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It’s Time: Review Your Debt Agreements Today

Most health care facilities rely on good part on various financing agreements, including mortgages and lines of credit. Much thought, effort, and professional consultation was involved in the initial set up of the financing. However, changes in the banking industry and accounting standards will necessitate a review of your current debt agreements.

Expiration of London Interbank Offered Rate (LIBOR)

LIBOR is a benchmark interest rate based on the rate banks would charge each other for unsecured loans. This is a commonly used basis for financing as banks were able to relate the return they receive on loans made (interest charged) as it related to their cost for money.

However, after the financial crisis it became apparent that LIBOR was being manipulated by banks, either to increase returns on interest rate swaps or to hide signs of financial weakness. LIBOR of late was not based on actual interbank borrowings, but rather on estimates of the rate the banks would charge each other. The estimated actual amount of interbank loans on a typical day was only six to seven transactions totaling about $500 million for the one- and three-month LIBOR panels. This is obviously a pittance in comparison to the estimated $200 trillion-plus gross notional amount of financial assets tied to LIBOR. Because of the problems with the LIBOR rate it will cease to be reported and will expire at the end of 2021.

Many loans and lines of credit include rates that adjust based on LIBOR. SWAP agreements that have been entered to mitigate the impact of adjustable rates are also often based on LIBOR and many loans that appear to have fixed rates, actually have embedded swaps that are tied to LIBOR.

It is important to review your documents to determine what the interest rates you are charged are based on. Many agreements do specify an alternative rate benchmark should LIBOR expire, such as Prime, or provide the lender the unilateral ability to determine another benchmark rate which may be significantly different from LIBOR. Now is the time to review your agreements so that there remains an opportunity to renegotiate or change financing arrangements that will work with your business model.

Lease Standards and Debt Covenants

Staying compliant with debt and loan covenants is a key component of securing cash flow for operations. Typically, those covenants include adherence to certain financial ratios or other financial metrics based on GAAP accounting. In addition, some, such as HUD regulatory agreements, require authorization prior to entering into new debt agreements.

The new lease standards included in ASC 842 are effective for public business entities (including those who are conduit debt obligors) for periods beginning after December 15, 2018, for all others it is for years beginning after December 31, 2020.

The key changes as a result of the standards are to record a liability for the present value of the future lease payments, to record a corresponding right of use asset, and to clarify what is a financing type lease versus an operating lease.

Generally, the right of use asset will be recorded as a non-current asset, while the corresponding liability will be broken out between current and long-term liabilities, with the next year’s lease payments being reported as a current liability. The effect of this can dramatically change the current ratio and may even bring it below one for entities that have significant lease agreements. In addition, while an operating lease agreement would not be considered debt under GAAP, the liability associated with financing type leases may be, thus resulting in new debt being reported on the balance sheet threatening compliance with covenants or regulatory agreements.

Now is the time to meet with your lenders to clarify the treatment of leases for meeting debt and loan covenants and, for those with HUD regulatory agreements, obtaining documentation of approval by HUD for debt that may now be reported on the balance sheet.

For more details relating to the new lease standards, see the following articles on our website:

https://www.bonadio.com/news-events/articles/what-your-business-can-do-now-about-new-lease-accounting-standard
https://www.bonadio.com/news-events/articles/change-it-coming-specifically-lease-accounting
https://www.bonadio.com/news-events/articles/horizon-lease-accounting
https://www.bonadio.com/news-events/articles/lease-standard-implementation-key-components-for-private-companies-to-consider

This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.