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Norwood Crossing: An FHA Case Study

Steven W. Kennedy, Jr.Senior Vice President / Regional Manager

Lancaster Pollard & Co.

Gail PreteChief Financial OfficerNorwood Life Society

• Norwood Crossing

• Project Scope

• Original Debt Structure

• FHA Alternative

• FHA Issues

• FHA Solution

• Leveraging FHA

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AGENDA

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• Privately held financial services firm focused on healthcare sector

• Healthcare & Affordable Housing• Investment Bank – SEC registered broker/dealer• Mortgage Bank – Agency approved lender

• FHA/HUD, GNMA, FNMA, USDA• HQ in Columbus, OH with 6 offices from Philadelphia to LA• Over 600 transactions totaling approximately $5 billion in 44 states

LANCASTER POLLARD

• SNF / ALF• 122 SNF beds

• 55 ALF beds

• 74 Sheltered Care beds

• Chicago, IL

• 501c3

• Founded over 100 years ago (1896)

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NORWOOD CROSSING

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• 55 unit ALF addition

• 61,554 square feet

• Opened Sept. 2009

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PROJECT

• $19.9M construction loan with bank

• Paid off $2.3M of tax-exempt bonds

• Funded ALF project

• Interest rate swap

• Construction loan intended to convert to LOC VRDB

• Bank’s credit profile downgraded below A1/P1, so construction loan remained outstanding

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ORIGINAL FUNDING

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DEBT FUNDING OPTIONS

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HISTORICAL HEALTHCARE RATES

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• FHA mortgage insurance programs allow borrowers to borrow on credit strength of a AA / AAA-rated government agency.

• FHA mortgage insurance programs are self funded (not direct loans from government) – FHA insures a loan made by a private lender

• Truly permanent debt – fully amortizing (no refinance or re-pricing event)

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FHA 232 OVERVIEW

• FHA 232 Program • New Construction or Sub

Rehab of licensed SNFs & ALFs

• FHA 232/241 Program• 2nd Mortgage Program for

expansion of existing HUD-insured Facilities

• FHA 232/223f Program • Refinance or Acquisition

of licensed SNFs & ALFs

• FHA 232/223a7 Program• Refinance of existing

HUD-insured mortgage

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FHA 232 OVERVIEW: KEY CONSIDERATIONS

• No Financial Covenants• No on-going Debt

Service Coverage, other financial ratio covenants or quarterly compliance reporting

• Non-Recourse

• Loan is Assumable

• Low, long-term fixed interest rates

• < 4% (including MIP; as of 4/2013)

• Long Term Fixed Rate• Up to 35 year ( 40 year for

construction) matching term/amortization

• Eliminates refinance risk

• Government Guarantee• Eliminates both health care

sector and credit pricing spreads

• “AAA” like debt

• Fixed Guarantee Fee• Unlike banks, does not

consider risk-based pricing• 0.65% refinance / 0.77%

construction

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FHA

Advantages• Full amortizing• Fixed rate• Non-recourse • No tax-exempt costs• No on-going financial covenants• No ancillary business

requirements

Challenges• Adverse to new construction• Improving but relatively slow• Won’t fund equity take-outs

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FHA VS. PRIVATE SECTOR CAPITAL

Private Sector Capital

Challenges• Term Debt• Re-pricing or refinance events • Recourse / Parent guarantee• Tax-exempt costs• On-going financial covenants• Ancillary business requirements

Advantages• Receptive to new construction• Quick to close• Will fund equity take-outs

• FHA requires new construction projects to be open for 3 years prior to submittal of FHA refinance application

• 3 year rule not applicable when new construction project square footage is less than 50% of total project’s square footage

• Norwood Crossing’s 55-unit ALF project was 34% of total square footage

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FHA 3-YR RULE

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• EBIDA for 12-months ended January 2011 totaled over $2.4MM, resulting in an estimated $19.2MM value (SNF = 13.5% cap; ALF & SC = 10% cap) and a max mortgage of $15.4MM.

• Management projected rolling 12-month financials by November 2011 will reflect a $3.1MM EBIDA due to the projected velocity of fill up in the AL facility

• March 2011 AL occupancy 65%

• November 2011 AL occupancy projected to total 85%

• Income cap value should total $25MM, resulting in a max mortgage of $20MM

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VALUATION

• FHA refinance deal cycles have dramatically improved• Today = 2 months for 232/223(f), 1 month for a 232/223(a)7

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HUD QUEUE

Source: HUD LEAN

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• Funded 6-month DSR to permit surplus cash flow distribution

• Prop-co / Op-co structure minimizes limitation• Lease = 1.05x debt service (including P&I, MIP,

insurance, RR)

• New FHA LEAN docs

• Eliminate semi-annual distribution restriction

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NP REGULATORY AGREEMENT

• Mortgagee Letter 2012-8: Swap Qualification

• No more than 10% of loan amount for swap payoff

• Only swaps entered into prior to 1/1/2009

• Fairness certification

• Tax-Exempt Swap

• Swap entered into in conjunction with closing of debt issue

• Qualified hedge

• Taxable Swap

• Swap entered into within 15 days of closing of debt issue

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SWAP PAYOFF

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• Loan Amount: $21M

• Interest Rate: 3.0% fixed (includes MIP)

• Term: 30 years

• Amortization: 30 years

• Bank Financial Covenants: None

• Ancillary Business Requirements: None

• Assumable: Yes

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FHA LOAN

• Interest rate reduced from 7.30% to 2.98%

• $625k of annual debt service savings

• No interest rate risk

• Term matches amortization; refinance risk eliminated

• Swap risk eliminated

• Reimbursed $345k of cash for previous cap ex

• Funded $100k for future cap ex

• Covenant freedom

• Banking freedom

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REFINANCE BENEFITS

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TARGET FED FUNDS RATE

• The Fed would likely need some combination of the following before raising interest rates:

• Faster economic growth = 3-4%• Lower unemployment = 6-7%• Stable PCE inflation = 2%

• Despite positive recent trends, none of these three measures have shown significant improvement

• LPIAG believe the Fed will remain on hold through 2013

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OUTLOOK: TARGET FED FUNDS RATE

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The Theory: The two structures have complementary strengths & weaknesses, so use them in combination for what they’re good for…..

• Private Sector Capital = Short / medium term uses• Leveraged equity take-outs• Acquisitions• Extending term debt to season a turnaround• New construction or facility expansion

• FHA = Long-term uses and permanent capital• Refinancing fully levered assets• Predetermined take-outs of bridge or semi-permanent debt used to

construct, expand, extract equity, or acquire a facility

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FHA & PRIVATE SECTOR CAPITAL COMBINATIONS

The Situation: A growing multi-site senior living organization owns some properties with low leverage (relative to their cash flow based or comparable value) and wants to expand.

FHA / Private Sector Solution:1. Value the existing assets, then lever them up to 75% LTV with a bridge loan (use private sector for the short-term goal)

2. Use the extracted equity as ammunition to continue to grow the organization’s portfolio (fund the new development with private sector debt)

3. Refinance the levered properties with FHA in two years (two year seasoning rule on debt used to extract equity) and the newly developed properties in three (three year seasoning rule on new construction debt).

The Result: Portfolio growth with the long-term goal of low cost, non-recourse, permanent debt.

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FHA & PRIVATE SECTOR CAPITAL COMBINATIONS: EQUITY TAKEOUTS

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The Situation: A senior living organization has an opportunity to purchase another senior living property

FHA / Private Section Solution:1. Use a private sector bridge loan to effectuate the purchase of the property (private sector solution to accomplish a short-term goal)

2. Refinance the newly purchased properties immediately with FHA, thereby locking in a fixed cost of capital below 4% on permanent debt (2 year seasoning not required b/c no equity takeout)

The Result: Efficient purchase of another senior living asset that is permanently financed with low rate, long-term capital.

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FHA & PRIVATE SECTOR CAPITAL COMBINATIONS: BRIDGE PURCHASE

The Situation: A senior living organization is interested in refinancing bank-related debt, but would also like to expand its facility (ex: new Medicare rehab or Memory Care wing).

FHA / Private Section Solution:1. Use a private sector bridge to refinance the existing debt and fund the new addition

2. Once the addition is built, immediately refinance the entire debt load with FHA thereby locking in a fixed cost of capital below 4% on permanent debt (no three year seasoning rule for new projects under 50% of the existing square footage).

The Result: The ability to quickly capture a market opportunity then immediately put the debt to bed, non-recourse, at AA/AAA fixed rates.

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FHA & PRIVATE SECTOR CAPITAL COMBINATIONS: FACILITY EXPANSION

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• Leverage bank-related financing for its purpose: short-term, quick, flexible

• Leverage agency financing for its purpose: low-cost, long-term, no bank ancillary requirements

• Combining private sector and agency financing can reduce risk, prudently accelerate growth and result in a more optimal capital structure

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CONCLUSION

Steven W. Kennedy Jr.Senior Vice President /

Regional Manager

Lancaster Pollard65 E. State St., 16th Floor

Columbus, OH 43215Phone: (614) 224-8800

skennedy@lancasterpollard.com

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QUESTIONS?

Gail PreteChief Financial Officer

Norwood Life Society6016 N. Nina Ave.Chicago, IL 60631

Phone: (773) 631-4856gprete@norwoodcrossing.org

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LANCASTER POLLARDSTEVEN W. KENNEDY, JR.

• Steven W. Kennedy, Jr., is Lancaster Pollard’s lead investment banker in Illinois and Wisconsin, as well as one of the firm’s regional managers, overseeing investment banking operations in several states throughout the Midwest.

• Since joining Lancaster Pollard in 2001, Mr. Kennedy has been instrumental in bringing to market a variety of financing structures totaling over $1 billion. He was named the firm’s Top Health Care Banker in recent years, and structured and underwrote the firm’s “Deal of the Year” in 2010. Mr. Kennedy gained national recognition in 2008 when he structured and closed the country’s first tax-exempt, non-housing bond backed by the Federal Home Loan Bank. Prior to joining Lancaster Pollard, Mr. Kennedy worked for U.S. Sen. Richard G. Lugar (Indiana) in Washington D.C.

• Mr. Kennedy earned his MBA from the Fisher College of Business at The Ohio State University in Columbus, Ohio. He received a bachelors degree (magna cum laude) in economics and political science and a certificate in organizational studies from Denison University in Granville, Ohio. He holds General Securities Representative (Series 7) and General Securities Principal (Series 24) licenses, and is a frequent speaker and author on capital funding for health care providers.

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NORWOOD LIFE SOCIETYGAIL PRETE

• Gail Prete is the Chief Financial Officer for Norwood Life Society which is umbrella company for Norwood Crossing (263 bed SNF and AL), Norwood Seniors Network (Home Care Agency with $1.5 million in revenue) and Norwood Life Care Foundation. Gail has worked in long term care or health care for 22 years; 10 years at Beacon Hill in Lombard; 2 years at Alexian Brothers Medical Center in Elk Grove Village; 2 years at the corporate office of Classic Residency by Hyatt (now Vi Communities) and 8 years with Norwood Life Society.

• Ms. Prete earned her Bachelors degree in accounting from UW Stevens Point in Stevens Point, Wisconsin.