In this episode, partner Jana Kolarik of Foley’s Health Care Practice Group and PYA principal Angie Caldwell host Heidi Jeffery, a partner in Foley’s Finance and Financial Institutions Practice Group and Matt Stuart, a Principal in PYA’s Audit Assurance Service Line, discuss the latest trends in the bond market and the bond compliance pitfalls that organizations should avoid.

Angie Caldwell

Hello and welcome to the Let’s Talk Compliance podcast series of Health Care Law Today presented by Foley & Lardner and PYA. I’m your co-host, Angie Caldwell, consulting principal with PYA.

Jana Kolarik

And I’m your other co-host, Jana Kolarik, a partner in Foley’s Health Care Practice Group. We’re excited to have you join us today. Before we begin the show, we want to remind you to subscribe to Health Care Law Today, either on iTunes or your preferred podcast app.Please visit healthcarelawtoday.com or pyapc.com.

For today’s show, Heidi Jeffery, a partner in Foley’s Finance and Financial Institutions Practice Group, and Matt Stuart, a principal in PYA’s Audit and Assurance Service Line, discuss the latest trends in the bond market and the bond compliance pitfalls that organizations should avoid. I’m going to turn it over to Heidi and Matt to introduce themselves.

Matt Stuart

Thank you, Angie and Jana, and appreciate everybody’s attention and letting us spend a few minutes with you today, wherever you may be listening, as we talk about risks and pitfalls with bond compliance. Again, as mentioned, my name is Matt Stuart, and I’m an audit principal with PYA, and I’m headquartered in our Knoxville, Tennessee office, and pleased to be here with Heidi Jeffery with Foley & Lardner. And Heidi, would you like to introduce yourself?

Heidi Jeffery

Great. Thanks, Matt. I’m Heidi Jeffery. I’m a partner with Foley & Lardner. I happen to be in our Chicago office, and I’m a member of the firm’s Finance Group. My practice really is focused on public finance matters, including bond issuances and also counseling senior living and other health care providers on compliance matters.

Matt Stuart

Yeah, that’s great, Heidi. So kind of our first question here just to break the ice and get going. What is a typical day like for you in your practice?

Heidi Jeffery

So, Matt, I spend quite a bit of time, as mentioned, counseling clients in the health care area. As we emerge from COVID and we have so many health care providers now wrestling with new realities facing staffing changes, inevitably, a lot of those questions revolve around counseling both in terms of financial covenant compliance, the development of compliance procedures. But we also talk about continuing disclosure, how to talk with investors and other credit providers, and also spend a lot of time, frankly and unfortunately, working with clients in developing waivers as well as forbearance agreements.

We’ve also lately been spending a lot of time, and my day-to-day focus is quite a bit on calls, relating to consultant call-ins and other matters just to make sure that senior management and staff at health care institutions are well-versed in what their compliance responsibilities are and, frankly, helping them navigate some of the trickier issues facing them today.

Matt Stuart

That’s great, Heidi. Thank you for the information. And just to piggyback on that, so in my role at PYA as an audit principal, I oversee a large number of the firm’s audits of clients across all industries. But in particular, my practice focuses very heavily on the health care industry, and that ranges from small physician groups to health care startup companies that need an audit or consulting advice as they’re maybe getting going all the way up to large multi-billion dollar health care systems.

And as you might imagine, the larger the entity, typically the more debt that they have, maybe the higher leveraged that they are. And that’s really where we come in as a firm on the audit side, is looking at the bond compliance and the debt covenants during the course of our audits of those systems. And as we go a little bit further into the discussion, we’ll discuss that in greater detail. But yes, we are very keenly aware as auditors just how bond compliance and debt covenants can certainly play a large role both in an organization’s financial statements as well as their operational health.

Heidi Jeffery

Well, it sounds like our days are very similar to one another in terms of the focus on compliance.

Matt Stuart

Absolutely. So the next question we wanted to discuss for a few minutes is, what type of trends have you noticed in the bond market lately? And if it’s all right, I’ll actually take this one first. So, as I mentioned, we spent a lot of time working with audits of large health systems that have a significant amount of bond debt. And what we’ve noticed over the past four years, and gosh, it’s hard to believe that we’re coming up on five years since the start of COVID-19 so time really has flown by.

But one of the trends that we noticed when COVID happened, and the government issued the Coronavirus Aid, Relief, and Economic Security (CARES) Act, and with it, of course, came a lot of Provider Relief Fund (PRF) money, is that some organizations that prior to 2020 may have been in distress with their bond covenants or right at the cusp of failing them, with that additional PRF money that came in, some organizations almost got a what I’ve kind of jokingly called as a “get out of jail free card” for a few years with the influx of the Provider Relief Fund money.

So organizations that maybe had a tighter debt-to-equity ratio or things like earnings before interest, taxes, depreciation, and amortization (EBITDA) margins that were maybe slim before that, the influx of the COVID-19 CARES Act money certainly was a life preserver to a lot of these organizations. What we’re seeing now, especially as we go into audits for organizations for years that ended in 2023 and then going forward, is that the government supplements from the CARES Act are largely gone at this point.

So some of those organizations that maybe were able to have some extra time with the Provider Relief Fund money coming in are now at a point where some of them are honestly back to where they were in 2019 and prior with some of their debt covenant compliance issues. So that is a trend that we’ve noticed from doing an audit on health care entities is that some of these organizations that maybe had a reprieve for a few years are unfortunately back in a situation to where debt covenant compliance is a matter that they need to be concerned about.

Heidi Jeffery

I think that’s a great observation, Matt. And I’d also add, it’s almost as though there’s been a double whammy because as we’ve seen the reduction in the supplemental government aid, and I think at the same time, we saw a dramatic shift in the labor market, and that impacted health care systems and senior living systems dramatically. So at the same time that we’ve seen supplemental dollars roll off, we’ve seen an increase in the cost for providing staffing and an increase in the cost of supplies, and that’s just led to a much more attenuated financial situation for so many of our health care clients.

And so we’re seeing more and more questions around system finances and operations, generally speaking from the legal standpoint, we are talking more and more with clients about distressed credit situations and compliance where whether it’s day’s cash metrics or coverage ratio metrics. We’re fielding more calls around those two topics and those types of compliance, we’re finding ourselves engaging with senior management in ways to think about covenant compliance and be a bit more proactive in terms of speaking to their investor base.

Matt Stuart

That’s a great point, Heidi. And as we’re all probably aware, this is a presidential election year in 2020, so certainly, I think there could be some major shifts both in the stock market and then just the overall economy as a whole as we go through the next several months and beyond.

So, potentially, we could be in for a buckle-up situation if things change dramatically, but that’s great advice for everybody to be aware of. So Heidi, kind of going off of what we just talked about, if you could give one piece of advice to an organization getting ready to do a bond issuance, what would it be?

Heidi Jeffery

So Matt, thanks. Great question. For me, in terms of the piece of advice, it really would be focusing on who your team is going to be, both internal and external to the organization. We frequently counsel clients on developing robust procedures as it relates to disclosure and as it relates to bond compliance. But knowing who your team internally is, is absolutely critical. Is your team comprised of just your treasury team? Is it treasury and legal? Is it treasury, legal, and accounting?

Who best within your organization is going to be primed and ready to build robust disclosure and also be willing to sign off on covenant demands and investor questions about covenant compliance? So as you get ready to do a bond issuance, making sure you know who your internal team is as well as your external team, making sure that you have an outside legal team and financial advisory team that’s ready to walk with you through the bond issuance process, I think that is absolutely key. And so again, the one piece of advice I would give is know who your team is both internally and externally, and walk with that team through the debt process.

Matt Stuart

Yeah, that’s great advice, Heidi. And one of the things I was hearing you say in there is that for something as complex as doing a debt issuance, especially in this day and age, you don’t want a firm or an advisor who is just kind of a generalist across a lot of areas. You really want to be engaging with a team that specializes in doing these types of bond issuances. One of the things that we focus on as auditors of an organization when they go out to the bond market is, a lot of times, we are asked to give what’s known as a comfort letter on the Appendix A.

And the Appendix A and bond issuances is typically where you have a lot of the financial information, both statistical analysis as well as historical financial information, and sometimes some organizations even include some pro forma forward-looking or historical pro forma information in there. So one of the things obviously that we would advise as the auditors and the Certified Public Accountants (CPAs) for these organizations is, to the extent that you’re able to, please include us in those conversations as early as you feel comfortable doing so. We’re often able to give advice on what we are able to give assurance on related to the Appendix A versus something that falls outside of the purview of what a CPA can attest to.

So again, like Heidi was saying, I think, the key is to just make sure that you have your ducks in a row before you actually kind of set out on this path of doing a bond issuance. Make sure you talk to legal counsel, make sure you talk to your auditors, and really make sure you have the team lined up and ready to go before you hit the start button. Because what we see is once you start down that path, there’s a lot of moving pieces. So having a good team in place and having the roadmap set out at the start of journey is much preferred as opposed to trying to build a plane while you’re flying.

Heidi Jeffery

And Matt, to add to that, I think one of the key ingredients of a successful financing starts early with board engagement and management engagement, making sure that senior leadership has a pipeline to the board and making sure that the board is both engaged and is properly advised as to the benefits and risks of a transaction.

We work frequently with finance committees or executive committees that then, in turn, are making recommendations to boards. So I think board engagement early on in the process is also a very key ingredient to a successful financing.

Matt Stuart

Heidi, that’s a great point, and honestly, it made me think of another item I wanted to mention as well. A lot of our not-for-profit system clients issue bonds through a health care authority. So, in other words, a governmental body that allows these bonds to have tax-exempt status for the purchasers of these issuances. So certainly, to Heidi’s point about engaging the board early on, it’s also important to make sure that there’s good communication with that health care authority.

If that’s not an organization that either meets frequently or you have regular contact with, make sure that they’re in the loop early as to exactly what the funds are going to be used for, the amount that the organization is looking to raise, those type of things. Because yes, Heidi, to your point, the last thing you want to do is spend months coming up with a wonderful plan, but then either having the board or a health care authority say, “No, we’re probably not on board with that.”

Heidi Jeffery

Thanks, Matt. Yep, all good points.

Matt Stuart

Great. Well, so now we’ve spent a few minutes talking about what are some of the good things that an organization can do getting ready for bond issuance. So let’s kind of turn the tables here and go to the other side on what are some bond compliance pitfalls that you would advise others to steer clear of?

Heidi Jeffery

Oh gosh, lots of lessons learned, having done this for quite some time. Two pitfalls. And these are very practical items and I think easily rectified, but the first pitfall, Matt, would be forgetfulness, to be honest. We’re all busy. There’s a natural letdown once a team closes a deal, but I think that, frankly, is one of the best times to take stock of where the deal landed and what the compliance responsibilities are now of your organization.

So I frequently recommend that actually once the deal closes, instead of taking that deep breath that we all want to take, that the team actually develops a checklist of compliance covenants, whether they’re focused from the tax agreement, from a continuing covenant agreement with a bank, with the loan agreement with your state bond issuer. There are a whole host of covenants that accompany a typical bond issue.

And so taking stock immediately after the deal closes or a couple of days after the deal closes, I think that that is key in terms of avoiding major bond compliance pitfalls.

And the second pitfall that we frequently see with organizations are pitfalls around not having proper procedures in place. And I mentioned earlier, we work with organizations to develop secondary market procedures in terms of continuing disclosure.

As we all know, the U.S. Securities and Exchange Commission (SEC) has put out a list of listed events of which organizations that are bound by continuing disclosure rules need to follow and give notice about. So having procedures in place that both serve to educate the health care system, health care organization, having procedures in place that serve as the basis for both education but also knowing when the organization needs to take action.

So whether this is around material mergers and acquisitions or about defaults relating to covenant compliance, having procedures in place that then can be followed, to then alert the investor community, I think those types of procedures, typically if they’re followed and if folks are trained and educated around them, those procedures really can help an organization avoid major bond compliance pitfalls. Matt, what are you seeing in this area?

Matt Stuart

Thank you, Heidi, and that’s great information that you just shared. So in our role as auditors, we’re often coming in after the fact, after the fiscal year has ended, and during the course of the audit, of course, the debt compliance covenants are one of the key areas that we focus on because as we’re going through the audit and conducting our procedures, as auditors, we’re always aware of the risk that in addition to the normal kind of fraud risks that we’re all aware of, right, there’s typically the risk to overstate revenue, understate expenses, or particularly for personal gain or for individual bonuses and things like that, that, of course, we’re all aware of.

We’re also aware of the risk that an organization could manipulate reserves in addition to the income statement in order to meet their bond debt compliance. So one of the things that we see that’s a common compliance pitfall, and again, our role as auditors, I’ve often joked with folks that we’re kind of like the people that come in after the battle, and bayonet the wounded, right. The year-end is done. There’s not much you can do at that point. And then we come in and start passing judgment as to what’s been done or not done during the year. But one of the pitfalls that we see quite often is that maybe there’s a MTI, a master trust indenture that’s several years old and it’s not been revisited in some time.

So one of the examples that I can give that we’ve seen several times in the past couple of years is there was a new accounting standard a few years ago regarding leases, and it used to be that only certain types of leases were put onto the balance sheet and the other types of leases were off-balance sheet. Now, for almost the entirety of organizations, whether they’re for-profit, not-for-profit, or governmental, those leases are required to be on the balance sheet as a gross up to assets and then as a gross up to debt. One of the things that we saw with some of our clients that had MTIs that had not been revisited in some time was that the language in there was speaking to debt to equity ratios, and it just said something to the effect of, “All long-term debt on the balance sheet.”

Well, if you’re doing a debt-to-equity ratio and then all of a sudden one year you don’t have $10 million of lease liabilities on the balance sheet, but the next year because of a new accounting standard you do, that’s obviously something that can cause a lot of heartache and then quite frankly, scrambling to get things corrected after the fact. So that’s one of the things we try to advise our clients on, and certainly, us, as auditors, do our best to keep our clients apprised of these things. But really take a look every so often at the language in the MTI and see if it’s still holding water with the current regulatory environment as well as the current accounting environment.

And if you see something in there that you’re like, “You know what? I read this thing that says there may be a new lease standard coming. I wonder if that’s going to really affect how much debt we have on the balance sheet.” Would definitely advise you to reach out to your legal counsel or your auditors, or probably the best method is to reach out to both parties and let’s have a discussion early before we get past a year-end period and there’s definitely more limitations on what can be done after the fact at that point. So that is something that we’ve seen several folks fall into a pitfall of not paying attention to the MTI. The language has been set, and they forget about it. So that, and honestly, just another pitfall is not monitoring those debt covenants throughout the year.

If I had a dollar for every time that we do an audit and we’re asking a client for their debt covenant calculations, and they say, “Well, I don’t know. Let me do those, and I’ll give those to you.” That kind of just makes me wince a little bit because it’s like, “Oh gosh, you all really should be tracking these throughout the year to make sure that you’re in compliance with them.” And that’s something that certainly would advise folks to just keep an eye on those. You don’t have to check it every day, but at least a couple of times a year it’s good just to have a level set on those debt covenant calculations to make sure that things are staying where you would like for them to. And if not, then certainly reach out and discuss it with counsel or your auditors.

Heidi Jeffery

Absolutely agree, Matt. And to your point, I think a good set of procedures, whether it’s in the form of a checklist so that you know what monthly, quarterly, annual reporting requirements and covenant compliance you have, it’s a good set of procedures, a good checklist that summarizes what your covenants are, can go a long way in avoiding some of those pitfalls you mentioned.

Matt Stuart

Yes, absolutely. Well, Heidi, as we come to the close of our talk together today, we’re just going to ask for your advice on when should an organization talk to an advisor about compliance matters.

Heidi Jeffery

Well, I would say it’s an ongoing dialogue. But the sooner you have the view that your organization is going to run into a compliance matter as, for instance, as an organization gets ready to close its books on a quarter or on the year, I think that organization and senior leadership team is going to have a good handle on whether or not they’re trending towards a covenant violation.

So our counsel there would be, rather than wait until that certificate of compliance is due, rather than wait for that reporting period to approach, be proactive and engage with your outside advisors, whether it’s your auditing team or your legal counsel, engage and start discussing strategy with them. And so I think that that is a very good rule of thumb prudent approach to keep your counselors in mind as you go through the year-end process and closing of the books.

Matt Stuart

Absolutely, Heidi. And I’ll second that and say, as far as from the audit team goes, please talk to us early and often relating to these type of compliance issues. It’s one thing to find out about it after the end of the year. Like I’ve mentioned, I think a few minutes earlier, there’s limited things that can be done at this point. Usually, you’re asking for forgiveness from whoever the bond issuer is at that point.

If we can have a conversation during the year, there’s certainly more leeway for us to work with counsel. And then work with the bond issuer to come up with a resolution, whether that’s a waiver or some sort of forbearance or other things that are certainly easier to do during the year as opposed to just kicking the can down the road and not looking at things until the end of the year.

So certainly, as your auditor would definitely advise you to reach out to your CPA, and I think that’s a good practice, whether we’re talking about bond compliance or just financial questions in general, is to reach out to your auditor anytime you have questions instead of just waiting until close to the end of the year. So, Heidi, I appreciate the time and the conversation today. I think this was very interesting and will be helpful to the audience. Where can people reach you if they have further questions or would like to discuss this topic more with you?

Heidi Jeffery

Sure, Matt. My information is on our Foley website, foley.com, again, Heidi Jeffery. And thank you so much, Matt, for speaking with us today.

Matt Stuart

Absolutely. Heidi, thank you for your time. And again, my name is Matt Stuart and my information is also on our website at pyapc.com. And with that, again, thank you to all of our listeners today for giving us the time, and I’ll turn it back over to Angie and Jana to close us out.

Angie Caldwell

Thank you, Heidi and Matt, for a great discussion. We appreciate you taking the time to join us today. We want to thank our listeners for joining our Let’s Talk Compliance podcast series with Health Care Law Today, your connection to timely legal updates in the health care and life sciences industry.

We encourage you to subscribe to this podcast, visit Foley’s Health Care Law Today blog at healthcarelawtoday.com and pyapc.com. If you liked this show, don’t forget to subscribe and be sure to rate us five stars. Until next time, I’m Angie Caldwell at PYA.

Jana Kolarik

And I’m Jana Kolarik at Foley & Lardner. Thanks so much for listening.