From reimbursement delays to regulatory hurdles, healthcare ABL demands precision, but Jennifer Sheasgreen and Howard Brownstein argue that for lenders who master its nuances, it offers resilient returns in a vital sector.
Healthcare is one of the largest and most varied industries in our economy, representing 17.6% of our GDP in 2023, and like companies in every other industry, healthcare companies need finance. However, some factors make healthcare different, and which can present challenges for financing, and this has led to healthcare finance becoming something of a specialty in the lending community.
First, the healthcare industry is heavily regulated at both the federal and state levels, so a borrower’s regulatory compliance is an area of focus for healthcare lenders. The borrower’s customer information is subject to protections under HIPAA (Health Insurance Portability and Accountability Act of 1996) and therefore must be handled properly by the lender. While the healthcare borrower may have many customers — i.e., patients as the recipient of healthcare goods and services — the party that remits payments to the borrower is often a third-party government or insurance payor, which may therefore mean significant concentration risk for the lender, as well as government payors being subject to regulatory and budgeting issues, etc.
Additionally, the borrower may be a nonprofit, which in some cases can mean management that might be less focused on profitability, as well as possibly weaker corporate governance. And the borrower’s nonprofit status may create PR and “optics” risk issues, since its corporate decisions may be judged differently than those of a for-profit company.
While some healthcare borrowers may have a limited amount of inventory, in general inventory plays a far lesser role in asset-based lending to healthcare companies.
And finally, while the sale of a borrower can sometimes be the solution to underperformance for the lender to get repaid, there may be restrictions on the sale or ownership of a healthcare company due to government regulations.
Notwithstanding all these factors, healthcare finance is still a valuable and important area of lending.
Why healthcare ABL? The macro drivers of this sector include an aging population, stable demand, staffing shortages, and reimbursement pressures; however, healthcare remains a resilient sector. Often capital-deprived by traditional lenders that perceive the regulatory nuances to be challenging, healthcare-focused ABL lenders can provide the appropriate flexibility in borrowing base structure that’s needed to face liquidity issues resulting from reimbursement delays or escalating labor costs. The dynamics present create both risk and opportunity for asset-based lenders.
The case for healthcare ABL is often centered around borrower liquidity. Reimbursement lags, PE consolidation, growth, or capex needs may generate challenges that aren’t always solved by a bank-structured solution. ABL is a good alternative to bank lending and not as constrained by rigid advance formulas. Non-bank lenders have advantages in speed, structuring, and risk appetite, often lending deeper into the collateral pool while closely monitoring and trending collection outcomes to effectuate a reasonable loan turn.
As noted above, a healthcare borrower may have only AR (Accounts Receivable) collateral to pledge, outside of real estate, with little or no inventory. In situations where inventory might be included as part of a collateral package, it may be structured as a sub-limit of the AR borrowing base, or capped at a certain percentage of the overall availability, but typically doesn’t dominate the asset pool. Inventory could also be considered “boot collateral” if the lender chooses not to lend against it. As with non-healthcare borrowers, there may also be a need for equipment financing, but most ABL lenders handle that outside of the borrowing base, or have lined up equipment finance lenders with whom they work regularly.
In considering the valuation of a healthcare borrower’s AR collateral and possible dilution factors, an ABL lender’s typical approach that it uses for non-healthcare borrowers of gross AR less ineligibles may not be applicable, since the valuation of a healthcare borrower’s AR is often more complicated. The payor of the AR (the “account debtor”) is likely not the recipient of the healthcare services provided by the borrower, i.e., the patient, but rather a third-party governmental payor or insurance company. There may be contractual discounts applicable and potential changes in reimbursement rates from those payors, and in any event, there is likely to be AR concentration and cross-aging issues. Healthcare lenders may have different approaches to these types of ineligibles. Recoupment and set-off may come into play due to the elaborate rules and regulations of government agencies and insurance companies. This adds a risk element for the lender of the borrower’s compliance with such rules and regulations, and the quality of its billing documentation, including required “coding”.
Unique collateral dynamics are an innate part of lending in the healthcare ABL sector. Government payors dominate certain industry sectors, like skilled nursing, and concentrations of government AR are common. Medicaid payors and regulations can vary by state, furthering the need to have expertise on your team to appropriately value the collateral be lent against. Additional risks such as claw-backs, fraud exposure, “upcoding”, overbilling, or unpaid provider taxes present challenges that may be mitigated through collateral audits and ongoing portfolio credit management.
All of these factors require lenders to develop and maintain expertise in their healthcare lending team, with personnel who are industry-knowledgeable and stay updated on the ever-changing regulations. Employing third-party collateral auditors that focus in the healthcare sector can also serve to enhance risk mitigation.
Healthcare lenders have an arsenal of tools in their box to mitigate potential pitfalls in portfolio management. Comprehensive underwriting is the first tool – as in traditional ABL, healthcare lenders tend to have a laser focus on collateral. As “not all payors are created equal”, slicing the data into historical roll-forwards, payor mix analysis, reimbursement cycle, collection history trends, government compliance, and billing efficiency are all part of the analysis that goes into dilution calculations. The dilution by payor class is then further reduced by the advance rate. Additional AR, such as patient pay, may serve as boot collateral but is not commonly part of the borrowing base availability.
Structuring is the second tool – complying with government anti-assignment regulations surrounding lien position and cash dominion are the first step. Dual blocked accounts and cash dominion triggers are an important differentiator in healthcare AR collections, as the government has specific requirements for complying with those provisions. Other protections in the loan agreement, such as incorporating covenants including loan turn and financial covenants, requiring frequent reporting, and including certain red flag triggers, allow the lender to engage outside consultants or take further action to protect the collateral, if needed.
Lastly, monitoring is key – unlike traditional ABL where receivable aging reports may suffice, healthcare lenders require more granular reporting, including payor-level performance, denial trends, and real-time transparency. Though not for the faint at heart, healthcare lending can be a lucrative business model.
Healthcare lenders’ approach to the market also involves competitive factors. Though some lenders avoid the healthcare space due to the complexity and compliance risks, those that take the leap can bridge healthcare’s capital needs and lenders’ search for yield. Private credit funds and specialty finance firms, with their dedicated healthcare lending teams, have become more prevalent in the healthcare ABL sector. These types of firms can provide the solution for private-equity roll-ups and M&A, driving larger deals sizes and creating demand while satisfying investor returns.
For healthcare lenders that can successfully navigate the complexity and nuances of healthcare receivables and regulatory oversight, asset-based lending offers not just a specialized portfolio addition with attractive yields, but an opportunity to support one of our country’s most essential industries.
Jennifer Sheasgreen is a longtime executive in the healthcare lending space, having started up two de novo healthcare ABL divisions.
Howard Brod Brownstein is President of The Brownstein Corporation, a turnaround management firm which frequently brings lending opportunities to market, including in healthcare.