Robert Shapiro recalls how tightening capital markets almost tripped up a $325 million construction project for North Shore-Long Island Jewish (LIJ) Health System, the nation’s second largest nonprofit healthcare organization.

“Construction began right when interest rates started spiking in 2008. The market was nervous, no one was buying bonds, the whole future looked uncertain,” the CFO says. To finance interim construction costs, the healthcare facility turned to its $200 million bank line of credit. “You just can’t turn off the cash spigot when you have these kinds of outstanding commitments. Having a line of credit at hand was like having our own internal bridge financing option.”

Quick thinking and the luxury of an established credit line allowed Shapiro to keep construction on schedule. Unlike other facilities that had their lines of credit pulled, banks were comfortable with North Shore LIJ’s strong credit risk rating, although the hospital didn’t escape completely unscathed. 

“They still hiked the annual fees and interest rate costs,” Shapiro comments wryly.

What a difference a few years make. Before 2008, capital markets were awash with financing options for healthcare facility renovations. Not anymore. Between Wall Street’s meltdown, spiking tax-exempt variable rates, disappearing bond insurance players, expiring Build America Bonds, and reduction of the bank qualification limits program, 2011’s capital markets are a far cry from the bullish healthcare finance markets of 2005 and 2006.

These days, financial due diligence is stricter and underwriting requirements are tougher. Even funding timelines have increased, ranging between 90 to 120 days and even longer if credit-enhanced financing is involved. “Five years ago, capital financing options were more flexible. Lenders are much more hands-on now to ensure construction draws stay on target and that the hospital has sufficient funds to complete the project,” says Michael Roynan, partner at Stradley, Ronan, Stevens & Young, LLP. “Want a new, 100-bed facility? Then expect greater compliance requirements than in the past.”

Yet while lenders are treading cautiously, Matthew Lindsay, vice president at Lancaster Pollard, an independent healthcare financing firm headquartered in Columbus, Ohio, advises that there are still plenty of financing options available for clients who understand the fundamentals and are willing to exercise a little patience and flexibility.

In the beginning

Successful projects begin with understanding the plans and the costs before approaching the bank. Is it a brick-and-mortar wing addition, an electronic records system installation, general renovations, or environmental upgrades like solar panels and seismic retrofitting? Answering these questions clarifies initial project scope while alerting executives to potential costly project overruns. 

Large projects, such as wing additions, require understanding architectural and engineering pricing contracts, plus any covenants connected to the site’s land purchase. “Keep in mind that the larger the project, the more hoops there will be to jump through,” warns Todd Nelson, technical director for senior financial executives at Healthcare Financial Management Association.
 
 Certain states also will require a certificate of need if costs are over a certain dollar amount. This involves filing an application with the local health department notifying it of the hospital’s intent to build a new wing or stand-alone building. Competitors wanting to challenge the expansion can insist on administrative hearings to determine whether construction can proceed, potentially holding the project hostage.

On the other hand, smaller renovation projects offer greater flexibility for executives wanting to keep things simple. For example, reduced energy costs, coupled with the opportunity to sell unused wattage back to utility companies, make solar panels a popular capital expenditure choice for hospitals looking to go green and save money.
 
 Once installation costs, projected expense savings, potential energy resale value, or utility company rebates are determined, hospital executives can decide whether capital campaign funds, an off-balance sheet maneuver (where a third-party investor owns the property but leases it back to the hospital), or a direct commercial loan is best way to finance the project.

Going beyond the balance sheet

Understanding cash flow within the context of credit underwriting is also helpful. Healthcare executives who analyze overall debt service coverage, operating margins, cash to debt, and day’s cash on hand will quickly see a facility’s financial strengths and liquidity problems. Keeping track of prior loan debt servicing and regulatory covenants is another necessity. Typically buried deep within loan documents, these agreements not only define the type of future debt structures a hospital can obtain, they also limit the total amount of debt-to-net revenue a hospital can carry.

Since Medicare payments represent anywhere from one-quarter to one-half of how hospital patients pay their healthcare costs, CFOs should also keep an eye on the federal budget review process. Any potential reduction in eligible reimbursement amounts will mean a reverberating impact on hospital revenues and bond payments.

Proper due diligence is also qualitative. Finance executives should prepare a detailed review of management experience and board member competence, local economic conditions, recent demographic changes, and competing healthcare facilities. “If the hospital’s CFO can clearly articulate the facility’s needs and available board member expertise to a lender, then that lender has a better chance of securing the right financing in the capital markets,” Lindsay advises.

Finding the right partner  

For some executives, securing financing is as simple as calling the facility’s long-term financial advisor. Recognizing that this is not always the case, Nelson suggests finding reputable lenders by asking colleagues for recommendations, interviewing several candidates, and following up on peer references to determine the best match.

Requests for proposals (RFPs) are another way to find a lender. “RFPs happen quite often and at least 50% of the deals are awarded this way,” Roynan says, noting that bigger institutions also submit RFPs as a way to let bankers know about competition for the business and pricing. For smaller facilities unwilling to go the RFP route, Roynan suggests developing relationships with local banks to help get bet
ter rates and more favorable terms than typically obtained through the RFP process. However, he warns that smaller facilities may need to provide market studies of the project if they appeal to a bank where there is either minimal or no established relationship.

Current financing trends

Historically, healthcare capital financing has been a 50/50 mix of both variable and fixed-rate bonds, yet a recent trend toward fixed-rate bonds is gaining popularity as economic uncertainty remains. “Our board prefers issuing fixed-rate, long-term bonds because there are no surprises,” Shapiro says, noting that many other healthcare systems holding shorter, variable-rate bonds either found themselves with a higher interest rate or no buyers when the bonds came due.
 
 There’s also a residual unease regarding the investment banking industry as a whole. “Hospital boards are more vocal with their discomfort about variable rate bonds because each one needs the support of a commercial bank. There is a discomfort with this idea, considering the recent banking industry volatility,” Lindsay observes.

Tightened financing requirements also are affecting stand-alone community hospitals. Smaller size and lower credit ratings make it increasingly difficult for these organizations to access capital markets. Wanting to retain their independence and community connections, many now are turning to strategic alliances, such as pooling management services for group purchasing power or even outright mergers to help put them on financial par with larger healthcare systems.

Private placement is another popular option where commercial banks will structure a deal similar in style to a tax-exempt loan before purchasing it from the hospital. The benefits include a quicker closing timeline in addition to no public offering costs or disclosures. Most lenders offering this option are the bigger regional and national banks as the smaller regional banks have legal lending limits on how much and how many bonds they can buy.

Another alternative involves commingling. Commingling occurs when four or five banks come together to finance a bond deal with one bank taking on the majority portion of the risk. The lead bank typically sets the credit terms and conditions and either networks with sister banks to pull together the funds or goes through an underwriter for help in placing the deal.

Making this process even more complex is the investment banker’s belief that one financing option does not fit all. An underwriter might recommend moving forward on a fixed-rate bond (Plan A) while actively keeping a private placement (Plan B) or commingling option (Plan C) on the backburner. Such a multi-pronged approach will understandably make financial executives hesitate as they see additional paperwork, unexpected fees, and a delayed closing slowing down their project.
 
 When this happens, the CFO should understand that lenders have a fiduciary responsibility to ensure the best long-term financing options for their clients as capital markets are highly fluid. Plan A rates may have worked on Day 45 but are now twice as expensive (or perhaps not even available) at Day 90. The long-term benefits from a savvy strategy shift can far outweigh short-run delays. 
 
  

A silver lining for stand-alone practices

One unexpected boon comes from the recently increased SBA and certified development company lending limits. Thanks to the 2010 Small Business Jobs Act, these loans can now provide long-term financing of up to $5 million dollars to acquire land, equipment, or buildings for medical practice expansion or modernization. Rather than sifting through a multitude of capital market options and investment lenders, medical professionals can, instead, simply reach out to their local community bank for either a variable 7(a) or fixed-rate 504 financing. It’s an attractive option for doctors wanting a stand-alone practice or their own medical office building.

Mark Decius, a San Francisco-based SBA specialist, cautions that while these financing options might be less complicated, it doesn’t mean project fundamentals can be ignored. “Regardless of size, knowing the project and understanding operational costs and gross monthly revenue needs before approaching a lender will make the financing process smoother,” he says.

Robert Shapiro couldn’t agree more: “Even though the market has changed, the [basic] principles haven’t.” HCD

Gwynneth Anderson is a freelance business writer specializing in business finance and banking. She can be reached at gwynnetha.anderson@gmail.com. For more information, please visit Healthcare Financial Management Association’s website, www.hfma.org.
  

Finding the right underwriter

Healthcare financing is a tightly knit, familiar field. For healthcare executives who are just beginning to test the capital market waters, however, the choices can be overwhelming. Correctly matching a facility’s needs to the right underwriter will help clear the confusion. Here are several tips for making the right choice.

• Read trade publication advertisements to get an idea of which underwriters funded what projects. Are those projects similar to the ones your hospital is considering?

• Word of mouth. Ask your peers for their recommendations.

• Attend conferences where underwriters frequently give talks on hospital financing issues.

• Can’t attend conferences? Consider browsing the Healthcare Financial Management Association’s website (www.hfma.org). The association offers capital financing webinars, addresses strategic healthcare operational issues, and pulls together newsletters filled with tips, tools, and ideas for members. 

Experts share their advice on the financing process

• Mark D. Folk, partner, Shutts & Bowen LLP: “The first question regarding financing is, ‘Who owns the facility?’ This dictates what sort of financing may be available.”

• Todd Nelson, technical director for senior financial executives at HFMA: “Start off by nailing down all the costs, then create the pro-forma showing the return on investment. Once the cost information, cash flow, and pro-forma are completed, you will know how much money you need to borrow in the capital markets.”

• Robert Shapiro, senior vice president, CFO of North Shore-Long Island Jewish Health System: “Minimize surprises with an established capital monitoring process. A strong balance sheet will provide for more access to capital when you need it the most.”

• Paul Phillips, senior managing director, capital markets group, Crews & Associates Inc.: “Keep in mind that this is a 30-year transaction. If you are not on your toes, you may be signing up for a loan covenant that seven or 10 years from now could be too strict.”

• Anitra D. Lanczi, partner, Shutts & Bowen LLP: “Regulatory compliance is as important as loan covenants. Hospital attorneys should look at these in preparation for financing. If you don’t have proper financial controls and aren’t in compliance, who is going to give you money?”

• Matthew Lindsay, vice president at Lancaster Pollard: “Ensure clear communication from both sides of the financing table, keep in mind that tougher underwriting times call for
  greater flexibility and patience, and tougher underwriting rules means pursuing a multi-track of options until the last minute.”

• Mark D. Folk, partner, Shutts & Bowen LLP: “Remember, you are dealing with the most regulated industry in the country with, perhaps, the exception of power plants.”