March 2014

Healthcare ABL — An Ever-Changing Industry Landscape

Two Wells Fargo Capital Finance Healthcare Finance insiders explain why lending to the massive healthcare sector presents extraordinary opportunity and risk, and is best managed by an experienced team that is not only knowledgeable about the industry, but also an active industry participant.

Tracy Maziek,  Senior Managing Director, Wells Fargo Capital Finance

Tracy Maziek,
Senior Managing Director,
Wells Fargo Capital Finance

Michael Janda,  Managing Director, Wells Fargo Capital Finance

Michael Janda,
Managing Director,
Wells Fargo Capital Finance

Many financial institutions, including banks and independent finance companies practicing outside of the healthcare industry, view healthcare as a fast-growing field ripe with opportunities. Standard practice for organizations positioning themselves to take advantage of these opportunities is to establish a market presence with little regard to industry trends, monitoring know-how and infrastructure, or even rudimentary knowledge of the credit profile of a typical healthcare company. “How hard can it be?” may be a common phrase uttered by those fairly new to the industry. And after all, aren’t most of these high credit quality receivables due from creditworthy payment sources like the government and large insurance companies?

While we can all agree that lending on healthcare receivables and other related assets doesn’t require the technical know-how of landing a man on the moon, detailed investigation of industry nuances and trends will reveal that asset-based lending to the healthcare industry is not an area to dabble in and definitely not for the faint of heart. Successful execution and long-term financial success requires resources, commitment, fortitude and know-how.

Changing Healthcare Industry Dynamics

We are, perhaps, experiencing the most challenging and fluid period for the healthcare industry since the introduction of Medicare in 1966. The Affordable Care Act, aging baby boomers, governmental budgetary pressure, improved technology and societal trends are but a few of the developments that have made this dynamic industry even more dynamic. The amalgamations of influential factors are resulting in a slew of new business models and approaches, threats and opportunities for the industry.

The hospital sector, for instance, is experiencing dramatic consolidation. Not-for-profits are merging, for-profits are merging and for-profits are buying not-for profits. Some systems are forming Accountable Care Organizations (ACOs). Others are buying physician groups. Sorting out what it all means, how consumers/patients will be affected, who wins and who loses and what models are sustainable is almost impossible to discern without knowledge and experience through various regulatory and economic cycles.

Hospitals are not alone in terms of changing sector dynamics or consolidation. Other sectors such as physician groups, skilled nursing, home health, Durable Medical Equipment (DME), imaging and many other ancillary services are all feeling the pressure to adjust to a changing business climate.
If one can grasp the various sector M&A dynamics, he or she must also understand the regulatory and reimbursement environment. It’s no secret that governmental payor sources (Medicare and Medicaid) are under tremendous cost containment pressure. The aging population is driving demand while the Centers for Medicare Services (CMS) are cutting reimbursement, sometimes aggressively, to various sectors.

Reimbursement Fraud Campaign

Another little-known, regulatory-related development to those new to healthcare is CMS’ massive reimbursement audit and fraud investigation campaign. Sometimes these investigations come under the purview of the Office of the Inspector General (OIG), while at other times, CMS hires outside consulting firms to investigate, often randomly, historical billing of claims by a healthcare provider. These firms typically are compensated in direct proportion to the amount of suspected overbilling uncovered during the examination. The auditors often extrapolate a small reviewed sample across a wide swath of billings with the maximum penalties tripling the liability owed to Uncle Sam.

Someone new to financing healthcare companies may relegate these industry risks to those attempting to beat the system or committing fraud. However, frauds comprise only a small portion of the alleged overpayments. Documentation requirements have become increasingly complex with constantly changing rules and requirements that are often subject to ambiguous interpretation. Non-compliance might be unintentional due to legitimate disagreement regarding what the requirements might be, the result of substandard operations or controls, or even innocent errors. No matter the cause, these can be severely detrimental to companies with outcomes ranging from mere managerial distraction to extended litigation defense, settlements and even outright business failure. Did we mention these claims can prime the lender’s collateral and/or directly offset other valid receivables?

Accurate Valuation

After clearing the business model, regulatory and reimbursement risks, lenders must then understand how to actually value healthcare claims and other assets. This topic alone could comprise several chapters of a book. Oftentimes, this process is not clear-cut being more akin to art than science. In addition to potential offset rights mentioned above, there are contractual allowances to account for and other items that reduce value from the amount billed. The difference between the gross amount billed and the amount expected to be collected ranges widely from sector to sector and company to company. Factors that affect ultimate collection amounts also vary by provider type, ultimate payor, billing practices, systems and even the provider’s business or patient location/region. For example, it is not uncommon for one provider to have low single-digit contractual and non-contractual dilution while another in the same sector, and even the same state, to have upwards of 20% or even 30%. Some sectors commonly exhibit net payment rates in the high teens (yes — 80% dilution). Accurate valuation of accounts receivable collateral must be examined carefully and in the context of the specific business, both initially and on an ongoing basis.

Business Operations

Business operations, including the back office and clinical outcomes, also drive the success of the business and affect collateral value. For example, if a provider has inadequate systems to ensure that its clinical staff is properly credentialed (and current), there is a risk that any services provided by such staff is not reimbursable and/or subject to recoupment by the payor. Quality of care is obviously an essential element when providing healthcare, but payor sources are beginning to compensate providers for improved quality outcomes while reducing compensation (i.e., penalizing) for negative results. There are various surveys and other data sources publically available that are indicators of whether a provider offers a high quality of care or has a history of life-threatening deficiencies that represent business and potential collateral risk.

Billing and collection systems and performance not only impact collections and cash-flow, but serious deficiencies can also lead to Medicare fraud and abuse investigations as well as a host of other regulatory issues. There are many examples where such problems have led to involuntary cessation of certain healthcare companies’ businesses. Billing is complex and the supporting documentation required prior to billing differs by sector. A laboratory business, for example, might only need a doctor’s order form to obtain reimbursement, while a Medicare home health company (under new rules) must have documentation signed by a physician that the patient has had a face-to-face meeting with the physician during the prescribed time period and the physician has personally observed that the patient meets the regulatory qualifications of being “home bound.”


Financial reporting, in the context of changing reimbursement, is also an important factor to consider as it varies from company to company. For example, recent Medicare rule changes that mandated a competitive bidding system have resulted in material reductions in gross margin for certain DME and medical supply companies. A company must have financial reporting systems in place to understand the impact the cuts will have on cash-flow and whether it even makes sense for them to continue that part of the business. Many providers “wing it” and don’t really know the impact to their business until they run out of cash.

When considering all the factors and risks mentioned above, the importance of having experienced and qualified healthcare managers cannot be overstated. Management teams that are flexible and creative enough to reposition their business as necessary are more likely to survive in the current changing healthcare environment.

Broad Sector Knowledge

For all the reasons noted above, as well as many others, the best-positioned healthcare ABL lenders are involved in a wide range of sectors across the healthcare industry, living and breathing the business on a daily basis. The continually changing landscape practically demands this constant vigilance. This is the vantage point where risk and opportunity are identified as developments affecting one sector, and are often predictors of impact on another sector. A dedicated lending team managing a broad healthcare portfolio, concentrating and utilizing its healthcare industry knowledge and experience allows a lender to better serve the healthcare borrower while best managing the credit risk.

The healthcare industry includes a wide range of players, each with unique needs and assets suitable for ABL financing. The industry can be viewed as having three broad sectors, each with various sub-sectors including: healthcare service providers, life science companies and ancillary service companies. An understanding of how the various sectors fit together is necessary for a lender to assess changing risk dynamics. The ability to identify nuances in the business and collateral that represent unacceptable risk, the need to tighten monitoring or controls and the need to identify likely exit scenarios or opportunities to safely “go outside the box” are essential to aid the borrower.

Lending to this huge complex sector presents extraordinary opportunity and extraordinary risk and is best managed by an experienced team that is not only knowledgeable about the industry, but also as an active participant. An institution planning to enter into the healthcare ABL business and succeeding should consider making the substantial investment of building a dedicated healthcare finance team and infrastructure, or alternatively partnering up with an experienced healthcare ABL lender. In this continually changing healthcare industry landscape, the only solid factor a healthcare borrower may be able to depend upon is the knowledge and experience of its lender to help navigate this shifting new world.

Tracy Maziek is senior managing director, Healthcare Finance, Wells Fargo Capital Finance; and Michael Janda is managing director, Healthcare Finance, Wells Fargo Capital Finance.