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MASSACHUSETTS
HEALTH AND
EDUCATIONAL FACILITIES
AUTHORITY
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WELCOME
TO HEFA
TO HEFA
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relcome to the Massachusetts Health and Educational Facilities
Authority (HEFA) handbook. This booklet is an informal guide to the bond issuance
process for Massachusetts nonprofit institutions, including colleges and universities,
hospitals and other healthcare providers, cultural organizations, and community
human service providers.
Structuring a bond transaction has become an increasingly complex task
in recent years. The rapidly changing market, evolving regulatory framework and
continuing change in the nonprofit sector have created a complicated environment
for raising capital. The purpose of the HEFA handbook is to explain the debt
issuance process so that a nonprofit institution's executives and board members
are more knowledgeable about this undertaking. It is directed particularly at
institutions that are new to the bond market or have not issued bonds in the last
few years.
HEFA is committed to helping Massachusetts nonprofit institutions access
the capital markets to obtain the lowest-cost capital possible. The transaction
example used in this handbook - a negotiated public offering - is the most common
of several types offinancing HEFA can provide. Financing through tax-exempt
leases, pool loans, private placements as well as competitively-bid transactions are
also available. HEFA welcomes the opportunity to meet with representatives of
nonprofits to discuss financial needs and objectives and the full range of financing
options available.
STEPS IN THE
ISSUANCE PROCESS
Selecting the Team 4
Structuring the Transaction 6
Preparing the Official Statement 10
Negotiating a Price 12
Closing and Investment of Proceeds .14
T
BOND ENVIRONMENT
THE
VIRONMENT
E
E
ach borrower oftax-exempt Recognizing the complexity ofthe
debt must reconcile the requirements and
expectations ofthree intersecting arenas - bond environment, HEFA interacts in
the municipal bond market,regulators,
each ofthese arenas so it can interpret
and competition in its field. Each of these
worlds has undergone radical changes in them for Massachusetts borrowers.
the past few years,dramatically altering
the way institutions raise capital. The Authority also routinely advocates
Until the mid-1980s the municipal bond
on behalfofits nonprofit borrowers
market was relatively stable, and nonprofit
institutions typically issued straightforward, with regulatory agencies and the
long-term,fixed rate bonds. In recent years,
against a backdrop ofvolatile interest rates, investment community.
Wall Street has developed increasingly com-
plex financial products, such as synthetic
securities or"derivatives,"that create new
opportunities for borrowers as well as new
risks. Significant changes in federal tax and THE MARKET
securities laws have increased the complex- The municipal bond market is large, as
ity ofbond issuance. Finally,unprecedented evidenced by the 10,694 municipal issues
changes in the competitive pressures in two brought to market in 1994. The par value
major nonprofit sectors - healthcare and
of those issues was $163 billion. This was
higher education - have created a demand- a 44% drop in par value from 1993's record
ing environment for the issuance oftax-
level of $292 billion.
exempt bonds.
As one ofthe largest issuers oftax-
exempt bonds in the nation,HEFA brings
market presence and expertise to the table
when an institution raises capital. Long-
standing and well-maintained relationships
with key analysts and managers at major
investment banks, rating agencies, and bond
insurers provide smooth access to the mar-
ket for Massachusetts nonprofit borrowers.
As a transaction is structured,HEFAs role
is to make sure that borrowing institutions
know about the availability ofa range of
alternative approaches to the market.
TheAuthority urges borrowers to
exploit competition in the financial
services industry. HEFA routinely solicits
bids on a range ofproducts including
tax-exempt leases,refunding escrows,
investment ofconstruction fund proceeds, HIGHER EDUCATION AND HEALTHCARE
float contracts,and guaranteed investment SECTORS
contracts for debt service reserve funds. Healthcare and higher education
These bidding processes exact the most are industries vital to the economy in
competitive price and the most advanta- Massachusetts. With a population base of
geous terms for borrowers. a little more than 6 million, Massachusetts
HEFA keeps in touch with the buy 117 public and private colleges and univer-
side ofthe securities industry as well. In sities enrolled more than 422,000 full-time
an effort to maximize the marketability students last year. The healthcare industry
and enhance the appetite for its securities, accounts for more than 10 percent of total
HEFA routinely interacts with portfolio employment in the Commonwealth.
managers and analysts nationwide to Demographic changes of the last two
keep them abreast ofdevelopments in decades have diminished the number of
Massachusetts. potential college students. Coupled with
the fundamental shift ofthe national
THE REGULATORY ENVIRONMENT
economy,this change has caused the
HEFA and its consultants have long academic community to adapt its curric-
experience in interpreting - and in helping ulum,governance structure, and mission
institutions comply with - the myriad of to become more competitive in the new
regulatory and tax code requirements
environment.
attendant to tax-exempt financing. The
The healthcare marketplace has evolved
Securities and Exchange Commission (SEC)
dramatically in the past year. Managed care
has federal regulatory authority over the
now
has flourished in Massachusetts, claim-
trading ofsecurities in capital markets and
ing 37 percent ofthe statewide market.
enforces anti-fraud regulations in the
Some markets,such asWorcester County,
municipal market. The Municipal Securities
have seen penetration of more than 65
Rulemaking Board (MSRB) covers the
percent. Like hospitals in other mature
activities ofbrokers and dealers in munici-
managed care markets,local providers
pal securities transactions. The Internal
are reshaping themselves into integrated
Revenue Service (IRS) imposes and/or
systems to compete for managed care
defines restrictions on tax-exempt
contracts.
organizations and the use oftax-exempt
bond proceeds. Both industries have undergone radical
change in the last several years, and it is
Legal and regulatory requirements are
HEFAs role to keep the investment commu-
subject to constant review and modifica-
nity abreast ofthese developments and the
tion. The finance team must be fully
underlying strategic considerations. As
informed about existing issues as well as
need arises to raise capital, the investment
anticipated changes. As the Securities and
community is well informed as to the
Exchange Commission, Internal Revenue
viability ofthese institutions.
Service or other regulators consider
changes, HEFA lends its voice to those
deliberations to shape any impact on
nonprofit institutions.
El EfTINfi
SELECTING THE TEAM
These advisors insure that the deal meets
decides to go forward with an issuance,the state and federal requirements for tax-
first step is to assemble a knowledgeable exempt bonds and that the OS presents an
team offinancial and legal advisors. Team accurate and complete picture ofthe insti-
members are the key players who will tution and the transaction. This team will
work closely with the borrower and make draft the legal documents and contracts
recommendations as to the deal structure that specify the respective obligations of
and marketing strategy - important theAuthority, borrower and bond trustee,
elements ofa successful transaction. as well as the rights ofthe bondholders.
A HEFA staffmember is assigned to every The bond counsel is responsible for
transaction and plays an important role in preparing the legal documents associated
coordinating the activities ofthe finance with the transaction and providing legal
team. The staffmember is also respon- and tax opinions. The underwriter's counsel
sible for obtaining the approval ofthe and the institution's counsel represent the
Authority's board for the deal through a interests oftheir respective clients and also
series ofpresentations at various stages of render certain legal opinions. All three
the transaction. The staffmonitors the work through the disclosure process to
process and assists the team in negotiating ensure the accuracy ofall information and
the terms ofthe transaction. conduct due diligence sessions.
HEFA may also assign a financial advisor When it is time to go to market,the
(FA) to the team. HEFA contracts directly team customarily includes co-managers
with a financial advisory firm to ensure (other underwriters),whose purpose is
independent,reliable advice on all aspects to help increase the demand for the bonds.
ofa transaction. The FA represents the While co-managers do not bear primary
interests oftheAuthority and the borrower responsibility for structuring a deal,they
and brings the team a national perspective share in the risk ofthe underwriting and
in the structuring and pricing ofbonds in participate in the marketing ofbonds.
the healthcare and higher education Co-managers provide broad market access
sectors. and help to create a competitive environ-
The borrowing institution must choose ment in which to secure the lowest interest
a lead investment banker (often referred to rates.
as the senior manager or underwriter) who The bond trustee selected for the trans-
structures the transaction and markets the action is the custodian ofcertain funds and
bonds. The senior manager and its counsel serves to protect the interests ofbondhold-
guide the team's efforts in compiling the ers. The trustee monitors the borrower's
Official Statement (OS) - the document compliance with the loan and trust agree-
that discloses detailed information about ment (a document establishing the security7
the structure ofthe bond issue and the for the bonds,restrictions on certain
finances and operations ofthe institution. corporate activities,legal covenants and
The legal team includes the bond obligations with respect to the project,and
counsel and the counsel for the senior payment ofdebt service and events of
manager and for the issuing institution. default).
'
The Team
Financial Legal
U
How long does it take togo
through the issuanceprofess
A
The process typically takes
three to four months. The
time line is determined by the
borrower's needs and the com-
plexity of the transaction; it can
be lengthened or shortened
accordingly.
Bond
U
Inder what circumstances
Counsel
shouldan institution solicit
bidsfor banking, underwriting
or legalservices?
A
It is essential that the
Borrower's borrower be comfortable with
the members ofthe team, and
Counsel
many institutions rely on long-
standing relationships. It is
advisable, however, to examine
these relationships periodically
through a bid process to assure
Underwriter's that fees are competitive. HEFA
Counsel will perform an RFP process if
requested.
U How do borrowersselect a
trustee andprinter?
Other Members A At the appropriate time,
HEFA staff issues an RFP for
both a printer and trustee and
then prepares a comparative
analysis ofall bids to assist the
borrower's selection.
U
What are the costs involved
in issuing bonds?
A
Issuance costs may include
fees for: underwriting, bond
counsel, Authority, rating
agencies, trustee and its
^ ^ counsel, printer, and institu-
tion's counsel. Issuance costs
may be financed through the
bond issue; however. t;i\ law
limits the amount that can be
financed at 2 percent of net
proceeds. Costs in excess of
that 2 percent must be paid as
The Transaction an equity contribution on the
part ofthe borrower.
B
HimiDINft
s
STRUCTURING THE TRANSACTION
TRANSACTION
1
S
"tructuring a bond issue is an analytic enhancers, as well as the needs ofthe
and strategic undertaking. While the team institution. The institution must fully under-
assesses the institution's competitive status stand any covenants that are proposed,
in the marketplace, it also considers the because they can impact future transactions,
structural elements ofthe transaction that such as mergers,acquisitions or raising
will impact the market's receptivity to the additional capital.
offering. The first task is to examine the Common financial covenants include an
needs ofthe institution and define the additional bonds test (to allow an institution
scope ofthe projects to be financed. to issue additional debt on a parity with the
Bond proceeds are used to finance a current issue); and a rate covenant (specify-
variety ofconstruction,renovation and ing a minimum ratio ofannual revenues to
equipment-related activities. Soft costs debt service). Security provisions commonly
associated with construction, such as include a debt service reserve hind (funded
architectural work and permitting, may be at a level ofone year's maximum debt
financed in addition to equipment and service); a pledge ofgross receipts;and a
furnishing expenditures. Bond proceeds, mortgage or negative pledge on real estate.
however, are not used solely for new proj-
ects. Nonprofit institutions may consider CREDIT RATINGS AND BOND INSURANCE
refinancing existing debt with bond pro- Having fashioned the structural
ceeds. In addition, ifan institution has used elements,the team then considers whether
internal funds for capital projects, it may, the deal will be rated by a national credit
within certain limits,use bond proceeds to rating agency or ifthe institution should
reimburse those funds and amortize the seek a form ofcredit enhancement such as
cost ofthose projects over a longer term. bond insurance. This is a predominantly
Bond proceeds are also used to finance the financial decision for the borrower.
issuance cost: underwriting,legal, trustee, Municipal bonds may carry credit ratings
printing and other fees. The finance team's from one or more ofthree agencies:
role is to make certain that the use ofbond Moody's Investors Service, Standard &
proceeds and amortization ofdebt comport Poor's Ratings Group, and Fitch Investors
with all relevant tax law. Once the scope of Service,Inc. The market generally likes to
the project is defined,the team considers see bond issues which cany two ratings.
the actual structure ofthe deal and negoti- The ratings process is fairly straightforward:
ates a variety ofcovenants and security a package ofinformation is provided to
provisions. rating analysts,and presentations are
scheduled,usually at the institution.
COVENANTS AND SECURITY PROVISIONS
Senior management, trustees,and key
Bond issues include covenants or
personnel are involved in the rating presen-
obligations that cover a wide variety of
tation. The HEFA staffand the team ensure
commitments by the borrower that,for the
that the presentations are well organized
most part,protect the interests ofthe bond-
and productive by meeting with presenters
holders. As the transaction is structured, the
in advance. During these meetings, the
finance team develops covenants,taking
team offers advice on how to present
into consideration the interests ofthe bond-
institutional successes,address any weak
holders, market, rating agencies, and credit
points, and provide a clear, consistent
picture ofthe institution. After the presen-
tations are made,each rating agency
completes its credit analysis and informs
the team and the borrower ofthe result.
The Transaction
Financial Legal
U
Whatfactors are considered
by the rating agencies.'
A
Ratings versus A few ofthe many factors
include: depth ofmanagement's
Insurance
experience and knowledge; his-
torical and prospective financial
and utilization/demand informa-
New Projects tion; organizational strategy for
Refinancing the future; enrollment and SAT
scores; strength of the hoard;
composition and credentials
ofstaff; and the institution's
Sole Obligor
standing.
versus Group
U
How can interestpayments
be coveredduring construction
Additional Debt when theproject is notyet
producing revenue?
Merger & Acquisition Provisions
Disposition of Property Mortgage versus A
Through capitalized interest a
Rate Covenant Negative Pledge
portion ofthe bond proceeds can
be used to pay the interest for a
specified period oftime.
U
Can an institution be reim-
Sources & Uses Security bursedforcapital expenditures
forthepreviousyear?
of Funds Provisions
A
Yes, but the reimbursement
of prior capital expenditures is
subject to various tax regulations;
for example, the institution's
Board must approve or record its
intentions to be reimbursed out
of bond proceeds.
U
How does a debt refinancing
Amortization work?
Term
A
Debt Service Reserve Fund In an advance refunding, the
borrower issues new bonds and
Capitalized Interest
escrows a sufficient amount to
Use of Derivatives
meet debt service obligations to
the existing bondholders until
the call date. The borrower pa\s
debt service only on the refund-
ing bonds.
o U
How many times can debt be
refinanced?
^O
A
Tax-exempi bonds issued
after the passage of the 1986 tax
law may be advance refunded
only once. There are no limits as
to the number of current refund-
Official Statement
ings (i.e., where the old bonds
can be called immediateh
)
A municipal bond insurance policy is a DERIVATIVE PRODUCTS
guarantee designed to protect the bond- Recently,Wall Street's major investment
holder from nonpayment ofprincipal and banks have been prolific in the creation of
interest payments on the part ofthe institu- new products known as derivatives for the
tion. The insurer receives an up-front pre- municipal bond market. Derivatives or
mium for the guarantee, which may be synthetic securities have been available
financed and amortized over the life ofthe in the corporate market for more than a
bonds. When bonds are backed by an decade. They are complex financial instru-
insurers'guarantee,they sell based on the ments whose value is based on an underly-
AAA credit rating ofthe bond insurer. The ing asset such as a bond or currency.
higher credit rating generally results in Derivatives can offer significant benefits to
lower interest cost for the borrower. The an institution, such as lower interest costs
team usually attempts to reduce the cost and/or greater flexibility, but they are not
ofinsuring a bond issue by soliciting bids without risk.
from a variety ofinsurers. While not every Several Massachusetts nonprofits have
bond issue will attract bids, ifthere is a rea- used derivatives such as inverse floaters,
sonable expectation ofinsurer interest,the interest rate swaps, and other innovative
finance team sends a packet ofinformation products that can enable an institution to
to several companies. Active negotiations achieve lower rates and substantial savings.
regarding premium and covenants ensue. These structures can create securities that
Approximately 45% ofthe bonds issued
at times can be sold at a lower interest rate
through HEFA in fiscal year 1994 were than standard fixed-rate bonds.
insured.
The decision to use derivative products
Once the rating agencies have com- is based on the economic benefits to the
pleted the analyses and the insurance bids borrower,the incremental risk, and compat-
are in,the team assesses the results. The ibility with governing documents. HEFA
finance team analyzes the difference staffand financial advisors are well versed
between current market interest rates in the advantages and disadvantages of
based on anAAA rating (and the cost ofthe derivatives. With the expertise ofthe finan-
insurance premium) versus interest rates cial team, borrowers are enabled to make
based on the underlying credit rating of informed judgments on the compatability
the borrower. While the option that carries ofa particular derivative product with
the lowest overall cost is generally selected, achieving their financial goals.
this is not always the case. Ifan insurer
requires covenants that are overly restric- THE IMPACT OF MARKET FORCES
tive, the borrower may opt to decline credit The structure ofthe transaction
enhancement and pay a higher interest rate responds to the needs ofthe institution
to avoid these restrictions. and the scope ofthe project, but it must
respond to financial market forces as well.
Market trends will affect interest rates and
choices about variable versus fixed rates
or using derivatives. Economists generally
agree that as economic activity picks up.
demand for capital increases and interest
rates rise. The tax-exempt market,where
nonprofit institutions raise funds,competes
with other capital markets for a limited
supply ofcapital.
