Dan Chapa, President, Healthcare Finance Group

Mike Gervais, Chief Operating Officer & President, Gemino Healthcare Finance

Jennifer Sheasgreen, Managing Director, Doral Healthcare Finance

ABF Journal asked the leaders of three healthcare finance companies to talk about their marketplace. Dan Chapa is president of Healthcare Finance Group, Mike Gervais is chief operating officer and president of Gemino Healthcare Finance, and Jennifer Sheasgreen is managing director of Doral Healthcare Finance.

“As an industry, I’d say healthcare held up better than most during the economic downturn,” says Chapa. “We were faced with the same issues as any other industry: access to capital, difficulty raising debt and more expensive cost of funds. The debt that was available went to the more financially secure healthcare providers. But even for lenders that were doing well, we found ourselves in a position where we couldn’t lend as much money as we wanted.”

As financial institutions lending to specialty finance companies exited the market, limited their loan portfolios and reduced assets on their balance sheets, several specialty lenders went out of business. On the provider side, healthcare companies suffered revenue loss and patient decline. “People put off elective surgeries and personal healthcare if they could,” Gervais explains. “Hospitals, homecare companies and skilled nursing felt the decline.”

“I think the retraction in our industry validated the fact that healthcare is not as recession-proof as we thought,” adds Sheasgreen. A 15-year industry veteran, Sheasgreen and her partners opened Doral Healthcare Finance in January 2011. “I can comment from the perspective of someone trying to raise capital to get back in the business and searching for a company committed to lending to the healthcare space,” she says. “A lot of banks were shrinking assets, eliminating specialty finance divisions and shifting back to core product offerings.”

Now the industry feels more positive, but Chapa says they are not yet seeing the pick up they’d like at his company. Gervais has noticed lending getting a lot more competitive over the last six months as banks and financial institutions begin lending again, and he predicts that trend will continue over the next 12 months. Sheasgreen says Doral’s deal flow is increasing, and yields are favorable.

Are Banks Back?

Now that the large financial institutions have gotten their houses in order and are ready to deploy capital, will they head back into healthcare? Accounting for 17% of the U.S. gross national product, the opportunities in healthcare are appealing. Baby Boomers represent a huge demographic, as they enter their sixties and rely on advanced medical technologies and solutions to keep them healthy and active. That should be good for revenues.

Gervais says federal healthcare coverage and reform are hot topics that make people — especially risk-averse large financial institutions — nervous about lending in the healthcare industry, but they are seeking ways to deploy more capital. From his perspective as CEO, he’s experienced this in two ways: “First, there are more banks and financial institutions calling on us, looking to provide warehouse facilities between $50 million and $100 million so that we can lend that money in the marketplace. Specialty lenders are re-entering the market slowly, but I expect to see activity increase over the next 12 to 18 months. This will offer more non-bank lending options for the provider. Second, the banks are back and need to place capital. I see small and regional banks coming back to lend to providers operating within their footprint. Larger banks are coming back, too, so the competitive landscape is definitely increasing.”

Chapa says banks and financial institutions are pursuing healthcare aggressively: “Our industry is very attractive right now: As healthcare providers have to demonstrate increasing evidence of their quality of service, they will need to expand and improve IT systems. We’re beginning to see more and more RAC reviews [Recovery Audit Contractors] coming in and looking for errors. These contractors are incented by the government to find errors in payment that can help recoup funds, and this increases the pressure to improve billing and collection practices. The pressure to operate more efficiently will cause consolidation among providers, thereby creating event-driven opportunities for lending. Then you factor in the demographics and increasing need for healthcare. All of these conditions and stress points create opportunity for financing and the need for capital in the industry.”

But there are pitfalls to lending in this market. Without the proper expertise and industry savvy, it’s easy to put a foot off the path to profitability and long term success. “Because healthcare is such a big part of our economy, it’s pretty normal for a company that doesn’t have healthcare expertise to consider targeting it,” remarks Gervais. “Some people get spooked because of the reimbursement risk, so lack of the right expertise is definitely a barrier to entry.”

“A lack of knowledge about the healthcare market is probably the primary reason potential entrants stay away,” Sheasgreen confirms. “However, trying to capture a piece of the aging Baby Boomer market is a very hot topic. Over the past year and a half, I’ve had the opportunity to talk to people at several large institutions with a strong desire to deploy capital into this space, but actually pulling the trigger and committing to lend is a different story.”

“If you are going to lend in this industry, it’s more important than ever to have good healthcare expertise,” declares Chapa. “It’s a very attractive industry, but you have to have the expertise to do it well — and do it well over time — if you want to be profitable.”

“If you don’t have that talent in your workforce, you’ll have to hire it,” states Gervais. “At our organization, we have collectively about 85 years of healthcare experience, and that definitely gives us an edge.”

For those companies venturing into the space, Sheasgreen sees promising opportunities. “I find that there are very few asset-based funders that are actively lending into our target sector right now. I think there will be continued interest not only in asset-based funding but also in factoring as the new institutions figure out how to best deploy capital in the healthcare space. This is a huge market that is going to get even bigger as the boomers age, and companies are going to want to capitalize on some of that.”

Risky Business?

Medicare, Medicaid and third-party insurance reimbursements add considerable risk to lenders that don’t understand the specific reimbursement methodology and collateral evaluation. “The key to lending in this sector is having the knowledge to understand what you are lending against,” insists Sheasgreen. “You also need the expertise and flexibility to adapt to the changes going on in healthcare reform. Experienced lenders will remember the sweeping changes in regard to payment systems and reimbursement reductions that resulted from the Balanced Budget Act of 1997. PPS [Prospective Payment Systems] dramatically changed the way providers were paid.”

“Reimbursements are always going to be our greatest risk,” seconds Gervais. “If the government comes in with a cut in your sector, you have to know how the provider will adapt. Can he reduce costs, improve efficiency and continue to perform to stay in covenant compliance with the loan? That’s the biggest impact of reimbursement risk. If we’ve done a cash-flow term enterprise-value loan, we’re doing a multiple of EBITDA. So if there’s heavy reimbursement pressure, the provider may not have the cash flow to pay that term loan. In theory, our accounts receivable piece is fully collateralized, because the receivables back our line of credit. But with term financing, when the reimbursement risk affects a certain industry, there could be exposure to a senior lender.”

“State budgetary problems will cause more cutbacks,” Chapa adds. “Already we are seeing delays in paying providers for services already delivered, and that puts pressure on cash flow. Some states are more problematic than others. The combination of the downturn, budget deficits and healthcare reform puts pressure across the board to cut back on reimbursements.”

“There will be increased focus on state Medicaid programs, and it will become a predominant theme in our industry,” agrees Sheasgreen. “There are several states, such as California, Texas and Illinois, that we will review with increased scrutiny. It doesn’t mean we aren’t going to lend there, but it does mean we’ll delve deeper into our credit review of each provider’s specific niche and payment outlook.”

“We typically do deals with regional providers that operate in several states, so they generally know what’s going on with reimbursements within their industry and sector,” Gervais states. “As part of our due diligence, we focus on reimbursement trends on a national level but also within their state. For example, Texas is talking about 10% cuts to long-term care, which would have a big impact on skilled nursing facilities. It’s more likely to be a 4% to 5% cut, but as a lender you have to be closely in touch with your providers.”

“To be successful in this industry, you also have to monitor the receivables base,” says Chapa. “You have to make sure your providers’ billing and collection practices are sound. The healthcare industry can present a greater risk of dilution in receivables than in other industries.”

Universal healthcare is also a potential issue. With everyone covered, there would be a wider pool of people eligible for healthcare. “This would be good for certain sectors, such as inner city hospitals that have a lot of indigent people who need care and will now have coverage,” comments Gervais. “This would increase provider financial performance. Universal healthcare would certainly be good for our business, but the big question is how do you pay for it? It requires a lot of programs, and the government would have to run it efficiently to provide the capital to pay for it.”

More Changes Ahead

The current healthcare environment squeezes providers from both sides. The number of patients and need for services are growing, but providers are going to be asked to do more in order to get reimbursed. “They will be forced to operate much more efficiently, putting more demands on the administrative and IT side,” Chapa stresses. “This always increases the potential for consolidation in the industry. Better capitalized providers will survive. The smaller, less capitalized providers that don’t have the resources to operate well administratively will be forced to partner up, sell or go out of business.”

“There wasn’t much M&A activity in 2009, but I think future pressure will cause a lot more of it in the next year or two,” predicts Gervais. “This will be good for our business because, as part of that consolidation, providers will need to access capital to integrate the different businesses into their core business and to fund acquisitions.”

“The industry is definitely going through some dynamic changes, but the demographics have never been more favorable,” exclaims Sheasgreen. “It’s going to create opportunity for those lenders positioned to meet the needs of the companies serving the aging Baby Boomer population. We’ll see an increase in mergers and acquisitions of healthcare organizations as well as a movement toward patient-centered outcomes such as the creation of accountable care organizations and medical homes. There will be increased attention toward electronic medical records, too. The healthcare entities open to aligning and creating strategic affiliations while focusing on patient outcomes will be the winners in this market. Lenders will place heavier emphasis on underwriting management teams that have the ability and financial capacity to adapt to these changes.

“Healthcare spending is expected to increase to 19% by 2017. We plan to take advantage of the expected industry consolidation and growth. This is a unique opportunity to gain market share for lenders that understand healthcare finance and have the capital to deploy,” Sheasgreen notes.

Lisa A. Miller is a freelance writer who has worked in the commercial finance and equipment financing industry for 12 years.