heyday of most of its residents. “Evansville folks are dyed-in-the-wool Midwesterners,” says Tom Slaubaugh, administrator. “They don’t retire to Florida. They stay in Evansville and are part of the town’s history.”

Besides simply refurbishing an old building, the goal of the “Recollections Project,” as it is called, is to create mental stimulation for the residents as they recall memories of the past in their own hometown. The hope is that the memories will encourage conversations and discussions about “the good old days” to help the residents stay connected.

The design isn’t the only novel approach. Lancaster Pollard & Co. devised a financing package for Good Samaritan Home that restructured its existing debt, covers capital improvements, and also provides net cost savings on annual debt service.

The project evolves...
More than 25 years ago, Slaubaugh worked with a fellow who owned a small nursing home and who enjoyed woodworking in his offtime. In a garage workshop, he would build architecturally interesting facades and affix them to the walls around the doors of rooms in the nursing home. Each facade was different. He put up mailboxes and porch lights, little roofs and awnings. “Essentially,” says Slaubaugh, “he converted the hallway to a street, a community, a little town.”

When the inspectors came for their annual survey, they took issue with the nonexistent fire ratings on the materials used for the facades and the fact that the lights and awnings ate into the required eight-foot hallway widths. While his intentions were good, the amateur woodworker had to rip out the entire project – a year’s worth of work.

Slaubaugh found the concept intriguing and thought Good Samaritan could do something similar by just complying with the code and regulations. “ I talked with interior designers and architects,” he says, “and they agreed. Over the course of time, we thought about how to do it, what materials to use, and then drew up plans.”

Enter Lancaster Pollard...
In early 2006, Slaubaugh and others at Good Samaritan approached Lancaster Pollard & Co. about financing some capital improvements and restructuring the home’s existing debt through a tax-exempt bond issue.

“We recommended a tax-exempt revenue bond issue enhanced by a bank letter of credit for the financing structure,” says Steve Kennedy, vice president at Lancaster Pollard, “which is very beneficial for a not-for-profit organization that does not have a stand-alone investment-grade rating. If that organization looks to borrow capital on its own credit strength, it probably could not access investment-grade rated debt.”

The letter of credit is an agreement between the borrower and the bank that states that the borrower will pay the bank an annual fee for the right to use its credit strength – for example, the bank’s AA rating – when the borrower issues bonds. The letter of credit fee amounts to a fraction of the total interest expense if the borrower with a low credit rating negotiated financing on its own.

Without a letter of credit, the bond issue would be priced based on the perceived credit strength of the not-for-profit senior living provider. The ratios are less strong when the provider has a smaller revenue base — even though it is a very clean, well-run operation. Therefore, the interest rate or coupon would be higher than for a provider with an investment-grade rating.

The financing package provided an opportunity for Good Samaritan Home to borrow at a cost of capital based on the credit strength of an AA-rated bank. Good Samaritan also had some existing debt on its books — a direct, taxable bank loan. By refinancing the existing debt along with the new capital at a low, tax-exempt cost and by ensuring that the bond issue had a long term (a 25-year amortization), Good Samaritan Home was able to borrow a lot more money and, at the end of the day, have a more favorable annual debt service payment.

“Our existing debt was actually a conventional loan with a conventional interest rate,” says Slaubaugh. “By going to a tax-exempt bond, we reduced our monthly outlay substantially and can put the savings toward the new project.” Successful publicity and fundraising campaigns brought in enough donations to start the project.

“Good Samaritan Home has a very committed, prudent, and diligent board, which is important,” notes Kennedy. “They assessed several different financing options and ultimately picked one that will allow them to build financial strength for the organization so that they can fund their mission in perpetuity.”

Of course, the Recollection Project design is much more expensive than a traditional design. “We’ll put a good $1.5 million into this project,” says Slaubaugh. “I could certainly refurbish the place a lot cheaper than that. But the financing will cover the cost of the project and, from a marketing perspective, the popularity of the new design will definitely influence the census in a positive way.”

Slaubaugh expects the financing package to preclude the need to raise fees to offset the remodeling costs. “Donors seem to be responding to this concept,” he says. He also expects to support any construction cost overage with the reduction in monthly interest expense that the financing creates.

The design unfolds...
The Recollection Project involves the home’s original building that opened in January 1962 and was renovated in 1980...“and it looked it,” says Slaubaugh, “with carpet on the walls below the handrails and colors from that era. Everything was worn and faded and torn.”

“Paint and powder” would dress up the building quicker and more economically; but since most residents suffer from cognitive impairments, quickly changing the decor with different colors and patterns would create even more confusion. Residents wouldn’t recognize their new surroundings and become agitated. They might have to be medicated to prevent wandering off, and that would increase the risk of falls — all in all, not a good scenario. The Recollection Project, on the other hand, incorporates the familiar in order to trigger the memory.

Each wing of the renovated building will be renamed after a local street with appropriate street signs. The entrances to rooms, offices, and common areas will resemble buildings on that street in the 1940s. To create the “look,” digital photographs were taken of office buildings with interesting architectural elements, and archived black-and-white photos from the 1945-1965 period were digitally colorized. The digital images were then superimposed onto floor-to-ceiling wall coverings. The flooring on “Main Street,” Evansville’s historic downtown area, will simulate cobblestones, sidewalks, and grassy areas. The handrail along the hallway will have spindles to resemble a fence. And between the doorways, walls will have digital images of pathways, gardens, and streams. “Storefronts” will have mannequins in the windows, dressed in 1940s style clothing. Nurse’s stations will be located in gazebos or on simulated verandahs.

Entering the lobby, people will see a river scene circa 1957. The Ohio River is a prominent feature of Evansville, and the scene is a huge image of the Delta Queen riverboat disembarking passengers. On the street in front of the riverboat is a 1957 two-tone Chevy — with lots of chrome!

The timeline...
The Recollection Project began in fall 2006. The first phase, which involves the wall coverings and nurse’s stations, should be finished in June 2007. The second phase, which will complete the hallways, should take four additional months. And the third phase, which involves the dining room, day rooms, and activity rooms, should be another six or eight months. In total, the project will probably take at least 18 months to complete.

“But that’s a good thing,” says Slaubaugh, “because a gradual change is less confusing for the residents than, say, having everything look completely different in a brief two-month period.”

Importantly, no one will be displaced during the renovations and refurbishing. “We aren’t shutting anything down while we’re doing this project,” says Slaubaugh, “and the residents will be involved, which is also stimulating for them. We talk to them about it and get feedback and try to incorporate some of their ideas, so it’s a very positive experience for everyone.”

...and the bottom line
A not-for-profit organization has the inherent ability to issue debt at tax-exempt rates, and that’s a comparative advantage that can result in very favorable savings. “We’ve underwritten projects like this throughout the country, ” says Kennedy. “The financing structure aligned very well with what Good Samaritan Home was trying to accomplish and with its overall credit profile — and it could absolutely work for others.”

Before any not-for-profit senior-living organization undertakes such a project, though, Kennedy suggests they first evaluate the existing debt on their balance sheet and then carefully evaluate the most cost-effective and term-favorable way to fund the project.

Going into this project Good Samaritan Home did have some cash investments on its balance sheet, but its liquidity ratios (specifically the “days of cash on hand” ratio), were lower than those of its investment-grade senior-living peers. “As part of this process,” Kennedy explains, “we were able to both fund the project and decrease annual interest expense, making more cash flow available on the balance sheet. Now, over the long term, Good Samaritan can accumulate cash and strengthen its balance sheet. Ultimately, that will put the home in a stronger position when the time comes to borrow again.”

Building up liquidity on the balance sheet has become more and more important for not-for-profit organizations, according to Kennedy. The investing community wants to see more cash on the balance sheet — especially for senior living providers that are exposed to so many factors that are beyond their control, e.g. Medicare and Medicaid reimbursements. Having a balance sheet with a good amount of cash allows those organizations to weather the storm of relatively volatile cash flows.

“We’re having a lot of fun with this project,” says Slaubaugh, “although it’s much like a 10,000-piece jigsaw puzzle. The individual pieces don’t look like much until they begin to come together and form a picture. Lancaster Pollard did an excellent job for us. I would definitely recommend that any not-for-profit provider that is seeking financing and/or restructuring existing debt to look at the tax-exempt bond market.”

And a letter of credit, if that applies!