Since the Tax Cuts and Jobs Act eliminated tax-exempt advance refundings, experts believe not-for-profit health systems may consider alternative strategies, including derivatives, that they may not have in the past. This is not a complete list of possible strategies.
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What it is: Traditional bond is sold today—locking rates in—but that bond is not delivered until closer to call date of the existing bond they’re refinancing.
Downsides: Market appetite for forward period may be less than a year and investors may require high premium. Can’t benefit from lower interest rates or better credit position at call date.
What it is: Borrower enters interest rate swap that becomes effective at a future date to lock in current interest rate. On the swap termination date, borrower issues new bond to refund existing bond. If new bond is fixed rate, swap is terminated upon redemption of existing bond. If new bond is variable rate, swap remains outstanding and continues to hedge variable rate.
Downsides: For fixed-rate refunding bonds, gain or loss in swap value depending on interest rate affects debt service cost. For variable-rate bonds, this can be risky because floating rate of credit support may be unavailable or more expensive. Can’t benefit from lower interest rates or better credit position at call date.
What it is: Issue private, taxable bond typically with a bank that converts to a tax-exempt bond within 90 days of the refunded bond’s call date. Locks in tax-exempt rate when bond is sold.
Downsides: Structure carries risk that conversion won’t take place and issuer will be stuck with taxable bond. More complicated and requires additional analysis from the issuer's legal counsel on taxes. Investors may want higher interest rates for committing to rate in the future.
What it is: Bank or another lender issues loan directly to borrower. Could have flexible repayment terms.
Downsides: Could come with higher interest rates and new lower corporate tax rate may have lowered banks’ appetite for tax-exempt bonds.
What it is: Issue a tax-exempt refunding bond within 90 days of the call date of the bond it’s refunding.
Downsides: Interest rate risk during the wait.
What it is: Proceeds of new taxable refunding bond used to pay principal and interest on existing bond more than 90 days prior to call date. Locks in current interest rate.
Downsides: Higher costs associated with taxable bonds. Less ability to benefit from lower interest rates or better credit position at call date.