Before the economic bust
“Before the credit crisis, you had very active capital markets with both strong debt and equity markets and a strong acquisition market. There was a wide range of financing options available to non-profit and municipal hospitals, and even sub-investment grade hospitals could get an acceptable issuance rating to access tax-exempt bond financing, reducing the cost of debt,” says Mr. Passarelli.
During this lending heyday, hospitals were considered sound investments, so finding bond buyers or lenders was fairly easy for hospitals that wished to undertake capital projects, says Mr. Passarelli. After the economic crash in late 2008, however, accessing capital became much more difficult.
“The subprime mortgage meltdown created shockwaves throughout the financial markets. Bond insurers like MBIA and AMBAC became distressed and their guarantees were no longer available for non-profit hospitals,” says Mr. Passarelli. “Borrowing costs for auction rate securities increased to, in some cases, 20 percent, and to make matters worse, commercial lenders suffered losses, drying up letters and lines of credit.”
Current market characteristics
Today, the capital markets appear to be partially recovering, but hospitals and health systems looking for capital, particularly distressed and sub investment-grade systems, will find a decidedly different market than the one of two years ago.
“Many large commercial finance companies have failed or withdrawn from the market, letters of credit are mostly unavailable and assurances are gone,” says Mr. Passarelli. “Ratings agencies are taking a harder look at issuers. Fundamentals of the borrower are now much more important than credit enhancements.”
Hospitals, which have suffered from investment losses and decreased elective visits, are no longer seen as safe-haven investments, says Mr. Passarelli. As a result, lenders are requiring more security — such as debt-service reserves and restrictions on rolling over or renewing debt — to obtain funds, and the cost to hospitals of acquiring capital has increased. Additionally, investors want greater transparency from and more frequent interactions with borrowing organizations, says Mr. Passarelli.
What it means for hospitals
Because of the increased need for transparency and interactions with lenders, it has become more important than ever for hospitals to have their “financial house in order and solid financial reporting,” says Mr. Passarelli.
Hospitals planning to obtain capital funding through debt financing should ensure their CFOs have experience in dealing with sources of capital. “Compared to other industries, hospitals have slower A/R cycles, so the CFO needs to be able to explain that to lenders,” says Mr. Passarelli. “He or she also needs to be able to tell the story of the hospital. Just being a hospital is no longer enough to be considered a safe-haven investment. Now you need the story of the hospital’s position in the market, why the hospital has staying power and how that translates to profitability and liquidity-generating capacity. “
Hospitals with poor market share and financial problems, such as a poor collections track record, can expect a harder road ahead. “While most hospitals did a good job of preserving cash and cutting expenses last year, hospitals that require additional reductions to stay solvent in 2010 face greater challenges in implementing a second-round of cuts,” he says.
Obtaining capital will be even more difficult for distressed hospitals, and there will be a growing division of “have and have-not” hospitals in the coming months, Mr. Passarelli says. Strong hospitals will prosper and weaker ones will have to make tough decisions about obtaining capital at higher costs to preserve market share or possibly affiliating with another hospital or system. “Those [hospitals] with a strong vision of the future that can continue to make investments in income-producing assets will be rewarded down the road,” he says.
Contact Shane Passarelli at spassarelli@hfgusa.com.
