Covenant Crisis

For organizations that used derivative or swap transactions to fix rates synthetically, the value of those swaps has dropped significantly, causing senior executives to wonder "whether they are going to get caught up in defaults that they thought they would never ever have gotten close to," says Sussman. "They can be distracted from day-to-day operations."

But operations can't be neglected for long. In fact, it's the way many of these hospitals are going to be able to extricate themselves from this mess.

A smaller system's lesson
When John Nilsson was hired as the interim CFO for Community Medical Center Healthcare System in Scranton, PA, through Nashville-based hospital consulting firm Intensive Resource Group, the system was in the middle of a merger with neighboring Moses Taylor Hospital—and a financial crisis based on patient throughput issues, length-of-stay problems, and overstaffing. Though CMC's financial crisis had nothing to do with external forces, they were facing the same problems many larger systems are facing today with unhappy debtholders ready to force changes.

"When John came, it was the beginning of the fiscal year [2006], and we were on the threshold of defaulting on our covenants," says Jeff Jacobson, CHS's chairman of the board. "We weren't in desperate trouble, but things were getting worse."

CMC had lost $9.5 million in 2006 and more than $20 million in the course of the prior six years. Nilsson focused exclusively on operations, including a real need to cut overhead and hold onto its high quality scores at the same time. That required headcount cuts, but also involved revenue enhancement strategies. Nilsson canceled several disadvantageous managed care contracts, choosing to forgo the negative-margin business they brought if the contracts couldn't be renegotiated. Nilsson got rid of large payers that are accessing contracts through a network of negotiating third parties and negotiated carveouts for certain high-cost medical implants.

"When a hospital is losing significant dollars, filling a bed is not always the most financially sound thing to do," he says. "We were better off without the payer or without that contract." Through those and other operational improvements, CMC achieved improvement of about $13 million in the first year. It was able to accelerate AR from slightly over 60 days to 42 days without writeoffs.

Perhaps most important, CMC has no problems with its debt structure. "We were really good until the markets dropped and our underlying investments took a hit," says Nilsson. But thanks to operational improvements, he says, "we are still above our covenants."

Now interim president and CEO, Nilsson is helping to prepare for the transition to a permanent CEO, the search for whom Jacobson says will begin in about three months.

A change in thinking
For hospitals and health systems affected by debt covenant problems to move forward, says Sussman, they have to revisit all of the assumptions they have in place in their current strategic plan.

"Financial plans have to reduce their reliance on external capital and increase its focus on generating capital internally through operations and cash flow," he says. "That's the biggest change in longer-term financial planning."