Senior Living Business: Flexible Financing—Updated Mission--
Lutheran Social Services of Michigan Expands, Renovates
At a ground-breaking ceremony in June, the planting of a maple tree symbolically marked the beginning of the expansion and renovation of MapleCreek, a senior living community in Grand Rapids, Michigan, and officially launched the largest project in the 73-year history of its sponsor, Lutheran Social Services of Michigan (LSSM).
The $30.5 million MapleCreek project involves the expansion and remodeling of existing campus buildings, along with additional memory care facilities, a new rehabilitation center for residents (inpatient and outpatient), new one- and two-bedroom independent living apartments with kitchenettes, and 33 new two-, three- and four-unit condominium-style cottages on the MapleCreek property. The entire project, which will be tackled in three phases, is expected to take two years to complete.
The June event also marked the embarkation of a new financing structure for LSSM, one that provides more financial flexibility for the organization and that will allow it to continue to reinvest and develop as senior living needs arise. Lancaster Pollard has been working with LSSM for the last several years to modify its existing capital structure, refinance its debt, lower its borrowing costs, consider various development opportunities, and position the organization so it can modify the senior living services it offers in Grand Rapids, Michigan, according to Gerald M. Swiacki, senior vice president at Lancaster Pollard.
“Embracing concepts about optimal capital structure or accessing the capital markets to meet strategic capital needs is not always an easy thing for a not-for-profit organization to do,” he says. “Traditionally, not-for-profits figure they’re meeting their fiduciary responsibility by firmly establishing their debt service and, therefore, issue fixed-rate debt. In addition, they generally try to minimize the amount of debt that they put into a project by investing as much equity (cash) as they can in the transaction.”
Also, not-for-profits, as a rule, have comparatively limited access to capital, which generally comes from sources such as operations, the disposition of assets, the generosity of benefactors, or, ultimately, the debt markets — and which, from a banking perspective, results in an underleveraged product.
“We’ve tried to get our clients to recognize that when they need cash or capital to fund projects, accessing the capital markets – whether that involves a regular commercial loan or a bond financing — usually results in the shortest time frame,” Swiacki adds. “If these organizations can manage their credit profile to allow access to the capital markets, that provides flexibility when they’re ready to pull the trigger on a project.”
Refinancing to gain liquidity
Specifically, Swiacki and his team try to get their not-for-profit clients to recognize the opportunity in variable rates for tax-exempt bonds, which have historically averaged 3.2 percent.
“If we can manage the ups and downs of the curve, we believe variable-rate bonds put the organization in a better financial position,” he says. “Negotiating a fixed rate of, say, 6.5 percent for long-term tax-exempt bonds and also paying for credit enhancement— either in the form of bond insurance or a letter of credit — means the organization would be looking at an all-in cost of capital approaching 7.0 percent or more. For LSSM, that would mean giving up, every year, three points on its $30.5 million in new debt.”
Once that was explained, LSSM embraced the concept and began positioning itself to accomplish its financial objectives. LSSM had to restructure $17.8 million in existing debt to improve its credit standing; then, it had to arrange the additional $30.5 million of debt for the MapleCreek project.
LSSM had a number of outstanding bond issues dating back to the 1990s. In 2003, LSSM refinanced all its outstanding indebtedness — the $17.8 million — through Lancaster Pollard, which also fashioned a plan to enhance LSSM’s operations. The plan focused on mission, on retaining liquidity, and on reducing the overall cost of borrowing. “After completely refinancing LSSM’s existing debt,” says Swiacki, “we worked for nearly four years on planning the redevelopment of the MapleCreek project.”
The 2007 bonds for MapleCreek amounted to $30.5 million of new money. But because a new bank relationship – a new letter of credit provider – was involved, it meant substituting the letter of credit on the old 2003 bond issue. Therefore, in aggregate, it amounted to a nearly $50 million relationship that Lancaster Pollard was competitively shopping to local banks for the lowest cost of capital and best terms.
Meeting the metrics
Banks, of course, measure certain metrics — creditworthiness, cash flow, and liquidity — when considering whether to issue a letter of credit. In 2003, LSSM had fantastic credit characteristics, in that it had a tremendous amount of assets to leverage a loan and offer as collateral, but the organization also needed to show healthy cash-flow and liquidity characteristics. Its cash-flow coverage was only reasonable, and liquidity was unenviable. So while LSSM had good borrowing capacity in one metric, it did not have it in two others.
“By refinancing our existing debt in 2003, we were able to build up our cash and our liquidity to give us a better opportunity for future financing,” says Lou Ellen McGrath, CFO of LSSM. “Originally, we were planning on selling some existing assets and using the money from that sale to build the new cottages at MapleCreek. We didn’t want to borrow any new money. Lancaster Pollard convinced us that we should keep the cash on our balance sheet and finance the new building project.”
Reducing its cost of capital in the 2003 refinancing began to have an effect on LSSM’s bottom line. Investing its own cash and borrowing to meet capital needs did a really good job of increasing liquidity and flexibility. “LSSM’s new financing structure is particularly noteworthy,” says Swiacki, “because the organization would never have been able to borrow that much money [$50 million] when we did the 2003 refinancing.”
The new project
LSSM is the largest faith-based, not-for-profit, human service organization in the state of Michigan, but only about half of its revenue comes from senior living services. The rest comes from other social services such as foster care, adoption services, child care, subsidized housing, homeless assistance, and refugee services.
Besides MapleCreek, which is a continuing care facility, LSSM sponsors a dozen subsidized senior housing apartment complexes, four nursing homes, three assisted living facilities, two independent living senior housing facilities, and MapleCreek At Home, a home-care service that is associated with MapleCreek and covers five neighboring counties.
MapleCreek currently offers traditional independent living, assisted living, and skilled nursing services. The independent living offering is in efficiency apartments with support, which are less marketable than a modern, full-continuum senior living community.
“LSSM wanted to enhance the amenities at MapleCreek to make it a more attractive campus,” says Swiacki. “We went through a number of iterations on the size and scope of the project, as well as the type and number of units to offer.”
The team worked concurrently on the financial and operational sides of the entire organization to help LSSM manage its bottom line and improve its credit characteristics in order to be able to access the capital market. “We also made sure that the market being targeted in the repositioning of the campus really existed,” he adds.
The new project involves a complete renovation and repositioning of the campus — a culture change. Essentially, LSSM is redeveloping the entire independent living area with brand-new condominiums and cluster homes. It is also instituting entrance fees, which the previous facility did not require. Residents will have access to certain amenities on the campus and pay a la carte fees for certain other amenities.
In addition, the assisted living area is being expanded by 50 percent, from 40 units to 60 units, over a two-year period so as not to displace anyone nor disrupt operations during construction. The memory care section will be expanded, and the nursing home will be upgraded. Part of the nursing home will have a new rehabilitation wing to accommodate both residents and nonresidents needing physical and rehabilitative therapy. In the end, MapleCreek will be a full-continuum senior care facility.
“I believe that the new culture change and the new financing structure go hand in hand,” says Swiacki. “When an organization modifies its approach in a market, it may be suffering from vacancy issues or the amenities aren’t attractive enough to entice people to move to the campus. A market study uncovers changes, expansions, and modifications that the market demands in the facility’s offerings.”
Once the project was defined, Lancaster Pollard opened up a competitive bidding process, and the bids came in very aggressively from every bank that received packages. “We actually went back to the bank that had the original relationship and said: ‘We need your credit enhancement to sell the bonds. We’ve structured the financing this way. And we’re giving you an opportunity to make a pre-emptive bid to keep the relationship.’ If that bank had come back with a fair price, we would have suggested LSSM continue what had been a long-term relationship. Instead, the quote was an increase over the existing pricing.”
In the end, LSSM’s credit enhancement cost decreased by more than 50 percent due to the competitive bid process, and much more flexible financial covenants and terms were negotiated. “We’re getting a better rate on the $17.8 million,” says McGrath. “The loans are for 27 years at 5.0 percent, so the refinancing is probably saving us 1.5 percent compared to the terms of the original loan.”
LSSM is also saving money on the reduced enhancement costs on the outstanding $17.8 million and in the cost of debt service in the neighborhood of $170,000 a year — also attributable to the initial $17.8 million. In the aggregate, of course, debt service is higher, because the $30.5 million is all new debt.
“The great thing about this project is that it’s designed to attract and meet the needs of the great middle market,” says Swiacki. “There’s just so much available to the high-end market, but the middle market isn’t well served with affordable senior housing. So that’s the mission of LSSM – meeting the needs of the middle market.”