Rodger Davis, managing partner of Northcreek Mezzanine Fund I, and Kurt Faulk, senior vice president at SNB Bank of Dallas, discuss five common questions associated with bank and mezzanine lending for ambulatory surgery centers. This information was originally collected during a webinar on access to private capital markets sponsored by Ambulatory Alliances.
Q: What is senior debt and what is its current market?
Kurt Faulk: Senior debt, from a real estate perspective, would be anything that a bank or finance company would have a first mortgage position on. There are several variations of this debt at this point. Typically it's based on the type of facility or the location of the facility, but the senior debt market at this time is fairly fluid. It has been restricted given the events of the last three years, but as we are now seeing, banks, in general, are getting an appetite in real estate lending. Our bank is certainly part of that wave that's moving forward now in trying to deploy capital back out in the market to good quality credits and companies.
Q: What is mezzanine debt and what is its current market?
Rodger Davis: Mezzanine is the debt that would sit in a second lien position. It can also be in a senior position if a company can't seem to attract any senior financing. It has a higher rate of interest. Typically all-in yields on mezzanine today are in the mid-teens to twenties. The benefits of mezzanine are it's much more flexible in terms of amortization; typically we receive no amortization and typically it's a lot cheaper than equity.
The instances where we've applied mezzanine in the ASC market have been companies that have plenty of opportunity for growth and can't or don't want to access another round of equity or can't get the capital they're looking for, so we sort of fill that gap.
Q: What are the current trends influencing credit markets for ASCs?
RD: Kurt mentioned the overall bank market is more liquid, and from where we sit, I think I would agree with that. We still see the ASC market, at least the transactions that we've invested in and have been involved in looking at, as not a normal bank market because in many cases you face some of the primary objections to lending to an ASC — the minority ownership issues and the companies may not have critical mass to have a profitable management company.
Nonetheless, the banks are more willing and able to lend than they were certainly two to three years ago. In terms of the mezzanine market, I don't know that it's vastly different than it was a year ago. The mezzanine market as a whole would echo the bank market. It's more liquid, there's more competition, prices are coming down, multiples are going up.
As we look at the ASC market, I think we're calmer now than we were two years ago. Considering some of the issues affecting healthcare globally, we look at the ASC market as responding positively to those trends. For good management teams, good operators, I think they can get more leverage than they could a couple years ago.
KF: I think Rodger hit some of the really good key points. We see the same trends. The pending legislation in the [Supreme Court] hasn't really impacted our decision process or banks' decision processes. We know it's out there. That's a variable that hopefully resolves itself very soon. What Rodger is pointing out, we look at the same things in debt financing as he would in mezzanine — who is the operator, what is the physician mix, the type of surgical procedures that are being performed, just some things that in ASCs historically have been translated over and created a positive operating company and good results from the ASC itself.
Q: What does a typical loan structure look like?
KF: For banks and lenders right now, it's still fairly conservative in its structure, but also depends on where the market is. If you said in a metropolitan area, Dallas, or Los Angeles or Pittsburgh, I would say those give a lender the ability if something does not go correctly to remarket the facility or the property. The rural markets or tertiary secondary markets are still very difficult for lenders. There are some credit enhancements that are available for the rural markets through the USDA program, which banks can underwrite effectively to that create opportunities out in rural markets.
To answer the specifics [on the structure], you would probably see fixed rates or variable rates depending on the appetite for the operator, and the terms would range from five years as a maturity, 10 years as a maturity, up to 20 years as a maturity. The one thing I think you're seeing in specialized stock property from a real estate perspective is no longer than a 20-year amortization and very keen on risk in the type of market where these facilities are being built or operated.
RD: For us, we typically get a current interest rate of typically 12-14 fixed, and then we have some kind of yield enhancement. Typically with ASCs, it's been in the form of additional PIK interest. The concept of warrants is very difficult for an ASC owner because they may or may not sell the entire company, they may sell an individual center. It's very difficult to try to understand and achieve an equity value.
We lend to multi-unit operators, and we might secure our loan with a member of interest only and then we'll take a pledge of the assets of the management company. But, again, everything we do is priced on a continuum of risk and so less leverage is going to be on the low end, mid-teens; higher leverage, less diversity, more profit concentrated in one or two centers is going to be on the higher end. All of our mezzanine loans are interest-only and they typically have a term of four to five years.
Q: How do you determine the amount you are willing to lend?
KF: It's a function of a couple of items, the first one being value of the asset. Whether it's equipment, or whether it's real estate or whether it's account receivable financing, a bank will determine through a third-party independent source what the value of that asset is from a market perspective.
Using real estate as an example, typically ASCs historically ranged from $200 per square foot up to $500 per square foot. The third-party person or company we engage with will do a market assessment of other similar type of ASCs to see if the value there supports what is being there or is presently in place. That's the first test. The second one is really profitability, the historical income needed in order to support the amount of debt or leverage that the principles or the borrowers are trying to achieve. If the ASC or physicians lack that, then it could create some issues in order to effectively finance the amount they are seeking. It's really a two-part question: One is the value of the asset, the other one is the historical income in order to support the debt or the leverage that is trying to be achieved.
RD: Everything we do is geared off of profitability. We'll look at the profitability of the underlying center or centers, and with more diversity, we'll be more aggressive. I don't think we have any hard and fast limits per se. It's more of an art for us than it is a science.
If it's a group of centers that has one or two moneymakers and then seven or eight trying to reach stabilization, we're going to be much more conservative. If they're highly concentrated in a geography, if they're highly concentrated in specialty, or if they're highly concentrated in the number of physicians, we look at this more as a creditor than we do as an equity. We're really looking for diversity across a number of metrics.
Kurt Faulk is senior vice president at SNB Bank of Dallas, a $3 billion bank with a primary focus in healthcare. Kurt has 30 years of national commercial banking experience in the financial services area, and previously had a 10-year career with GE Commercial Finance Healthcare Real Estate.
Rodger Davis is managing partner of Northcreek Mezzanine Fund I, LP, a $75 million SBIC mezzanine fund located in Cincinnati. Northcreek makes debt and equity investments in lower middle market companies (EBITDA $1-8 million) nationwide. Its targeted profile includes a wide variety of industries including healthcare, service, specialty manufacturing and distribution.
Ambulatory Alliances s a middle-market boutique investment banking, surgery center brokerage, physician recruitment and syndication and strategic advisory firm. The company focuses exclusively on ambulatory centers and more specifically radiation oncology and ambulatory surgery center niche markets.
Q: What is senior debt and what is its current market?
Kurt Faulk: Senior debt, from a real estate perspective, would be anything that a bank or finance company would have a first mortgage position on. There are several variations of this debt at this point. Typically it's based on the type of facility or the location of the facility, but the senior debt market at this time is fairly fluid. It has been restricted given the events of the last three years, but as we are now seeing, banks, in general, are getting an appetite in real estate lending. Our bank is certainly part of that wave that's moving forward now in trying to deploy capital back out in the market to good quality credits and companies.
Q: What is mezzanine debt and what is its current market?
Rodger Davis: Mezzanine is the debt that would sit in a second lien position. It can also be in a senior position if a company can't seem to attract any senior financing. It has a higher rate of interest. Typically all-in yields on mezzanine today are in the mid-teens to twenties. The benefits of mezzanine are it's much more flexible in terms of amortization; typically we receive no amortization and typically it's a lot cheaper than equity.
The instances where we've applied mezzanine in the ASC market have been companies that have plenty of opportunity for growth and can't or don't want to access another round of equity or can't get the capital they're looking for, so we sort of fill that gap.
Q: What are the current trends influencing credit markets for ASCs?
RD: Kurt mentioned the overall bank market is more liquid, and from where we sit, I think I would agree with that. We still see the ASC market, at least the transactions that we've invested in and have been involved in looking at, as not a normal bank market because in many cases you face some of the primary objections to lending to an ASC — the minority ownership issues and the companies may not have critical mass to have a profitable management company.
Nonetheless, the banks are more willing and able to lend than they were certainly two to three years ago. In terms of the mezzanine market, I don't know that it's vastly different than it was a year ago. The mezzanine market as a whole would echo the bank market. It's more liquid, there's more competition, prices are coming down, multiples are going up.
As we look at the ASC market, I think we're calmer now than we were two years ago. Considering some of the issues affecting healthcare globally, we look at the ASC market as responding positively to those trends. For good management teams, good operators, I think they can get more leverage than they could a couple years ago.
KF: I think Rodger hit some of the really good key points. We see the same trends. The pending legislation in the [Supreme Court] hasn't really impacted our decision process or banks' decision processes. We know it's out there. That's a variable that hopefully resolves itself very soon. What Rodger is pointing out, we look at the same things in debt financing as he would in mezzanine — who is the operator, what is the physician mix, the type of surgical procedures that are being performed, just some things that in ASCs historically have been translated over and created a positive operating company and good results from the ASC itself.
Q: What does a typical loan structure look like?
KF: For banks and lenders right now, it's still fairly conservative in its structure, but also depends on where the market is. If you said in a metropolitan area, Dallas, or Los Angeles or Pittsburgh, I would say those give a lender the ability if something does not go correctly to remarket the facility or the property. The rural markets or tertiary secondary markets are still very difficult for lenders. There are some credit enhancements that are available for the rural markets through the USDA program, which banks can underwrite effectively to that create opportunities out in rural markets.
To answer the specifics [on the structure], you would probably see fixed rates or variable rates depending on the appetite for the operator, and the terms would range from five years as a maturity, 10 years as a maturity, up to 20 years as a maturity. The one thing I think you're seeing in specialized stock property from a real estate perspective is no longer than a 20-year amortization and very keen on risk in the type of market where these facilities are being built or operated.
RD: For us, we typically get a current interest rate of typically 12-14 fixed, and then we have some kind of yield enhancement. Typically with ASCs, it's been in the form of additional PIK interest. The concept of warrants is very difficult for an ASC owner because they may or may not sell the entire company, they may sell an individual center. It's very difficult to try to understand and achieve an equity value.
We lend to multi-unit operators, and we might secure our loan with a member of interest only and then we'll take a pledge of the assets of the management company. But, again, everything we do is priced on a continuum of risk and so less leverage is going to be on the low end, mid-teens; higher leverage, less diversity, more profit concentrated in one or two centers is going to be on the higher end. All of our mezzanine loans are interest-only and they typically have a term of four to five years.
Q: How do you determine the amount you are willing to lend?
KF: It's a function of a couple of items, the first one being value of the asset. Whether it's equipment, or whether it's real estate or whether it's account receivable financing, a bank will determine through a third-party independent source what the value of that asset is from a market perspective.
Using real estate as an example, typically ASCs historically ranged from $200 per square foot up to $500 per square foot. The third-party person or company we engage with will do a market assessment of other similar type of ASCs to see if the value there supports what is being there or is presently in place. That's the first test. The second one is really profitability, the historical income needed in order to support the amount of debt or leverage that the principles or the borrowers are trying to achieve. If the ASC or physicians lack that, then it could create some issues in order to effectively finance the amount they are seeking. It's really a two-part question: One is the value of the asset, the other one is the historical income in order to support the debt or the leverage that is trying to be achieved.
RD: Everything we do is geared off of profitability. We'll look at the profitability of the underlying center or centers, and with more diversity, we'll be more aggressive. I don't think we have any hard and fast limits per se. It's more of an art for us than it is a science.
If it's a group of centers that has one or two moneymakers and then seven or eight trying to reach stabilization, we're going to be much more conservative. If they're highly concentrated in a geography, if they're highly concentrated in specialty, or if they're highly concentrated in the number of physicians, we look at this more as a creditor than we do as an equity. We're really looking for diversity across a number of metrics.
Kurt Faulk is senior vice president at SNB Bank of Dallas, a $3 billion bank with a primary focus in healthcare. Kurt has 30 years of national commercial banking experience in the financial services area, and previously had a 10-year career with GE Commercial Finance Healthcare Real Estate.
Rodger Davis is managing partner of Northcreek Mezzanine Fund I, LP, a $75 million SBIC mezzanine fund located in Cincinnati. Northcreek makes debt and equity investments in lower middle market companies (EBITDA $1-8 million) nationwide. Its targeted profile includes a wide variety of industries including healthcare, service, specialty manufacturing and distribution.
Ambulatory Alliances s a middle-market boutique investment banking, surgery center brokerage, physician recruitment and syndication and strategic advisory firm. The company focuses exclusively on ambulatory centers and more specifically radiation oncology and ambulatory surgery center niche markets.