Skip to main content

Healthcare Funding Options for Securing Large Capital

 |  By kminich-pourshadi@healthleadersmedia.com  
   November 08, 2012

This article appears in the October 2012 issue of HealthLeaders magazine.

Addressing a litany of government mandates while dealing with a sluggish economy and decreasing patient volumes and reimbursements have created a challenge for CFOs looking to raise large amounts of capital. Only a handful of organizations have the wherewithal to generate enough cash from existing operations, reserves, or endowments, leaving most to weigh the options. Small and large hospitals and health systems are turning to mergers to find financial strength. However there are other opportunities, including joint ventures, venture capital, bank loans, and blends of these that can provide the critical dollars needed to stay competitive.

As value-based care and bundled payment systems take root, the demand for often expensive organizational competencies, such as IT, can put slow or underperforming hospitals at risk for faltering long-term. It's the precarious financial situation that some providers are now in that is limiting access to badly needed capital and that has sparked a jump in healthcare mergers in the past two years. But that avenue is not attractive for many organizations, and so they are looking at new ways to deal.

"Actually there's nothing new or different in capital financing that has occurred for at least 10 years, but now there are lots of shades of gray in how deals are created," says Robert Shapiro, senior vice president and CFO at North Shore-Long Island Jewish Health System in Great Neck, N.Y. In April the system, which has approximately $1.3 billion in long-term debt, issued about $50 million in tax-exempt fixed-rate debt to save money by taking advantage of low interest rates. With a $6.7 billion annual operating budget and 16 hospitals in the system, North Shore-LIJ has consistently used what Shapiro describes as a traditional capital allocation model, with cash generated from operations, fundraising, and borrowing; but that's changing.

"We've tried to take an approach our investors are comfortable with, and when you have access to the capital markets it's a pretty efficient way to access capital," he says. "However, we are looking at making acquisitions as we feel the need to expand into markets sooner than we may have before healthcare reform. Now we're starting to consider alternatives such as healthcare partners or joint venture dollars. We haven't done it yet, but we're likely to do so in the next year or two."

Until 2009, debt financing—or raising money for working capital or capital expenditures through the sale of bonds, bills, or notes—was considered an easy process, but those days have passed. Now, finding the scale and financial resources to secure a top-notch public credit rating can prove challenging, especially for hospitals with finances hit hard by the recession and in dire need of facility or infrastructure upgrades. A hospital's inability to secure a BBB- or better credit rating can stymie access to capital. 

For the organizations that fall below that rating, mergers can be a good pathway to get access to capital for infrastructure upgrades or technology updates. Buyers tend to look beyond the credit rating and balance sheet and at the hospital's leadership, market position, and long-term viability.

For instance, in May 2010, North Shore-LIJ initiated an agreement to acquire the 652-bed Lenox Hill Hospital, which represented its first hospital in Manhattan. (The deal was finalized
in April 2011.) The partnership offered financial refuge for Lenox Hill Hospital—one of the last independent hospitals in New York City. Having no affiliated hospitals or networks of primary care doctors to feed patients into the 10-building complex, Lenox Hill found it was fighting a tide of declining admissions and carrying an operating loss with a five-year total of $165 million. Then in 2009, Moody's Investors Service downgraded Lenox Hill's credit rating to outlook "negative" and projected a possible $20 million operating loss for the hospital by the end of 2012. Shortly thereafter, the organization responded by putting out an RFP for potential partners.

"We had no presence in Manhattan, and we felt it was important to be there. So this was a very good opportunity from a strategy standpoint," Shapiro says. "But we also had to look at the organization to be sure we were compatible culturally, and we do monthly post-acquisition check-ins."

While the Lenox Hill merger allowed North Shore-LIJ to expand its market a strategic alliance with Hackensack (N.J.) University Health Network announced in March should serve to strengthen the credit standings of both organizations. But the outcome will depend on the programs generated by the endeavor through Hackensack University Medical Center, which is a leading tertiary provider that has created the clinical strength and depth of services that has allowed it to maintain a dominant (28.8%) market share in its service area, according to Moody's.

The alliance will allow both organizations to create joint programs and initiatives, but each entity stays independent and continues to be responsible for its own assets, operations, and liabilities. The as yet undefined programs will be jointly developed and the funding and operational management determined by a joint operating committee.

The alliance of North Shore-LIJ and HackensackUMC is an opportunity created by the current healthcare and economic environment, but HackensackUMC is also at the forefront of trying some unique capital lending transactions. In a recent transaction, Hackensack University Health Network, the parent company of HackensackUMC, created a joint venture with Dallas-based LHP Hospital Group, Inc., a for-profit company that forms joint ventures to own, operate, and manage acute care hospitals with not-for-profit partners. LHP served as an equity partner for the opening of two Hackensack-UMC hospitals: HackensackUMC at Pascack Valley in Westwood, N.J. and HackensackUMC Mountainside Hospital in Montclair, N.J.

In late 2007 and early 2008, HackensackUMC purchased a hospital's assets out of bankruptcy and negotiated a joint venture arrangement with LHP to reopen and refit the community hospital The agreement transitioned the former not-for-profit Pascack Valley Hospital into a for-profit one, and not-for-profit HackensackUMC holds a 35% interest in the facility and operations.

The HackensackUMC and LHP joint venture is written so HackensackUMC didn't need to invest any additional capital into the hospital; however, LHP is expected to contribute approximately $95 million, according to an LHP statement. Additionally, LHP and Hackensack partnered in a similar structure to take over the license for 365-bed Mountainside Hospital, a move that was approved by the state's attorney general in June.

"There's no high-quality organization out there that isn't also financially strong; to get there you need to grow. We started on these transactions over five years ago and the regulatory process for the first initiative took a long time; the second hospital took just four months," says Robert L. Glenning, executive vice president and CFO at HackensackUMC. "We looked at our situation and did an honest assessment of how we could achieve multiple and sometimes competing strategic goals for capital. We decided we needed to find a way to address how we could take on a new hospital without jeopardizing ourselves financially or losing sight of our mission."

Glenning says that by engaging LHP as a partner to help manage and operate these hospitals, HackensackUMC could keep its pocketbook out of risk and still align with the organizations.

"It was $190 million to just purchase HackensackUMC Mountainside; if we did that by ourselves that would've significantly impacted HackensackUMC's credit rating, and it would've only developed one community hospital. But our larger goal is to bring some stability to the region by being a well-run network that our community can depend on," he adds.

The HackensackUMC capital approach may be unique, but it's also on point with the industry trend toward consolidation. In the January HealthLeaders Media Intelligence Report M&A: Hospitals Take Control, 80% of healthcare leaders said they will have an M&A deal under way or will explore one in the next 12–18 months, and the prevailing reason was to shore up existing geographic markets. Also, HackensackUMC's use of private equity funds is in keeping with the widely reported slow and steady uptick in use of these firms in the healthcare space, though not all financial leaders see it as the right opportunity to pursue.

"Venture capitalists need to generate a substantial return," says Richard Magenheimer, CFO at Inova Health System in Falls Church, Va. Inova is a not-for-profit system that serves more than 2 million people per year and consists of five hospitals with more than 1,700 licensed beds and 16,000 employees. "Venture capital is probably one of the most expensive forms of financing; it can easily be 15%–20%. That's a very expensive form of financing, especially when you're talking about a bricks-and-mortar hospital. Plus, the venture capital hurdles can vary depending on the project; it can be very difficult to structure something with venture capital that works from a compliance standpoint."

In 2010, Inova Fairfax Hospital broke ground on the first phase of an $850 million campus improvement project. The three-phase, multiyear project is intended to upgrade the campus to meet increasing demand for services—particularly for senior patients and obstetrics patients—and continued population growth in the hospital's catchment area. It also took years to get under way; though ready to go to contract in 2009, and costing an estimated $1 billion, the project was deferred following the market downturn in 2008–2009.

"Following the capital markets' disruption in the fall of 2008, we determined we could not move forward with construction until we had confidence that we could access public debt markets as part of our financing plans," says Magenheimer. "In order to mitigate the financial risk of the project, we broke it down into three distinct phases and contracted separately for each phase. We had set aside $200 million in a special portfolio as a capital contribution toward the project. When the market meltdown hit, the portfolio retained its value."

To finance phase one of the project, a $225 million patient tower, Inova borrowed $190 million in the public debt markets. It's a financial approach Magenheimer says serves the organization well. "Generally, the public markets still tend to provide the best pricing compared to private financing. We have one bond issued as a private placement with TD Bank—and it was competitively bid—but in most instances our best pricing is in the public markets," he says.

In August, Inova completed a $400 million offering in the capital markets. Magenheimer says $300 million of that financing will go toward phase two of the south patient tower and a portion of phase three—a renovation of the existing campus slated for 2015.

"We are confident that Inova will have the necessary capital to complete all three phrases of the project. There's always a balance needed between borrowing at competitive rates and retaining some internal liquidity," he says. "One should first look at internally generated funds for project financing. However, we think the public markets in general will offer the most competitive cost of capital, provided an organization has to have the financial performance to access those markets," Magenheimer notes.

Though Shapiro and Magenheimer agree that commercial lenders tend to be better for short-term capital rather than long-term capital, such institutions are, nevertheless, viable lenders. Banks generally lend by directly purchasing tax-exempt debt with fixed or variable interest rates. The American Recovery and Reinvestment Act of 2009 widened the definition of bank-qualified debt, which encouraged approximately $70 billion of direct tax-exempt loans in 2009 and 2010, according to The Bond Buyer.

Although the temporary debt provisions under the ARRA ended with 2010, banks have continued to actively lend to healthcare organizations. "We're seeing a lot more activity, but the conversations are different," says John Hesselmann, specialized industries executive for Bank of America's Global Commercial Banking.

With borrowing, generally, the overall interest rate on direct bank loans is competitive when compared to public debt issuance levels. The interest rate varies with the borrower's creditworthiness and the credit spread. Hospitals have become more strategic about their borrowing approach, Hesselmann says, with more willingness to access lower-cost medium-term financing options, as opposed to longer-term borrowing for short term-needs.

In addition, cost savings from focusing on efficiency gains in the revenue cycle are getting more attention than ever. "Where we are having more conversations is as it relates to counseling clients on creating efficiency through treasury solutions, going end-to-end through the payment mechanism, and accelerating the receipt of cash and optimizing the back end by using the products that do that," Hesselmann says.

To gain savings within their true financial picture, hospitals are focusing on improvement in the revenue cycle, striving to reconcile their claims data with their reimbursement payment dollars to the highest automated degree possible, he adds.

Deciding which capital lending approach to take is individual to the organization and the project, says Glenning.

"There's no system that's grown significantly without a trail of tears in the learning process," says Glenning. "For those who want to avoid that, my best advice is to figure out what's important to your organization's core mission. For us it was our academic and tertiary service. … Investing in a community hospital was a way to ensure that goal, and this joint venture was the way to do it."


Reprint HLR1012-8


This article appears in the October 2012 issue of HealthLeaders magazine.

Pages

Karen Minich-Pourshadi is a Senior Editor with HealthLeaders Media.
Twitter

Tagged Under:


Get the latest on healthcare leadership in your inbox.