Financing Process
The following is a summary of the typical steps involved in arranging a publicly sold bond financing through The Health and Educational Facilities Authority (the "Authority"). Some issues are also done on a private placement basis. This would not change the following, except the marketing of the bonds would be privately to institutional investors. It is not unusual for this process (public or private) to take between three to six months from start to finish, though bond issues have been completed in as little as thirty days. The following will give you a general idea of the financing process; however, please remember that every deal is unique and this process may not totally reflect your specific transaction. Reference should also be made to the Authority’s Policies and Practices.
PUBLIC SALE OF BONDS
PHASE I: PRELIMINARY ORGANIZATION
A. Application Process
Once the institution and its counsel have determined its financing needs, the Authority should be contacted. The institution will send a letter to the Authority (generally in the form attached as Exhibit A to the Policies and Practices) outlining the project and its approximate size and acknowledging the Authority’s Policies and Practices. If the project meets the eligibility requirements, the Authority's counsel will draft an inducement resolution for the approval of the Board.
• Preliminary Approval
Certificate of Need (CON): A health care institution that is contemplating a financing to expand its current level of service will typically require a Certificate of Need to proceed with the project. The CON is the process by which health care projects are reviewed on the basis of need, financial feasibility, and impact on quality of care. Information regarding this process is available from the Missouri Department of Health.
• Selection of Parties to the Transaction
Senior Managing Underwriter: The senior managing underwriter or investment banker is the firm responsible for structuring and marketing the bond issue. The individuals assigned to the financing are typically specialists in tax-exempt and health care or educational finance.
The senior manager's chief responsibility is to ensure his client (the borrower) the lowest possible cost of borrowing. The senior manager will perform the following services to achieve this goal: (1) secure necessary approvals for financing, (2) oversee the preparation of the Preliminary and Final Official Statements, (3) analyze financing options (term, variable vs. fixed rate, credit, etc.), (4) structure the financing, and (5) assist in the rating process and/or selection of credit enhancer.
Due to the key role of the senior manager, the Authority believes the institution should make its own choice of senior manager. The selection may be made prior to first contacting the Authority. However, the Authority's staff is available to assist the institution with the selection process at no additional cost.
The senior manager will be required to execute and deliver to the Authority a letter acknowledging that it has received and reviewed a copy of the Authority’s Policies and Practices. A form of the letter is attached to the Policies and Practices as Exhibit A.
Bond Counsel: Bond Counsel is retained to determine the validity of the proceedings that authorize the issuance of bonds and the existence of the features that render them tax-exempt.
In an Authority financing, bond counsel is selected by the Authority with input from the borrowing institution. The firm will be a qualified law firm that is located in Missouri. Its role is to render a legal opinion that states the following: (1) the Authority is authorized to issue the proposed bonds and has met all the legal requirements necessary for issuance, and (2) the interest on the proposed bonds will be exempt from state and federal income taxation.
In addition to rendering opinions as to the legality and tax-exempt nature of the transaction, bond counsel also assumes responsibility for drafting the financing documents including the trust indenture and the loan agreement.
Underwriter's Counsel: The underwriter's counsel is hired by the senior manager to assist in ensuring that adequate disclosure has been made so that potential investors can make an informed decision about purchasing the bonds. The underwriter's counsel will perform a review of the institution and the financing ("due diligence") and will be responsible for the drafting of the Preliminary and Final Official Statements. The Authority requires that the senior manager select a qualified law firm that is located in Missouri to serve as underwriter's counsel.
Co-Manager/Co-Managing Underwriter: Additional investment banking firms, which are often local or regional firms, are appointed by the Authority in larger fixed-rate financings to enhance the marketing capabilities of the financing team and to ensure the broadest distribution of bonds. The appointment of co-managers allows MoHEFA to fill perceived marketing needs and to satisfy certain constituent interests. The number of co-managers is determined by the size of the financing.
Bond Trustee (Trustee Bank): The bond trustee is a financial institution with a Missouri charter and a Missouri office, and is usually a large commercial or savings bank meeting certain capitalization requirements. The Bond Trustee acts as a fiduciary for the bondholders and is responsible for creating, maintaining and administering the various accounts/funds established by the bond documents. Toward the end of the financing process and before bonds are sold, the trustee bank is selected through a competitive bid process facilitated by the Authority. The bids are then reviewed with the institution and a selection is made.
The selected bank will then serve as trustee throughout the term of the bond issue. As a fiduciary, the trustee is involved in the administration of the business terms of the financing documents and in the exercise of remedies in the event of a default. In addition, the trustee is responsible for ensuring the proper use and flow of funds and for the institution compliance with bond document covenants.
• Organizational Meeting
After the parties to the transaction have been selected, all parties to the financing meet to discuss the structure of the financing and to plan the timing of the events for the remainder of the financing process. The Authority requires either (a) an in-person organizational meeting at the outset of the financing involving all available relevant parties before bond documents are drafted or (b) an organizational conference call among all available relevant parties at the outset of the financing before bond documents are drafted followed by an in-person document review session.
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PHASE II: STRUCTURING OF THE FINANCING
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Drafting of Financing Documents
As a result of the discussions at the organizational meeting, preliminary documents are drafted and distributed to all participants. These documents typically include Trust Indenture, Loan Agreement, Preliminary Official Statement, and Purchase Contract. These documents are drafted by the attorneys in conjunction with the institution and the senior manager to ensure the documents adequately describe the agreed upon terms of the financing. The documents are subject to review at three to four drafting sessions before being finalized by all parties for the sale of the bonds.
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Credit Enhancement/Rating Process
A key decision in the structuring process concerns the feasibility of credit enhancement of the bond issue. Credit enhancement comes in two forms - bond insurance and letters of credit. Typically bond insurance is used when the bonds are expected to carry fixed interest rates, and letters of credit are used when the bonds will carry changing or variable interest rates (e.g., bonds may be issued with a seven-day variable interest rate where the interest rate is changed weekly to the market rate). The decision to pursue credit enhancement and/or a rating from the rating agencies is usually made with input from the institution, the senior underwriter, and the Authority’s financial advisor. An analysis of cost versus interest rate advantage helps to determine the best path for each financing. Several options can be pursued simultaneously, until the best available option becomes apparent. Under either scenario, it is typical for the documents to be submitted to the credit enhancer/rating agencies and a meeting at the project site to be held prior to a commitment being issued.
The Authority will not automatically finance a public issue with less than any "A" category rating from Standard & Poor’s or Moody’s. See Policies and Practices for more information.
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Interim Financial Statements
Unaudited interim financial statements may be required from the institution, depending upon the timeliness of the most recent audit. These financial statements, as well as the most recent audit, may be included in the Official Statement.
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PHASE III: MARKETING
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Bidding of Printing Services
Official Statement: The Authority will solicit bids from Missouri printing firms (absent special circumstances) for the handling of Official Statement printing services.
Bonds: If applicable, the selection of the printer for the bonds is typically handled by the bond counsel. The counsel will also take bids and then consult with the institution before making a final selection.
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Contact Potential Investors
All managers in the financing are provided with copies of the Preliminary Official Statement (POS) prior to the marketing of the bonds. Potential investors (individuals and institutional investors) are sent copies of the POS and are advised of the timing for the issuance of the bonds. Occasionally an issue will be discussed at meetings with investment brokers. This would be especially true if the issue is large (over $50 million) and the borrower has not been in the market for several years.
* Pricing
Background: The underwriters' discount is the traditional mechanism through which the underwriting firms are compensated for their work in structuring and marketing a bond issue. The underwriters' discount for a bond financing is divided into four components: Management Fee, Expenses, Underwriting, and Takedown. These components are described in detail below:
Management Fee: This is the fee paid to the managers, compensating them for their professional services in implementing the financing, including (1) assisting in the design of the transaction, (2) preparing certain documents associated with the transaction, (3) managing the underwriting syndicate (the group of firms which actually sells the bonds to investors), and (4) coordinating the sale and marketing of the issue.
Expenses: This component is reimbursement to the managers for the out-of-pocket expenses incurred in connection with the structuring, syndication, and marketing of the bond issue. Normally, such expenses will include (1) fees and expenses of underwriters' counsel, (2) preparation and printing of the Blue Sky and Legal Investment memoranda, (3) expenses incurred by the managers (travel, communications, computer time, advertising, etc.), and (4) day loans (for the purchase of the bonds).
Underwriting: The underwriters are compensated for participating in and committing their financial resources and sales organization to marketing the bond issue through this component. This component further reflects the market risk incurred by the syndicate members in underwriting the issue. While the management fee and the expenses are typically split between the members of the issue, the underwriting compensation is paid to all of the members of the syndicate according to their respective participation in the underwriting.
Takedown: The largest component of the underwriters' discount is the takedown, which is, in essence, selling commission or incentive to sell given to a member of a syndicate for selling bonds. The takedown is realized only if the syndicate member resells the bonds purchased from the syndicate at the initially established terms. It must be competitive in amount with commissions available on other offerings of similar security, size and maturity, and reflect the degree of difficulty in marketing the bonds.
The underwriters' discount (or "spread") is usually expressed as dollars per thousand dollars of bonds, as a percent of a bond, or as a percent of a bond issue. Thus, on a $10,000,000 bond issue, an underwriters' discount of $200,000 is commonly expressed as a 2% or $20 spread.
Federal law limits the amount of bond proceeds that can be used to pay both the discount and the costs of issuance. In general, if the discount and the costs exceed 2% or $20 per $1,000 bond, the institution must pay the excess from its own funds. While this limit has put pressure on underwriters to lower their fees, on small to medium size bond issues it is often hard to be below the 2% level because that amount can be quite small and there are certain dollar costs associated with a financing regardless of its size.
Time of Sale: The interest rates are set early on the morning the bonds become available for sale. The underwriters will present the terms of the sale (the interest rates on each maturity on bonds) to the institution, the Authority, and the Authority’s financial advisor. The Authority and its financial advisor will consult with the institution on the appropriateness of the terms of the pricing prior to its release in the marketplace. The interest rates will be based largely upon a determination of prevailing market conditions including the bond rating, type of credit enhancement (if any), and perceived financial strength of the institution.
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PHASE IV: SALE
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Award of Bonds
After the initial marketing period (typically 12-24 hours), the institution, the Authority, the underwriters, and the financial advisor consult and agree upon the final terms of the bond issue. At this time, the Authority, in agreement with the institution, will execute the purchase contract with the managing underwriter.
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Bond Closing
Ten to fourteen days after the marketing of the bond issue (earlier if the bonds are issued in a variable interest mode) the bond issue is closed. At closing, bonds are delivered to the underwriters and payment is received by the trustee. All documents are finalized and signed. At this point, the institution has direct access to the funds and the financing is completed.
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PHASE V: FOLLOW UP
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Disclosure
The result of SEC Rule 15c2-12(b)(5) is that for tax-exempt financings after July 3, 1995, borrowing institutions have been required to make certain annual and periodic reports. The Rule technically applies only to underwriters during the initial issuance of bonds. Yet, the underwriter avoids violating the Rule by getting the borrowing institution to undertake in a continuing disclosure agreement ongoing disclosure at the times and in the manner contemplated by the Rule.
A continuing disclosure agreement is a contract between the borrowing entity and the bondholders (a) to make timely disclosure of the occurrence of any of eleven listed events, if material, and (b) to provide an annual report by a specified date each year, which contains certain designated information. If the borrower fails to provide the information it can, at a minimum, give bondholders the right to bring a lawsuit to force proper compliance. Bondholders might also try to bring damage claims asserting that they would not have bought, sold or held the bonds had the borrowing institution properly given continuing disclosure notices. The amount of damages might be measured by any change in value of the bonds after the disclosure was due.
The Rule contemplates, and continuing disclosure agreements typically undertake to provide, only disclosure of particular, relatively discrete categories of information. Yet, another SEC Rule (i.e. SEC Rule 10b-5), is applicable to nearly all disclosures to the securities market and it requires that all such disclosures be accurate and not omit any material information necessary to make the information included not misleading. Accordingly, it may often be necessary to include in annual reports information beyond what is specified in the continuing disclosure agreement. To do so, however, will make ongoing disclosure not the mechanical process most borrowers expected, but a procedure involving many judgment calls, some based on legal concepts of materiality, and with possible exposure to securities law claims. In some cases, decreases in market price for bonds could result in bondholder claims that they have been damaged by alleged deficiencies in the ongoing disclosure. Given the foregoing considerations, it might be a good idea for legal counsel to be consulted in connection with annual reports and material event notices.
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NOTES/BONDS
The Authority assists health care and educational institutions in financing equipment purchases and capital projects at the lowest possible cost. Financing options that the Authority offers to Missouri institutions consist of the following debt instruments:
Floating or Fixed Rate Notes
The interest rate on these one to two year notes either floats, with the rate adjusted periodically, or is fixed for its term. The borrower is able to take advantage of lower interest rates while planning long-term financing according to projected needs.
Variable Floating Rate Bonds
While these instruments have a nominal long-term maturity, the interest rate is adjusted periodically (usually daily or weekly). The borrower is able to take advantage of low short-term rates, but also, if conditions warrant, to lock in a fixed interest rate without many of the costs associated with a new issuance of bonds.
Fixed Rate Bonds
Short to intermediate term bonds
A variation of traditional fixed rate long-term bonds, these fully amortized bonds are for borrowers who desire shorter prepayment provisions and can generate sufficient revenues to retire the principal over a shorter maturity. The bonds are generally issued for periods ranging from 10-15 years, with a 5-8 year prepayment provision.
Long-term bonds
These traditional 20 to 60 year fully amortized term bonds are issued at prevailing market rates. This type of instrument offers the security of fixed rates and the opportunity to stabilize interest costs in a volatile market while matching a longer term liability with the expected useful life of the asset.
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REFUNDING OF PRIOR DEBT
Health care and educational institutions often refinance to take advantage of lower interest rates in the market place than existed at the time of prior financing. Similarly, such institutions often wish to avoid restrictive covenants or collateral requirements contained in a prior financing that would no longer be necessary in a new financing. The Authority has the ability to issue "refunding bonds" which can accomplish these goals. Such bonds often can be issued to refund the institution’s obligations even if the Authority was not involved in the original financing. Such "refundings" may, depending on the terms of the prior financing and what is advantageous at the time, either be "current" refundings in which the prior debt is paid off within 90 days of the issuance of the new bonds, or "advance" refundings in which the proceeds of a new bond issue are placed in escrow to pay off the old bonds at some designated time in the future. The Tax Reform Act of 1986 placed restrictions on advance refundings, yet most institutions are still able to take advantage of this financing technique.
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