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March 6, 2009
Financing and Operational Strategies for Surviving an Economic Downturn
Amy HaymanManaging DirectorCain [email protected]
Joe MulliganManaging DirectorCain [email protected]
2
Today’s Discussion Topics
Current State of the Capital Markets
Strategies for Operating Efficiently in Tough Economic Times
Strategies for Financing, Securing Bank LOC Extensions and Growth
Appendix A: Specific Financing Strategies for Senior Living Facilities
Review of Capital Markets
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
'90 '92 '94 '96 '98 '00 '02 '04 '06 '08
SIFMA RBI30yr
Treasury
Maximum 7.96% 7.83% 9.16%
Minimum 0.46% 4.38% 2.55%
Average 3.04% 5.76% 6.04%
Current 0.55% 5.76% 3.61%
Historical Interest Rates (1990 – Present)
4
Taxable and Tax-Exempt Interest Rates (1990 – Present)
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
1/ 08 4/ 08 7/ 08 10/ 08 1/ 09
5
SIFMA RBI30yr
Treasury
Maximum 7.96% 6.48% 4.79%
Minimum 0.46% 4.63% 2.60%
Average 2.04% 5.39% 4.16%
Current 0.55% 5.76% 3.61%
Recent turmoil leads to dislocations in tax-exempt markets
Taxable and Tax-Exempt Interest Rates (2008 – Present)
6
Credit spreads widen
3.50%
4.50%
5.50%
6.50%
7.50%
8.50%
9.50%
5/ 1/ 06 8/ 1/ 06 11/ 1/ 06 2/ 1/ 07 5/ 1/ 07 8/ 1/ 07 11/ 1/ 07 2/ 1/ 08 5/ 1/ 08 8/ 1/ 08 11/ 1/ 08 2/ 1/ 09
AAA GO AA Healthcare A Healthcare BBB Healthcare
Long Term Tax-Exempt Fixed Rates
777
Subprime Mortgage Loan
Defaults
Restructuring of Auction Rate
Securities
Failure of Variable Rate Demand
Bonds
Significant Investment Write-
offs at Banks
Bond Insurer Rating
Downgrades
Failure of Auction Rate Securities
Recent Events in the Capital Market- The Big Picture
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September 8th: Fannie Mae and Freddie Mac receives government assistance September 15th: Lehman Brothers files for Chapter 11 bankruptcy September 15th: Government lent AIG $85MM September 15th: Bank of America acquires Merrill Lynch for $50billion September 26th: JPMorgan purchases some of Washington Mutual assets October 6th: Stock Market closes below 10,000 for first time in 4 years October 24th: PNC announces purchase of National City Bank
November 14th: Capital Purchase Program announced -$250 billion equity in US Banks-9 of the largest banks were given $25 billion
each December 16th: Fed Funds rate lowered to a range between 0 and 0.25% December 19th: Auto rescue plan passes, $13.4 billion to auto industry January 9th: Unemployed rises to 7.2%, highest level in 16 years January 16th: Merrill posted $15 bn in Q4 losses and Bank of America
received $20 billion January 20th: Dow down 4%, largest drop on inauguration day due to
bank fears January 29th: New Homes Built fell by 331,000 in December, lowest level
since 1963 February 10th: Financial Stability Plan announced February 27th: 4th quarter GDP reported a 6.2% decline, steepest since 1982 March 2nd: AIG announced $61.7 billion in losses and Dow dropped below 7,000
in first time since 1997 March 6th: Unemployment rises to 8.1%
Timeline of Credit Crisis
9
Source of Data: Bloomberg – February 4, 2009
$750 Billion and Counting – Total writedowns and charges since the beginning of 2007, although driven by the collapse of the subprime mortgage market, also incorporate losses that do not stem from high-risk home loans.
In Billions
97.9
85.0
55.9
48.6
45.6
40.2
33.1
29.5
26.2
21.5
17.3
14.5
13.7
13.6
12.2
11.9
9.1
8.8
8.4
7.7
6.7
6.4
Wachovia
Citigroup
Merrill
UBS
Washington Mutual
Bank of America
HSBC
JP Morgan Chase
Nat City
Morgan Stanley
Wells Fargo
Royal Bank of Scotland
Credit Suisse
Bayerische Landesbank
ING
Deutsche Bank
HBOS
Credit Agricole
Fortis
Societe General
CIBC
Barclays
Investment Banking Losses
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S&P Moody's
Prior Rating New Rating Date Prior Rating New Rating Date
ACA B NR 12/15/2008 NR
Ambac AA A 11/19/2008 Aa3 Baa1 11/5/2008
Assured AAA Aa3 Aa2 11/21/2008
CIFG A- B 8/22/2008 Ba2 B3 10/28/2008
FGIC BB CCC 11/24/2008 B1 Caa1 12/19/2008
FSA AAA Aaa Aa3 11/21/2008
MBIA AAA AA 8/14/2008 A2 Baa1 11/7/2008
Radian AA BBB+ 12/5/2008 Aa3 A3 6/25/2008
Major Credit Rating Events
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Banks
Over the last few months, there has been considerable liquidity tightening and bank market narrowing
– Merrill Lynch Acquired by Bank of America
– Fifth Third Bank downgraded from ‘A1’ by Moody’s
– Sovereign Bank Acquired by Bank Santander
– JPMorgan downgraded to ‘AA’- by S&P
– National City Bank Acquired by PNC Bank
– Morgan Stanley downgraded to ‘A’ by S&P
– Wachovia Acquired by Wells Fargo
– RBS Citizens Bank downgraded to ‘A+’ by S&P
– Allied Irish Bank rated ‘Aa2’, but on negative watch by Moody’s
– Bank of America downgraded to ‘Aa2’ by Moody’s
– KBC on negative outlook by Moody’s, currently rated ‘Aa2’
– Bank of Scotland acquired by Lloyds Bank
Major Credit Events
12
207 9
25 22
6789
31
67
147
56 65 5573
9867 65
92
95
229198
135
21-3
50
—20
35+
Mark
et
Cap
italiza
tion
($
bn
)
2007 (12/31/07)
2009 (1/22/09)
Market cap ($bn)
35 36 67 86 8956
18 22 25 26 2722 33 34
1 2 3 3 5 7 7 9 12 13 13 17
Source: Bloomberg, Yahoo Finance. Please note that Bank of West is a subsidiary of BNP Paribas and Union Bank of California is a subsidiary of Union Bank Corp. Market cap information for Union Bank is unavailable. While J.P. Morgan considers this information to be reliable, we cannot guarantee its accuracy or completeness.
Note: Wells Fargo includes Wachovia and Bank of America includes Merrill Lynch
2217
147176
Current State of the Capital MarketsMarket Capitalization of Major Banks, 2009 versus 2007
12
13
Equity Market Volatility Milestones Since September 2008
7000
7500
8000
8500
9000
9500
10000
10500
11000
11500
12000
Fannie Mae & Freddie Mac receive assistance from the U.S. gov.
Lehman files for Chapter 11;U.S. gov. lends AIG $85 billion;B of A acquires Merrill Lynch
JP Morgan purchases Washington Mutual
$700 billion federal bailout plan fails passage in Congress
Bailout plan passes in Congress;DJIA closes below 10,000
DJIA at 8,100 after weeks of volatility
Big Three ask U.S. gov. for capital for the first time
Congress doesn’t approve Big Three bailout for the first time
Dow hits lowest point (7,552) since 6/23/1997
Uncertainty surrounding the government aid for the ailing financial system
Lawmakers near stimulus deal
Municipal Bond Market Conditions
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Continued trends from the past 12 months Auction rate bond conversions – soaks up credit enhancement capacity Bond insurance – fewer survivors and less availability LOC banks – interest shifted to high grade credits LOC pricing has increased dramatically Tighter loan to value requirements Tighter operating covenants
Trends over the past several months Stampede into T-Bills and T-Notes – “flight to quality” VRDB rates shot up and came back to normal ranges Most LOC banks continue to sit on the sideline Muni fund assets shrank by more than $50 billion in the last four months of
2008 Money flowing back into money market funds for the three weeks in a row Estimated $12-15 billion in healthcare waiting to price Credit spreads have ballooned in both the tax-exempt and taxable fixed income
markets
15
What Was The Impact on Senior Living Bond Issuance?
Source: Cain Brothers Research* MMD = Municipal Market Data Scale daily index of generic AAA municipal bonds
Comparison of Non-Rated Fixed Rate Senior Living Bond Issuance
DSC DCOH
Generic AAA
Spread
2008 Averages $ 24,138,571 1.59 206 227
2007 Averages $ 44,785,492 1.69 209 147
2008 Total Par $ 168,970,000 (7 issues)
2007 Total Par $2,731,915,000 (60 issues)
Strategies for Operating Efficiently in Tough Economic Times
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Option #1 – Uncle Sam’s Solution
Option #2 – Strategies For the Rest of Us
Integrated Strategic Plan Market Competition Economy Technology Stakeholders
Strong Leadership Setting a direction Aligning stakeholders Demanding Accountability
Operational Efficiencies Performance Measurement System
– Balanced Scorecard Benchmarking
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1919
Leaders Must Manage Complexity
Planning and Budgeting: Set targets and goals Steps to achieve goals Allocate resources to achieve goals and meet targets
Organizing and Staffing: Organizational structure Competent staff Communicate plan Delegate responsibility Monitor implementation
Controlling and Problem Solving: Monitor results Identification those areas not meeting targeted projections Organize to solve the problems
Transparency and Disclosure: Providing meaningful information to consumers and payers Articulating the difference that your services make in the lives of the persons
served
20
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Why Do Finances Matter?
Provides resources to reinvest in the enterprise
Facilities
Technology
Staffing
Programs
Financial flexibility allows your organization to maintain your market niche and capitalize on strategic opportunities as appropriate
Access to Capital
2222
Consistency
Average Performance Is More Important than Boom and Bust Performance
Can maintain a level of performance that meets financial obligations, with a reasonable cushion
Consistency – including consistent and predictable rate increases as needed
Profit From Operations (not just from investment reserves)
Information
Cash is king
Financial Model Can Support Future Needs, Not Status Quo
Investment in plant is essential for future viability
Set financial goals consistent with your Organization’s program and capital plans and changing industry standards
Monitor progress against budget and multi-year plan
Leaders Look for Steady Improvements Over Time
23
You can’t improve what you can’t measure!
Identifies areas of strength or weakness for an organization
Allows alignment of strategic activities to strategic plan.
Provides a rational basis for selecting what business process improvements to make first.
Allows managers to identify best practices in an organization.
Supports better and faster budget decisions and control of processes in the organization, reducing risk.
Provides accountability and incentives based on real data, not subjective judgments.
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Top Reasons for a Performance Measurement System
“People and their managers are working so hard to be sure things are done right, that they hardly have time to decide if they are doing the right things.”….Steven R. Covey
“The definition of insanity is doing something the same way…while expecting a different result.” ……..Albert Einstein
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Performance and Improvement Measurement
Reliability: Process of obtaining information in a consistent or reproducible manner, usually when the process is administered under similar circumstances.
Validity: Appropriateness meaningfulness, and usefulness of a measure and the inferences made from it. Commonly regarded as the extent to which a test measures what is intended to be measured.
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What you are Measuring Must be Reliable and Valid
Strategies for Financing, Securing Bank LOC Extensions and Growth
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Commercial Bank Letters of Credit – An Overview
In the near term, only cash-rich credits have ready access to bank LOC support
Many existing bank LOCs are not being renewed due to both weakened bank and faciliity balance sheets
Banks have reduced per borrower credit exposure
Banks demanding commercial business as a lending prerequisite
Exceptions:
Local community banks
Projects with strong sponsorship/parental guarantees or that serve specific constituencies
Isolated aggressive banks looking to grow market share
29
Today’s Capital Markets : Bank LOC Refinancings
While bank LOC renewal credit is difficult to get, when available, “overall debt costs” are <5%
Variable rate debt and swap rates are at historic low costs
LOC fees have increased, terms have shorted
Borrowing covenants have been greatly tightened:
Cash is King, cash to debt thresholds have increased dramatically with 50%+ common
An unprecedented number of LOCs are not being renewed
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Today’s Capital Markets: Fixed Rate Bond Markets
Institutional funds (high yield/high risk) do not have sufficient surplus capital to support new projects
Many available funds are gravitating toward larger hospital debt issues
There has been only one new fixed rate senior living bond issued in the last six months
Mutual fund investors have sought safer, shorter term investments such as U.S. Treasuries
Fixed rate bond lending will remain at the A- level or higher until private investors re-invest in “high yield” bond funds
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What Does this All Mean?
Letters of credit will likely be more expensive and difficult to obtain
Community banks will need to be looked at more closely when evaluating credit enhancement
The challenging market will make it difficult for weaker projects to be financed
Each project and financing needs to be assessed on a case-by-case scenario
We expect strong projects for solid communities will continue to get funded
A measured approach should be taken when evaluating the next steps:
What were the original objectives with respect to the new project? Have any of them changed?
What are the implications of postponing the Project?
How do you best mitigate risks whenever you choose to proceed?
Have you defined what you are waiting for?
Trigger factors?
Indicators or signs?
Psychological or emotional factors?
What are the implications to waiting?
What are the other providers in the market doing?
Would postponing the project now mean entering a more competitive environment in 2010?
Will construction costs rise in 2010?
When will the credit markets turn around?
32
Questions Related to New Projects
33
Capital Markets
So what financing strategies can work in today’s capital markets?
1. The repurchasing of fixed rate debt that has been heavily discounted from par due to interest rate increases
2. Federal Home Loan Bank wraps that enhance the credit strength of local community banks
3. Debt restructuring where we attempt to renegotiate current loan conditions to more affordable levels
4. Senior Living Specific: The use of federal programs (FHA, Fannie Mae, Freddie Mac) as a full or partial replacement for bank LOC linked balance sheet lending. See Appendix A.
34
Purchase Existing Fixed Rate Bonds at a Discount
30-year, fixed-rate, lower-grade bonds (5.5% to 6.5%) with 10+ years to maturity are selling at a 25% to 40% discount to par value as fixed rates have greatly increased
Generally, a borrower can offer to repurchase its outstanding bonds in the secondary market from both institutional and retail bond funds
But cash is king so “buy backs” should be considered as part of a larger refinancing strategy
Can be 12 to 18 months later but need a strategy today for replenishing cash used in repurchasing your bonds
For these reasons, we would suggest targeting the longer term bonds for repurchase
35
Federal Home Loan Bank Wraps
In 2008, Congress gave the Federal Home Loan Bank (FHLB) expanded powers to “wrap” or guarantee the underlying LOCs of their member banks for a fee
These wrap fees are quite affordable at 7 to 15 basis points and allow a FHLB corresponding bank to upgrade its current LOC rating to AAA
Money market funds typically want A to A+> LOC credit guarantees
AAA - FHLB wraps allow community bank LOCs to be remarketed to all tax-exempt money market funds
While the FHLB provides considerable credit enhancement to the local community bank, first dollar risk remains with the local bank
Thus, local banks participants will undertake considerable due diligence before committing to the program and will expect considerable commercial business in exchange for assuming risk
Activity has been picking up with most FHLB deals remaining under $20 million due to this risk concentration factor
36
Debt Restructuring*
A growing number of financings undertaken over the last five to seven years have never reached stabilized occupancy or positive cash-flow generation
When a facility’s liabilities exceed its assets, the facility has entered the legal concept of the “Zone of Insolvency”
When entering the Zone of Insolvency, Trustees and Management have a responsibility to creditors that equals that to residents and mission
Trustees must make decisions that are in the best financial interest of all parties
In many cases, that requires Trustees to approach lenders for debt relief and/or restructuring
Most creditors will resist debt reducing/restructuring requests so borrowers must be persistent and establish a formal record of seeking such relief
There is an established pattern for justifying a campus’s need for debt relief from a bank and/or institutional or retail bondholders
*See handout, The Financial Crisis Hits The Senior Living Industry: Operational and Debt Restructuring Considerations for Trustees and Executives
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Debt Relief Options
Variable Rate Debt – Letter of Credit Banks:
Reducing swap rates by lowering interest rates and extending terms
Reducing LOC fee levels
Not amortizing debt – paying interest only (only a 1- to 3-year strategy as debt reduction is a long-term necessity)
Extending amortization term
Actual debt reduction/forgiveness
Fixed Rate Bond Holders
Reamortizing debt back to 30 years, even 35 years
Interest rate reduction
Debt reduction
Principal deferral
All the above, through bifurcating bond issue (for example, taking 30-year bonds at 6.5% with 22 years of term remaining and re-amortizing 50% of those bonds to 30 years at a 5% interest rate)
38
Negotiating Principles
Key debt restructuring negotiating principles:
Any solution must allow for sufficient annual capital replacement funds to keep the campus marketable
Transparency and honesty should guide all suggested operational improvement suggestions/evaluations. You must offer to pay what you can afford
In cases where more than 10% of debt is held in retail hands, existing underwriter tends to have conflicts so good to switch
Having take-out strategies such as FHA/Fannie Mae incentivizes existing debt holders to cut a deal as bondholders have learned that many “half-way” negotiated restructurings tend to return a few years later
If debt holders fail to respond, keep regulators and the State’s Attorney General informed of your debt restructuring goals as they will not want to hear of a bankruptcy filing in the newspaper instead of from you and they may advocate on behalf of the residents
Appendix A: Specific Financing Strategies for Senior Living Facilities
40
Federal Government Agency Credit Enhancement Sources
Cash to debt is the most important lending criteria in today’s capital markets. There are two ways to improve this ratio to current bank LOC lending standards:
1. In the long run, make more money
2. In the short term, reduce the amount of debt underwritten by the banks
Banks want as much as 50%+ cash to debt ratios prior to offering or renewing LOCs
Proposed strategy is to reduce bank debt by bifurcating existing CCRC bank LOC bond debt and allocating a portion into separate government agency financing
As agency debt underwriting is cash-flow driven versus balance sheet based, it allows a borrower’s balance sheet to be fully committed to a smaller amount of bank LOC debt
41
How Does FHA Financing Work?
The amount that FHA will lend is determined by the following formula:
A third-party appraisal establishes value
FHA will lend up to 85% of appraised value
Appraised value is primarily determined by applying a capitalization rate to free operational cash-flow
AL/dementia/SNF facilities typically have a combined capitalization rate of approximately 10%
– $1.5 million EBITDA divided by 10% results in $15 million of value at 85% = $12.7 million in FHA debt allowance
The $12.7 million in new FHA debt is subtracted from the entire CCRC debt of $45 million leaving $32.3 million in debt guaranteed by the bank and allocable to the remaining CCRC housing and existing balance sheet alone
All free cash-flow above FHA mandated 1.17 debt service coverage would be available to build the housing/CCRC’s balance sheet and to supplement the CCRC’s debt service payment
42
Overview of FHA Insured Debt
Advantages
Can be used for refinancing, acquisitions or new construction*
Once issued, borrower’s exposure is not influenced by market collapse/change
100% non-recourse
Underwriting is driven by cash-flow, not balance sheet, which allows excess cash > 1.17 debt service coverage to be up-streamed to parent
Gains access to the U.S. Govt. AAA status
75 basis points credit enhancement is highly cost competitive
Always available, with expedited processing resulting in a 4- to 6-month processing period
Credit enhancement is “pay as you go”
Disadvantages
Can only insure fixed rate debt
Deferred capital improvements must be funded based on physical needs assessment study
At present primarily for SNF, assisted living, dementia only
43
Other FHA Advantages
Responding to the credit crisis, the Feds have greatly expanded staffing for the FHA Section 232 program and centralized all application processing
As they realize that some nonprofits treat their AL/SNFs as cost centers versus profit centers, they allow those campus components to mark expenses to revenue industry averages
This is called mark-to-market appraising, thus allowing for more market-oriented operating budgets than the specific nonprofit’s actual operating experience which increases appraised value
85% expense to revenue for a SNF
65 to 68% expense to revenue for assisted living
70% expense to revenues for dementia care
These ratios might compare to the 90%+ expense to revenue ratios for many nonprofits
44
Fannie and Freddie Mac
While the FHA Section 232 program is AL/SNF-oriented, Fannie Mae and Freddie Mac credit enhancement programs are the Government Agency programs for independent and congregate housing credit enhancement
These two housing agencies have gone from being semi-formal obligations of the federal government to full (AAA) guarantees
Both agencies prefer communities that are predominantly independent living units with little supportive care (SNF, AL and residential dementia)
Underwriting methodology is very similar to FHA with the following exceptions:
Requires 1.35 to 1.4 times debt service coverage projections
Will typically provide credit at only 80% loan to value with 85% allowed for exceptional nonprofit properties when tax-exempt bond debt is used
Can be used in partnership with FHA (see following pages) or for acquisition financing
45
Overview of Fannie Mae/Freddie Mac Debt
Advantages Can be used for acquisitions or refinancings Low interest rates 30-year amortization Can be fixed or variable rate debt Underwriting methodology is totally cash-flow driven and does not require minimum
cash to debt Credit enhancement is “pay as you go”
When used with FHA to fully refinance out of bank LOC debt or low rated fixed rate bonds on a nonrecourse basis, allows transference of all balance sheet assets onto a foundation or new entity
Allows parent corporation to pledge these unencumbered assets in pursuit of acquisitions or expansion
Disadvantages With some exceptions, is limited to rental projects – very modest entrance fee levels
only Very limited acceptance of skilled nursing (less than 10% of total campus bed/units)
– Why often combined with FHA for multi-level campuses 30-year amortization but 10-year term re-set
