Eliminating Personal Guarantees
Physicians Shed Personal Guarantees
When seeking real estate financing from traditional bank lenders, it is common practice that partners are required to personally guarantee the debt. Such was the case with OrthoTennessee, a group of over 40 physicians and the single largest orthopedic provider in the state of Tennessee.
Glenn Sumner, CEO of OrthoTennessee, enlisted the help of CMAC to analyze the group’s existing debt structure for two of its real estate properties. The intent was to determine if it would be possible to secure new financing that could release them from the guarantees while maintaining or improving the current cash flows. CMAC leveraged the strength of OrthoTennessee with its own market potency and restructured the debt without personal guarantees, while simultaneously reducing the loan spread at a fixed rate over an extended loan term.
Something like a domino effect among lenders has occurred in the finance marketplace. As one agrees to loan without personal recourse, another will follow in order to compete- and on it goes. “The secret to success is being able to point out the competition and produce credible documentation”, says Liz Allport, a Principal with CMAC Partners. “It’s akin to showing a competitor’s coupon when shopping.” Ms. Allport went on to explain that she always requests pricing on both recourse and non-recourse financing options so that any premium in pricing can be quantified. It’s important to realize that, even if a medical practice isn’t the heavy hitter like OrthoTennessee, there’s still a middle ground and great improvements to be made. Personal liability mitigation has become a real hot button among borrowers, and the degree of success can be substantial when working with the right competitive data.
THE REAL RISK
While most of us are aware of the most obvious reasons for loan default (not paying back the money), a more common risk of default comes with the breach of covenants. Many borrowers are routinely in default without even being aware and are putting themselves in harm’s way. Personal Guarantees are the primary cause of such defaults.
Personal Guarantees generally include a requirement that updated personal financial statements be provided by each guarantor on an annual basis. Beyond the hassle factor for whoever is charged with the collection of these documents is the reality that at least one of the partners will invariably fail to submit financials on time. That is a technical default. While your local banker who has always serviced your account may turn a blind eye, that can change in an instant when the bank gets acquired or a regulator comes in to inspect documentation. Many loan documents don’t have a “cure period”, so turning in late financials doesn’t automatically end the default.
While the idea that a bank would call the loan based on this type of technical default sounds farfetched, CMAC has witnessed a spate of such actions by banks who may be looking for an excuse to remove or improve a loan that was added through acquisition or that does not meet its current portfolio standards.
Personal Guarantees are just one of the many technical defaults to be aware of. Others such as loan-to-value (LTV) or Debt Service Coverage (DSC) ratio also trigger defaults. Consider the case of a doctor-owner in Fort Myers, Florida who was cited for a breach when his property’s value declined below the specified LTV in the documents. The bank used this technical default to terminate the loan. Of course, the borrower could not come up with funds to immediately pay, so the bank offered a new loan at a much higher rate. In this way, the bank was able to legally increase the yield on a long-term client.
Another common technical default is not meeting the specified DSC ratio. Even with the most lenient DSC of 1.0x (every penny made that year can be distributed) may be inadvertently broken if a practice estimates net income when making year end distributions.
It is important not to leave yourself unnecessarily exposed to technical defaults. It’s like having your head on the chopping block: even if you trust the person wielding the axe above you, it’s an uncomfortable situation.
Springhill Hospital Secures $20.8 MM + Non-Recourse Refinance in Preemptory Move
MOBILE, AL: A few months ago, the executives at Springhill Hospital met to decide whether to sit tight with what was generally considered a favorable interest rate for the remainder of their financing or move immediately to explore the market with the objective of extending the term without increasing the loan spread. One of the primary considerations was the long-standing relationship that Springhill had with its current bank and the concern over upsetting that relationship by shopping the financing.
Eventually, the decision was made to move forward with CMAC and the result exceeded expectations on more than one front. The short remaining term was replaced with a 10 year rate that was nearly a full percentage point less than the existing loan. Additionally, the financing was secured without recourse to the principals.
This transaction came on the heels of the refinancing of a very similar privately owned Arkansas hospital where CMAC reduced a rate (renegotiated only 6 months earlier) to produce a $2MM interest expense savings.
CMAC’s Director of Finance, Elizabeth Allport, stated that both of these hospitals were exceptionally well run and that she was able obtain the exceptionally favorable pricing in both cases by leveraging the negotiated rates from other recent CMAC deals in other areas of the country.
Origin of the saying “Better Off Debt”?
Consider the case of a 20 person orthopedic practice in Texas that constructed a $15 million 60,0000 sf center and leased that center back to the practice and its related entities. The partners had thought that they would have to guarantee the debt until a broker presented them a “Non-Recourse” deal. Talk about pleased partners! But had they actually reduced their personal liability?
The lender promised no recourse on the debt but there was no mention of recourse on the leases. The leases? Not a big deal. Everyone guarantees the leases. After all, that’s the obligation of your business and you are a partner in that business. In the Texas case, the partners gladly signed as guarantors on the leases and were relieved that they did not have to guarantee the debt. But did this group really have anything to celebrate and did they help themselves? Let’s look a little closer.
In this case, the group had borrowed $12 million (80% of the cost). The leases were 10 years at a rate of $27.50 psf. Guarantees totaling $12 million on the debt would have been divided proportionately among the partners. Instead, the partners ended up guaranteeing the value of the leases, in this case $16.5 million. To make matters worse, the guarantees on the leases were joint and several unlimited rather than pro rata. Therefore, each partner ended up with a $16.5 million guarantee rather than an average limit of $600,000 under the loan guarantees… and for what benefit?
In a situation where a building is occupied by tenants that are related to one another and to the building ownership, the risk of payment default on the leases and payment default on the loan is one in the same. The only way that the debt is not paid is if the lease is not paid and, if that happens, the partners are personally liable… and in this case, for far more than the debt.
The “Eyes” Have It
Ophthalmology Sets New Mark
Richmond, Virginia and Bettendorf, Iowa may have more in common than one might initially think. Both cities serve as home for two highly regarded Ophthalmology practices, and both made some notable improvements in their financing this last year.
Bettendorf, Iowa is one of the Quad Cities that also include Moline, Illinois, which is the home of ORA Orthopaedics. Based on ORA’s experience with CMAC, ORA’s CEO suggested that Eye Surgeons Associates in Bettendorf might also benefit as a CMAC client. Through CMAC, Eye Surgeons didn’t merely improve its financing; it set a new mark for competitive pricing across the country. By partnering with a bank eager to increase its medical market share, some of the skinniest pricing CMAC has ever arranged was secured for the ophthalmology practice. The bank was willing to forego its normal level of profitability in order to build a relationship with this well-established Eye Group.