Hospital Trends for Accessing and Unlocking Capital

s the industry confronts changes in payment, greater demands for services, and shifting competitive dynamics due to healthcare reform and heightened merger and acquisition (M&A) activity, hospitals and health systems face many unknowns as they formulate their capital strategies for the near future. This HFMA Executive Roundtable, sponsored by KeyBank, focuses on need for capital, processes to ensure adequate levels of liquidity, and strategies to support access to low-cost financing.

What does the capital planning process look like at your organization? Is it changing in any way post reform?

Clay Ashdown: Our capital planning process has become increasingly transparent, rigorous, and forward-thinking. We have two groups that oversee capital requests: the capital planning committee and the project review committee. The capital planning committee, which consists of our senior executives as well as leadership from our various operating entities, evaluates major project proposals that are generally greater than $5 million. The committee provides a forum for fellow operators and system leaders to pose questions and challenge assumptions. The committee then scores the projects, which is one of the key determinants of whether a project gets included in the system's five-year plan. We don't simply make capital decisions based on what can be "afforded." Even if capital is available, we are being increasingly thoughtful about not investing in outdated business models. As we undergo healthcare reform, we've realized that too many financial decisions in the industry are based on stale assumptions. Since most capital decisions have ramifications for decades, we strive to be pragmatic about how and when those investments are made.

Our project review committee gives us another level of scrutiny on large projects, but also provides greater agility for sub-$5 million capital decisions with shorter time frames. The project review committee utilizes more granular investigation that's informed by clinical practice. This cross-functional group is comprised of leaders from our hospitals, employed medical group, health plan, and corporate functions (including significant clinical representation). It is chaired by our healthcare transformation leader, and it strives to review and vet projects based on their ability to succeed in a new healthcare environment. Historical metrics are weighed far less heavily than future criteria. This group will increasingly mine our clinical data to help make recommendations that are closely tied to what will be transpiring in our facilities and communities.

Irene Richardson: Every year, our executives and department leaders present three-year capital-budget requests-for patient care, emergency needs, physician requests, new services, and regulatory needs-and then we prioritize. We strive to keep the age of our plant low, which means we're constantly reinvesting in our facility.

For Sweetwater, we would like our capital budget to be equal to the amount of depreciation for that year, but since we fund our capital budget from our operational gain, the capital budget is typically less than the amount of depreciation. This practice of funding our capital budget from operations means we don't need to touch our cash reserves. We believe in never exceeding our capital budget. Our CFO and CEO review the capital requests and forward their approved choices to the finance committee and audit committee. Once these committees approve a proposal, it is forwarded to the board.

The key for us in staying ready to address shifting needs in the industry is always staying within our capital budget-even if that means adjusting expenditures as the year unfolds. Although we have a good payer mix and excellent liquidity, we have to remain vigilant to ensure we steer clear of any potential pitfalls that may come with shifts in volume or payment change.

<person>Mike Lukaszewski: When it comes to funding clinical equipment and technology, our process is fairly straightforward. We have assembled clinical teams that include physicians and administrative leaders that meet regularly throughout the year to assess the current state of equipment and technology and to propose replacements or newer technologies. Annually, they present a five-year forecast of their needs for vetting by the C-suite. As for information technologies, we perform a similar annual assessment, focusing on needed upgrades to existing systems and technologies but more recently concentrating on emerging options that can enhance our ability to improve quality and patient satisfaction or to position us for successful population management.

Where are the strongest needs for capital originating, and what are some plans to help fund them?

Melissa Whitmer: It's safe to say that real estate continues to be the dominant need. Real estate comprises as much as 75 percent of our finance activity in 2013. In particular, we are seeing a lot of demand for medical offices as more health systems acquire medical practices and employ physicians. Hospitals are seeking employment to improve alignment with community physicians, as cross-continuum care strategies grow increasingly important under value-based payment models. Physicians also are becoming more receptive to employment as they face increasing regulatory complexities, desire greater work-life balance, and seek to minimize business-management burdens and risk exposure. Because of this trend toward employment, hospitals are building, expanding, or renovating medical office space.

Counterbalancing this trend is the fact that many hospitals are looking at the capital-intensive nature of building/owning these facilities and the annual operating costs and deciding that real estate is no longer central to their mission-even as the demand for outpatient services increases. So they're working with third-party developers to design facilities-but subsequently leasing the finished buildings and taking them off of their balance sheet. For many health systems, that's a sound strategy.

The nature of hospitals is changing as well. That's why many hospitals have converted from semiprivate rooms to private rooms.

Of course, we've also seen a healthy demand for capital to help health systems implement electronic medical records, but most of those efforts have been completed. The upgrades and updates to systems are primarily being funded by cash budgets and working capital from operations, not capital budgets.

Richardson: For Sweetwater, real estate has been a major focus for our capital investments for some time. We have a broad footprint and have been aggressively acquiring medical practices to improve our physician alignment and operating efficiencies-but we have had nowhere to put them. We literally couldn't recruit more physicians. For instance, right now, we have a $19 million capital project underway to consolidate our physicians from three different locations into a single facility.

We are in a sparsely populated region and our strategy is to become a regional referral center, so we're investing in expanding our capacity and building a new cancer center. Naturally, this strategy also involves equipment, so those needs factor into our capital plans as well.

Cass Wisniewski: Our capital needs have been fairly balanced among real estate, medical equipment, and IT infrastructure.

In 2010, we went to the bond market and borrowed $35 million for renovations to our ED and our lobby area, which we completed in the spring of 2012. But we've also used a private bond placement of $5 million to build out a magnetic resonance imaging facility. And last year, we completed about $22 million in bonds, largely to finance the acquisition and deployment of our clinical information systems and revenue cycle's registration and billing system. We recoup about 25 percent of the investment through meaningful use incentives.

Ashdown: We 're not necessarily expanding significantly, but we have a growing population, so our strategic focus lies in meeting the needs of our ever-changing communities. That means a commitment to outpatient facilities, wellness initiatives, technology, and home health, while obviously not neglecting our existing infrastructure. We're also building more multispecialty clinics to create better continuity of care. We're endeavoring to bring our primary care physicians out into the communities and enhance collaboration between them and our specialists. Balancing access with efficiency or scale is a key strategic focus.

Lukaszewski: We've invested a lot of money in bricks and mortar over the past decade, including two new hospitals in 2005 and an 11-story pediatric and adult bed tower in 2012. These investments have expanded our capacity and enhanced our competitive position. We generally finance about 70 percent of a facility's total cost and then pay for the rest with cash from operations. As for our medical office buildings, we pay for those in cash. Our current skew toward bricks and mortar will ratchet down to about 30 percent of the capital budget going forward, with the balance targeted for technology and clinical equipment. We've recently completed a full EMR (electronic medical record) implementation with CPOE (computerized provider order entry), and we still have more investments to make as we expand deployment of that technology to our primary care and specialty physician practices. We've spent more than $40 million and expect to spend another $20 million on EMR systems in the next five years. That's offset by about $20 million in meaningful use incentives.

How does your organization view liquidity?

Ashdown: Liquidity is something that we monitor very closely. Balancing liquidity, leverage, and performance is paramount, and we have specific guiding principles that dictate our targets in all of these areas. We are extremely diligent in our efforts to honor our commitments to rating agencies and bondholders, so we strive to generate thoughtful and achievable plans and then execute on those plans. We also communicate frequently with ratings analysts and investors to ensure they are aware of our key strategies, and that surprises are kept to a minimum. We're fortunate in our ability to fund a significant portion of our capital-budget needs through operations, but we strategically tap the debt markets to retain balance-sheet flexibility and support our capital plans. Our ability to generate funds through the capital markets is not something we take for granted, so thoughtful ratio and market analysis, coupled with open communication with analysts and investors, is a key component of our financial planning activities.

Richardson: No question: Cash is king for our health system and in our industry. In the past few years, it's been one of the points of emphasis, financially speaking. When we remodeled a major facility in 2006, we relied on a bank-issued letter of credit, which was a very helpful partnering. The covenant required 75 days cash on hand. We've used that requirement as a starting point and steadily increased cash position, eventually reaching 225 days cash on hand. Our approach is simply to collect more cash than we spend in expenses each month. If our bottom line is below budget, then we simply adjust our capital purchases and investments. With greater reserves, we now have the flexibility to react to changes that are on the horizon. Our reserves will also help to weather the changing landscape and make investments needed to stay competitive.

Lukaszewski: We're a not-for-profit system, so our cash comes through operations, philanthropy, and tax-exempt borrowing. Fortunately, we haven't experienced a capital-access problem-we have a strong credit rating and longstanding relationships with investment banks. We try to keep our debt-to-capital ratio at about 33 to 35 percent and, with some healthy EBITDA and a moderately conservative investment portfolio, we've made our targets. We have a variety of variable-rate and fixed instruments. About 55 percent are variable, and that structure provides us with very attractive shortterm savings. We have about 250 to 300 days of cash on hand, so we can exit variable arrangements at any time if we foresee notable rate spikes.

Wisniewski: As a municipal hospital, we don't have a corporate parent to bail us out if liquidity becomes problematic. So we have to be extra careful in managing our cash. Our bondholders have covenants requiring 50 days of cash on hand, and we're meeting that. However, we do have some concerns as we switch to a new billing system and ICD-10 takes hold. There is little doubt that the conversion and shift in documentation and coding will impact our accounts receivable- at least for a period of time. We have to pay a lot of attention to cash flow; it's critical because we don't have the luxury of establishing a line of credit with a bank due to our municipal ownership.

Whitmer: We closely monitor the liquidity of our borrowers and like to see 75 to 100 days cash on hand for community hospitals and a minimum of 175 days for larger health systems. We're seeing these liquidity thresholds being met or exceeded by many providers, particularly as hospitals prepare for ICD-10 going into effect October 2014, which could have a negative impact on their cash flow. Fortunately, we're still in a low interest rate environment, and capital is available, so it's a great opportunity for hospitals to borrow and preserve their cash.

What do you perceive as the greatest threats to stable capital management?

Richardson: For our organization, which funds capital projects from operations, the pitfalls come from anything that threatens liquidity and cash flow. And today, we see several key areas of concern: Medicare sequestration, value-based purchasing, changes in payer coverage due to the Affordable Care Act, the rising costs of equipment and supplies, RAC audits, and réadmissions challenges. The solution is to invest in capturing revenue, ensuring appropriate reimbursement through clean billing cycles, and minimizing expenses. If we can perform these functions well, then we'll have most of the capital we need from year to year.

Whitmer: I think success going forward hinges a great deal on a hospital's ability to sustain patient volumes. What's the strategy for affiliations, for instance? And when a hospital expands, can it fill that capacity? So revenue strategy really becomes a point of emphasis. Also important will be knowing where your strategy fits as payment increasingly focuses on outcomes and quality delivered across care settings. *

PARTICIPANTS IN THIS HFMA EXECUTIVE ROUNDTABLE

Clay Ashdown is assistant vice president ol linancial planning and capital investment lor Intermountain Healthcare, Salt Lake City

Mike Lukaszewski is senior vice president and CFO lor Baptist Health System, Jacksonville, Fla.

Irene Richardson is CFO lor Memorial Hospital ol Sweetwater, Rock Springs, Wyo.

Melissa Whitmer is senior vice president ol healthcare banking, KeyBank, Denver

Cass Wisniewski is senior vice president and CFO ol Hurley Medical Center, Clarkston, Mich.