The article below is reprinted with permission from The Capital Issue, a quarterly newsletter published by Lancaster Pollard.
Let’s face it, community hospitals. When playing the financing game, the cards aren’t exactly stacked in your favor.
Credit risks are to you like egos are to Washington politicians; they’re pervasive. Losing a physician or your town’s major employer can choke off your revenue base. And if you have any notable debt on your balance sheet, your leverage ratios already resemble a losing hand. And now you have the gumption to attempt to access capital to fund a major expansion, renovation or replacement facility?
Then be prepared for today’s lending world to give you the cold shoulder, making your project feel more risky than financing ice sculptures in Arizona. To parody Sen. Stuart Smalley, “You’re small, you’re risky, and doggone it, people don’t like you!”
The investment-grade health system an hour down the road has a full house, while the high card you’re left holding is a six of clubs.
You’re playing tougher odds
Despite the countless risks with which the capital markets’ brush will paint you, it’s no secret that many community hospitals have been able to reinvest and reposition themselves over the last decade. From leveraging the easy credit of 2005-2007, taking advantage of record low interest rates or, for critical access hospitals, benefiting from a saving grace called Medicare cost-based reimbursement, many of your peers have found ways to refresh their physical plants in the 21st century.
However, today is different for a couple reasons. First, some projects that were financed were simply bad deals. Take a $40-million-debt offering for a replacement CAH in the Midwest that had less than $15 million of net patient service revenue. Are any of us surprised that offering defaulted within three years of being funded? No, and the architects, bankers and attorneys on that deal are probably not surprised by the result either. But the current market will try to guard against making that same mistake again.
Second, non-profit healthcare providers have recently been lumped in with other municipal, tax-dependent credits. At a time when historic state and federal budget deficits have coupled with an overall miserable economy, these municipal credits, including hospitals, have all taken a hit.
So given this challenged hand that lacks any face cards, how can your community hospital deal still get done?
Adopting a proper poker face
First, a community hospital can introduce a teammate into the game by seeking a financial partner. This usually means it will be purchased, either gradually by affiliation or immediately. That decision changes the community's control of the hospital's operations and strategic future. It also impacts the hospital's credit profile — more than likely for the better.
But if a hospital decides to take on the capital markets solo, leadership needs to remember to put on a proper poker face by adopting the right attitudes:
So here’s the house’s advice: as a community hospital, you’ll never have a royal flush. But if you plan correctly and have the appropriate attitude towards your project and the funding process, you can throw down a respectable hand and get your deal done.
The Importance of a Strong Investment Policy Statement
Becoming a (Financially Stable) System
Let’s face it, community hospitals. When playing the financing game, the cards aren’t exactly stacked in your favor.
Credit risks are to you like egos are to Washington politicians; they’re pervasive. Losing a physician or your town’s major employer can choke off your revenue base. And if you have any notable debt on your balance sheet, your leverage ratios already resemble a losing hand. And now you have the gumption to attempt to access capital to fund a major expansion, renovation or replacement facility?
Then be prepared for today’s lending world to give you the cold shoulder, making your project feel more risky than financing ice sculptures in Arizona. To parody Sen. Stuart Smalley, “You’re small, you’re risky, and doggone it, people don’t like you!”
The investment-grade health system an hour down the road has a full house, while the high card you’re left holding is a six of clubs.
You’re playing tougher odds
Despite the countless risks with which the capital markets’ brush will paint you, it’s no secret that many community hospitals have been able to reinvest and reposition themselves over the last decade. From leveraging the easy credit of 2005-2007, taking advantage of record low interest rates or, for critical access hospitals, benefiting from a saving grace called Medicare cost-based reimbursement, many of your peers have found ways to refresh their physical plants in the 21st century.
However, today is different for a couple reasons. First, some projects that were financed were simply bad deals. Take a $40-million-debt offering for a replacement CAH in the Midwest that had less than $15 million of net patient service revenue. Are any of us surprised that offering defaulted within three years of being funded? No, and the architects, bankers and attorneys on that deal are probably not surprised by the result either. But the current market will try to guard against making that same mistake again.
Second, non-profit healthcare providers have recently been lumped in with other municipal, tax-dependent credits. At a time when historic state and federal budget deficits have coupled with an overall miserable economy, these municipal credits, including hospitals, have all taken a hit.
So given this challenged hand that lacks any face cards, how can your community hospital deal still get done?
Adopting a proper poker face
First, a community hospital can introduce a teammate into the game by seeking a financial partner. This usually means it will be purchased, either gradually by affiliation or immediately. That decision changes the community's control of the hospital's operations and strategic future. It also impacts the hospital's credit profile — more than likely for the better.
But if a hospital decides to take on the capital markets solo, leadership needs to remember to put on a proper poker face by adopting the right attitudes:
- Humility. A high-school buddy had the phrase “Humble Thyself” penned on his book bag. That proverbial directive should be a mantra for any community hospital seeking capital today. Of course, the hospital leadership team needs to be confident about its ability to execute its project and service the proposed debt. However, the leadership team must recognize that financial institutions and investors, for right or for wrong (and whether they tell it to your face or not), will probably not view your town as special. Therefore, you may not be able to build as large of a facility as the neighboring community hospital that is part of a system. And you may not be able to finance as much of the project as you would like through debt. Hospital leadership needs to keep that perspective in mind before trying to build a monument to its architect, CEO or board chair.
- Flexible. Your deal will not be a straight forward, uneventful experience, no matter what the investment banker, commercial banker or financial advisor tells you to win your business. The financing of your project will likely be more difficult than the architectural-design or market-feasibility processes. Therefore, it is absolutely critical that hospital leadership and its project team remain flexible. Multi-tracking financing options (pursuing multiple funding options simultaneously) are important and hospital leadership needs to be open to amending the project scope as it receives project criticism and feedback from different sources of capital. Listen to what potential capital market participants are telling you; their perspectives could be extremely valuable.
- Manageable. You must be able to afford your project. Historical cash flow should be greater than one times projected debt service. Cash to debt should quickly trend towards 100 percent after stabilization, and outstanding debt should not be greater than four times EBIDA (earnings before interest, depreciation and amortization) if avoidable. After all, this isn’t Field of Dreams; it’s Field of Reality. So when you “build it”, they “may not come.” Also, having a for-profit developer fund and build your campus’ medical office building will have a cost, which often will be more expensive than if the hospital funded the project on its own. Keep in mind that the only difference will be that the cost of capital is taxable (hospital lease payment is greater than for-profit developer’s taxable borrowing cost) rather than tax-exempt.
- A-Team. I'm not talking about telling investors and banks that you will "pity the fool" that doesn’t buy your bonds. I’m talking about making sure that you have an A-rated project team. Your investment banker, bond counsel, accountant, architect and general contractor need to be proven, patient and creative. The team members need to be proven by having done similar financings for other low- or noninvestment-grade hospitals. Tell the potential project participant who rolls out their resume highlighting a "$250-million project for AA-rated system" to take a hike. Your project will be way too difficult for them. And the project team, including the management team, must be patient. Again, this isn’t a rubber stamped A-rated hospital deal where the investment banker’s biggest question is how big their firm’s logo should be on the Official Statement. No, your project team will have to answer complex questions and make difficult decisions. And finally, your team must be creative. You may leverage a Federal Home Loan Bank letter of credit to wrap around a community bank syndicate’s letter of credit. Or you may issue FHA 242 mortgage-insured debt in the form of taxable GNMA securities in order to access AAA rates and minimize negative carry. No matter how your deal gets done, it will certainly take some creativity and your project team needs to embrace it.
So here’s the house’s advice: as a community hospital, you’ll never have a royal flush. But if you plan correctly and have the appropriate attitude towards your project and the funding process, you can throw down a respectable hand and get your deal done.
More Articles Featuring Lancaster Pollard:
Opportunity Knocking: Taking Advantage of Low Short-term Interest RatesThe Importance of a Strong Investment Policy Statement
Becoming a (Financially Stable) System