Some Provisions Offer Opportunities For The Senior Housing Sector
March 1, 2009
Among the provisions of the American Recovery & Reinvestment Act of 2009, the $787 billion stimulus bill signed by President Obama on February 17, some of those provisions may positively impact senior living providers seeking financing in 2009 and 2010 — specifically, those provisions that encourage investments by banks in all kinds of tax-exempt bonds and that provide economic incentives to the issuers of tax-exempt bonds.
“Small issuer” redefined
In general, financial institutions may take a tax deduction only for that portion of their interest expense that applies to the cost of buying and carrying tax-exempt bonds that are designated bank-qualified by a “small issuer.” The Act redefines “small issuer” by increasing the amount of bonds that can be designated as bank-qualified during calendar years 2009 and 2010 from the previous limit of $10 million to the new limit of $30 million.
Further, the Act provides that those bonds will be treated as if they were issued by the entity for whose benefit they were issued — the underlying borrower (the senior housing provider) — for purposes of designating them as bank-qualified. In the past, the limit was applied to the actual issuer (the municipal conduit). In most states, bank-qualified bonds are issued through a city housing authority, county health care authority, or other eligible municipal conduit. Sometimes, a borrower had to shop around for a municipal authority that had not already reached its $10 million limit — an almost impossible task in areas with five or six not-for-profit senior housing providers within the political boundaries of that issuer. In those cases, only one borrower might be able to access the program.
Now, by applying the limit (now increased to $30 million) to the borrower or direct obligor of the bond, the issuer (the senior housing provider) has a lot more control over whether its bonds will be bank-qualified.
The increase to $30 million per issuer is also significant, because $10 million is certainly not enough in today’s market to accomplish the goals of many borrowers — particularly for large projects. The $30 million limit would work for most expansion or repositioning projects, as well as for many refinancings or acquisitions.
“The higher limit could be a good opportunity,” observed Bill Pomeranz, managing director of Cain Brothers in San Francisco. “A client who was looking for $10 million in financing, for example, will now be able to finance a bigger project.”
Safe harbor for banks
The Act also creates a safe harbor, called the “2% de minimis rule,” which permits financial institutions to deduct 80% of the cost of buying and carrying all tax-exempt obligations — bank-qualified or otherwise — to the extent that the bank’s tax-exempt holdings do not exceed 2% of the average adjusted basis of its total assets.
If the bank has $1 billion in assets, for example, it could hold up to $20 million or less in tax-exempt obligations and qualify for the 80% deduction of interest on indebtedness related to those tax-exempt obligations. Again, this provision applies only to tax-exempt bonds issued in 2009 or 2010.
In the past, banks could take the tax deduction only for bonds that were designated as bank-qualified. The safe harbor creates a more liquid market for tax-exempt bonds by allowing the bank greater access to the deduction that’s typically associated with tax-exempt interest and thereby opens up a whole new area of investment. Expanding the number of tax-exempt bond buyers should also help push interest rates down.
“A number of banks that are interested in working with senior living providers do not have investment grade ratings that are high enough to allow them to issue a letter of credit to enhance the tax-exempt bond issue,” explained Rod Rolett, Executive Vice President at Herbert J. Sims & Co. “By providing a letter of credit, the bank essentially guarantees to the buyer of the bond that principal and interest will be paid on a timely basis. But if the bank’s rating is below the A category — even at the bottom of the A category, such as an A- — there may be little demand for tax-exempt bonds that are enhanced with that bank’s letter of credit.”
Many small and mid-size regional or local banks, however, are very strong or healthy from a capital perspective and have a desire to lend to qualified not-for-profit 501(c)(3) senior housing providers. They’re just not able to issue a letter of credit that works for the buyers of the bond. Now that the bank can agree to purchase the bond issue directly, Rolett believes that will be of great value to the not-for-profit senior housing market.
“Clearly, these provisions of the Act are an attempt to open up some money for tax-exempt investments and make it easier to close those transactions,” he said. “It gives the not-for-profit borrower permission to issue a larger amount of bank-qualified debt and it gives the banks a greater incentive to buy those bonds, because they’re getting a greater tax deduction.”
Bonds that are not bank-qualified could be offered more widely than was previously the case, as they can now be offered directly to banks. And that could be very beneficial for the not-for profit senior housing market, according to Rolett.
Impact on the sector
“From a practical standpoint, bond underwriters have always wanted issues to be bank-qualified,” noted Tom Green, CEO of Lancaster Pollard. “Banks historically had ready cash to buy municipal bonds, and being bank-qualified opened up the issue to a bigger market. The changes provided in the Act should effectively expand the number of issues that are eligible for the bank-qualified designation.”
The changes will also allow more issuers to access the lower interest rates historically available for bank-qualified bonds. And while few empirical studies have analyzed the interest-rate difference between bank-qualified and non-bank-qualified bonds, the differential prior to 2008 was generally about 10 to 20 basis points, according to Green. So a benefit did accrue to not-for-profit senior living projects — but only on the shorter term maturities that were purchased by the banks.
“With the crisis that began in October 2008, the rate differential increased to as much as 50 basis points for these maturities in which the banks had an interest,” he explained. “Due to the increased number of bank-qualified, tax-exempt bonds that will be issued in 2009 and 2010 — combined with the 2% de minimis rule, or safe harbor — banks will now have an interest in buying tax-exempt bonds that are not designated as bank-qualified. As a result, non-bank-qualified tax-exempt bonds should be priced at a slightly lower rate, which should significantly reduce the rate differential.”
The involvement of investment banking firms with regard to the changes affecting “small issuers” in the next two years will remain about the same in terms of their services to senior living clients. Instead of offering the bonds to its stable of investor clients or to investors in the broader community, however, the bonds could be sold directly to a bank. The investment advisor will still structure the bond offering for the borrower (the senior living client), prepare and distribute a request for proposal for loans, and then help the borrower identify interested banks, negotiate with those banks, and document and close the loan. Any bond offering under $30 million that is issued for that borrower would be bank-qualified.
Whether the banks have an appetite for this paper will depend, of course, on the bank’s general interest in tax-exempt bonds and its current profitability. “Banks generally purchase the bonds with shorter maturities — three, five, seven, or ten years,” added Green. “Bonds with maturities beyond ten years are generally institutional sales.”
So while by no means a cure-all, Green believes the changes provided by the Act are certainly going to benefit the senior living communities. “During late 2008, the municipal market had completely disconnected from the rest of what I would call the interest-rate complex,” he said. “It’s still a bit disconnected; but this is, in part, an attempt to open up that market and make it more liquid. We hope it proves to be a benefit for all of us.”