Who Wins? And What Can We Learn From The Clare Experience?
 On July 1, investors holding $91.5 million in bonds in The Clare at Water Tower, the struggling high-rise CCRC in downtown Chicago, overwhelmingly agreed to exchange their Series 2005 bonds for a package that included a Series 2010A bond at 70% of par value and a second Series 2010B zero-coupon bond at 30% of the value and due in 40 years. The closing date for the new issues was July 15.
 The tender exchange agreement that was worked out between the Franciscan Sisters of Chicago Service Corporation and representatives of the investors required acceptance by at least 95% of the bondholders. Mutual funds own 75% of the bonds and approved the restructuring before the offer was tendered. Bondholders owning an additional $137 million in debt, backed by a letter of credit from Bank of America,  accepted the same restructure without participating in the tender offer.
 “This agreement was done voluntarily with the creditors, both the commercial banks and large institutional bondholders, and then a tender offer was presented to all the retail investors,” said Thomas M. Barry, Managing Director of Cain Brothers in New York and the point person for the workout. “At the end of the day, we had phenomenal acceptance of more than 98% by the three participating groups. And for a tender restructuring, breaking 80% is doing well.” If the required number of creditors had not accepted the exchange, the likely alternative was filing for bankruptcy protection.
The Clare scenario
From the Franciscan’s perspective, and that of the bondholders, The Clare project initially appeared to be a great deal. It was conceived, financed, and built in what was a very heady time in terms of new development, access to credit, and general economic optimism. The Franciscans had a competitive edge on the site; and with no other CCRCs in downtown Chicago, the location was a competitive advantage in and of itself.
 The Franciscans borrowed $229 million for the project, which was 100% financed. Apparently, about $50 million of the proceeds immediately went to pay the investment banker fee, a portion of the developer fee (which extends through 90% occupancy), and the return on the seed capital equity (paid out of the developer fee). The fact that more than 20% of the borrowed funds were used to pay fees at closing probably should have raised a red flag.
 The Clare was certainly a highly leveraged project, as were most projects being financed at the time. From the closing date forward, everything had to go perfectly for the financing structure to work. The Clare had to open on time. It had to come in on budget. And it had to fill up according to projections.
 But things didn’t go perfectly. The Clare opened in December 2008—13 months later than expected and three months after the Lehman Brothers bankruptcy triggered a financial meltdown. It was the worst time to open a CCRC in light of the historic plummeting of home values and freefalling personal investments.
 The Clare also came in over budget—for the most part, for reasons beyond the sponsor’s or the developer’s control. For example, it was discovered well into construction that the foundation required extra pilings. And despite test borings, subsoil conditions caused delays. Overall, construction cost overruns pushed up the budget by $9.5 million, or about 8%; development and marketing fees were also higher than anticipated.
 And then, fill up didn’t occur as expected. A few months prior to the original opening date (November 2007), The Clare had deposits in hand for just under 90% (220) of its 248 units. When the building finally opened in December 2008, only 80 of those units filled—60 original depositors and 20 brought in by Retirement Dynamics, a marketing consulting firm in Charlotte, North Carolina, that helps CCRCs deal with occupancy challenges, among other issues. The Clare’s 160 other original depositors cancelled their contracts because they couldn’t sell their houses, their other assets withered away as the stock market tanked, or they just weren’t willing to make a move during such a dire economic time. So fill up also became a huge problem. And since revenues were based on fill-up assumptions, less money was available to pay operating expenses and to prepay certain outstanding indebtedness. That resulted in the unanticipated utilization of debt-service reserves. This spiraling effect made a restructuring of the debt vital. The other option was filing for bankruptcy protection.
 “My biggest worry when I became CEO was making sure that The Clare opened on time and that the 220 people with reservations would have ample access to the freight elevators when moving their furniture into the building,” recalled Thomas Allison, who became CEO of the Franciscan Sisters of Chicago Service Corporation in mid-2008. “Between October 2008, when we sent letters to our depositors inviting them to book their move-in time, and the actual opening that December, the cancellations started to come in. By mid-February 2009, we realized that we wouldn’t meet our marketing covenant test on March 31 nor our occupancy covenant on June 30.”
 It was evident that immediate and aggressive action was required to protect, both legally and morally, the rights of the residents who had already moved in and to find a way to continue to market The Clare that was in the best interest of all the creditors.
 “The 18-month journey to make the restructuring work took a lot of effort, but we’re excited about the result,” Allison said. “Frankly, I believe it’s the right solution for our creditors. The only way they get paid back is if The Clare fills,” he added. “And the only way The Clare fills is if it’s in a stable financial position. With both of those needs balanced against each other, it was crucial to put this road map in place.”

 Some people say that more could or should have been done earlier to avert this situation or to seek other remedies. “All those people had their chance to contribute and couldn’t come up with any other ideas,” Barry emphasized. “The Clare couldn’t continue to sell units without appropriate disclosure. And when the reality was nowhere close to the projections, the project had to be transformed to a workout position.”
The tender exchange
Simply put, bondholders were offered The Clare Series 2010 bonds as a package. For example:
 A bondholder with a Series 2005A, -B, or -C bond valued at $1,000, with a maturity date between 2011 and 2038, would exchange that for a Series 2010A bond valued at $700 (70%), with the same interest rate as the Series 2005 bond but with a maturity date between 2014 and 2041.
 The bondholder would also receive a Series 2010B capital appreciation (zero coupon) bond valued at $300 (30%), with a compound interest rate of 5% and a maturity date of 2050.
 The new A and B bonds total 100% of the initial value; however, the maturity date for the Series 2010B bonds is, by design, well into the future. “Bondholders will definitely get paid 70 cents on the dollar, and the hope is that they’ll get the other 30 cents, too,” said Barry.
 Prior to the acceptance of the settlement agreement, when bankruptcy was contemplated, the bonds were trading at about 30 cents on the dollar—and that was optimistic, according to Allison. “Bondholders agreeing to accept a certain 70% return in the short term and a long-term 30% bond enables us to market The Clare and to service existing residents,” he said. “It provides stability for our organization, our current residents, and our future residents. And it gives our lenders the best chance of getting their money back. I really believe we’ve done the right thing.”
 Currently, The Clare has a $10 million debt-service reserve fund. And even though they had no legal obligation to do so, the Franciscans have agreed to contribute $5 million to ensure that the restructuring will succeed. 
 To cover operating costs and debt-service requirements, the breakeven point is about 200 filled units, depending on the mix of the units sold, according to Allison. So the focus now is on marketing. One depositor (#81) is cued up and scheduled to move into The Clare in mid-August, while final closing is pending for a handful of others. Efforts to re-approach some of the people who cancelled are being made, as well. The property remains spectacular, with beautiful accommodations, lots of activities, outstanding food prepared by a French chef, and a sophisticated group of residents who are ardent advocates for The Clare’s success.
 “The Clare now has a fighting chance to make it, which it didn’t have in any period over the last 18 months,” said Barry. “Now, it’s up to the marketing folks. Usually when projects go sideways or down, residents organize, hire lawyers, become very critical, and want to get out. That hasn’t happened here. The residents are incredibly enthusiastic about this restructuring, appreciate the Franciscans for being so supportive, and remain steadfast in their belief in the value of The Clare. They’ve been very vocal, and that’s also very helpful for the marketing.”
The learnings
Many projects have faced financial difficulties in the past several months and are still struggling but, with few exceptions, have made progress toward restructuring their debt and filling up somewhere short of drawing a line in the sand with bondholders. A major element of the relationship between a not-for-profit organization and its investors is the trust and belief that the organization will act in the best interest of all parties. Once that trust is compromised, investors become wary, credit becomes tighter, and debt covenants become stricter. So if asking bondholders to “take a haircut” becomes a common business strategy, could tax-exempt financing as a whole suffer?
 It’s probably unfair to The Clare to think that its situation and its remedy alone will negatively impact future bond financings, since it’s certainly not alone with respect to deals that have had problems. Many other projects that have gone adrift and are facing a workout situation are seeking their own solutions. Some of the methodology used by The Clare to reach agreement short of bankruptcy may be helpful to them; in fact, bondholders and the banks involved in The Clare restructuring have said as much. “The agent bank, in particular, was very clear with me about using our methodology as a model for other situations, depending on the circumstances and the composition of the creditors,” noted Allison. 

 The methodology the bank has in mind, Barry suggested, involves perfect disclosure, everyone doing their jobs correctly, measuring risk appropriately, and dealing with the financial issues in a very disciplined fashion in terms of rejuvenating marketing and lowering costs, as appropriate. It’s also likely that financing structures for future projects may be modified. For example:
 Bond covenants. It’s reasonable to assume that all covenants, even for the strongest credits, will tighten up, as investors become more risk averse. Sooner or later, if not already, that will apply to the senior care market.
 Deposit requirements. Setting up comprehensive marketing protocols, with appropriate hurdles for deposit refunds, is crucial. The deposit must be significant enough in terms of cost that it is more than just an inexpensive option. The break fee for The Clare’s original depositors was de minimus—only about $250 on life-care contracts ranging from $500,000 to $1 million—and perhaps the most precarious decision made regarding the project. Given the economic uncertainty at the time, prospective residents easily walked away from what were, essentially, refundable deposits (less the $250). “Certain residences or certain units require stiffer deposits,” cautioned Barry. “You want to make sure that people are committed to moving in. Deposits are clearly a critical element of measuring the probability of success and adding certainty when dealing with so much money and with people’s lives. Allowing depositors to simply walk away creates a false sense of optimism.”
 Developer fees. Developers (including sponsors acting as developers) often take a substantial portion of their fees at the closing of financing, reducing their risk beyond that point. If they were to take more of their money out when the project reaches sustaining occupancy (rather than when presales reach the point where financing is available), developers would have more of a vested interest in the project. “We’re hearing from banks and bondholders that this is something they want,” said Barry. And unless that’s the deal, even though the timing of the payment is negotiated between the sponsor and the developer, bondholders may not be willing to provide the financing.
 Entrance fees. As a practical matter, entrance fees are considered part of the equity in the project. Yet residents—whose contracts usually include some type of entrance-fee refund—are often unaware of that reality. Prospective residents are likely to view entrance fees in a different light due to: 1) the recent Covenant at South Hills bankruptcy, where residents lost their entrance-fee refunds; and 2) the added risk created by the economy when entrance-fee refunds are dependent on the resale of the vacated unit. As a result, investors may look harder at the value of presales. 
Equity requirements. Many of the not-for-profit deals that are (or have been) in trouble were financed at 100%. Often, that is no longer the case; lenders are requiring equity more in line with the 20% or so that for-profit developers have had to invest. 
 Support agreements. In the offering statement to prospective bondholders, the investment bankers that structure the deals can require the sponsor to guarantee the loan through a support agreement. In other words, the sponsor is willing to support the project with its other assets should the loan get into trouble. Sponsors generally don’t want to provide a support agreement, because they want the investors to look only to the assets of the project being financed as the primary guarantee for the loan without jeopardizing or risking their other assets in case of default. (Neither the original Series 2005 bonds nor the new Series 2010 bonds for The Clare included a support agreement.) The rationale for standalone deals: It’s not fair for residents in the organization’s other facilities to suffer if the new project doesn’t work out. By accepting a standalone deal (without a support agreement), investors accept the added risk and usually require a higher interest rate. Conversely, a sponsor who is willing to provide a support agreement should benefit from a lower interest rate. 
In the end, who wins?
Was this a successful outcome for The Clare? It seems to be for the sponsor. It’s probably good for current residents, who may avoid a negative impact on their investment. And the developers, investment bankers, and other consultants received their fees and should be pleased.
 The bondholders may have a different perspective, although their overwhelming support of the settlement agreement seems to indicate a consensus that bankruptcy would have been a worse option. Most likely, bankruptcy would have driven down the value of their investments in The Clare even further—perhaps another 30-40%—and also put current residents at risk. “While it may not have been optimal for everyone, bondholders realized that this approach was the best outcome,” said Barry. 
 The Franciscans chose what they consider a “quick and realistic” strategy—although it was an arduous process—and they believe it will work. But the story of The Clare is not finished. The project lost a lot of marketing time while all the negotiations were going on. Rebuilding the marketing momentum and reestablishing confidence among prospective residents is crucial—but will not be easy.