The recent wave of refundings in healthcare and other municipal sectors has meant more borrowers are dealing with prepayment provisions, and many are finding out that depending on the coupon mode and type of debt, prepayment can involve large penalties.
Debt in floating rate mode such as Libor or percentage of Libor is generally callable at any time without penalty since the lender can redeploy funds at similar rates.
Fixed rate debt is different. Most fixed rate bonds sold to the public have a 10-year no-call period before the borrower has the option to redeem them at par or at a premium. The majority of fixed rate bank placements (unrated, unregistered bonds with a bank as sole bondholder) also have a no-call period followed by an option to redeem subject to a prepayment penalty. This penalty can vary from lender to lender and can range from a simple "step down" formula with fixed amounts declining over time, to a more complex "yield maintenance" formula based on the difference between original cash flows and the cash flows the bank expects to receive when redeploying the loan proceeds at current market rates.
Hospitals wanting to prepay non-callable debt or avoid penalties on callable debt have two major options:
- Advance-refund the bonds (subject to the bonds not having been advance-refunded before in the case of tax-exempt debt). Because the bonds are not technically called, no-call provisions and prepayment penalties are avoided, but advance refundings can be inefficient as they require investing escrows in high grade securities at low coupons while continuing to pay high coupons on the defeased bonds; or
- Ask bondholders to voluntarily surrender (tender) the bonds. Public bondholders have no expectations about future business, so they may not agree to a tender offer. Private bondholders such as banks are different, because they usually have other business at stake, so they may be willing to renegotiate prepayment terms.
Unlike public bondholders, banks use loans as a foot in the door to lock in other, more profitable ancillary business, which can include deposits, treasury and purchasing cards. Ancillary business is often contractually required in loan documents, but once the debt is paid off, this obligation goes away. If the hospital is prepared to maintain ancillary business after the debt is gone, that business can be used as bargaining chip in renegotiating prepayment terms.
Here are some basic steps to renegotiating prepayment penalties with banks:
- Review loan documents; we often see prepayment language with inconsistencies or even lacking a specific formula, which makes the final amount subject to negotiation.
- Ask the bank for a payoff letter, and verify calculations.
- Survey other lenders for standard prepayment terms; terms which are outliers and unfair to the hospital set the stage for negotiations.
- Get consensus on what ancillary business the hospital is willing to maintain and put a dollar value on it; the more the bank has to lose, the more room there is for negotiations. On the flip side, keeping that business with one lender could make the hospital less attractive to other lenders.
- Use a financial advisor or another experienced party familiar with banking practices and specifically, direct placements.
Following these steps can help hospitals lower or even eliminate prepayment penalties, which can mean millions of dollars in cash savings.
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