Tip:
Highlight text to annotate it
X
Access to Capital Rural Hospital DARIN SIMMONS: Good afternoon, everyone, and
welcome to today’s edition of the Weekly Webinar Series. Today’s topic provides an
overview of how to prepare a rural or critical access hospital to apply for a loan. I am
Darin Simmons and I will be your host today. So, now I’d like to welcome our presenter.
Leading today’s discussion will be Hal Fudge from MidFirst Bank. So now, without any further
ado, I’d like to turn it over to Hal. HAL FUDGE: Thank you Darin, and it’s a pleasure
to be here today to give a perspective at least and a commercial lender’s viewpoint
on what we think a health care provider in rural America would encounter if they were
to walk into a bank anywhere and request a loan specifically, probably an NEHR loan.
Joining me here for this presentation is our point person on EHR lending and its possibilities
within rural America, Carol Kinzer. She is our senior relationship manager in health
care lending. I have been asked to put together a package
of what I think would be the issues that one would face -- critical access, hospital, or
any other rural hospital -- once they enter the doors of the bank and ask for a loan.
And some of this may be very basic for those of you who have already crossed over that
threshold, so I apologize for those areas that you may have already been well-versed
at. Commercial banks across the country refer
to their process of evaluating a loan request as “underwriting”. It’s basically from
the very beginning to the end of the analysis of the request for a loan prior to its going
to various forms of approval inside of a bank. So, when you go into a bank and you ask for
a loan, the underwriting essentially begins right there at the request. Once they understand
the request, what typically follows is that a bank will go through the gathering and the
analysis of the borrower’s financial information. You’ll get a long list. Usually financial
statements is the basic core piece of information that they will ask for. Obviously, it will
be the income statements and the balance sheets. And once they’ve typically asked for three
years of financial information, they will begin to formulate the terms and conditions
of the potential loan based on each bank’s internal policies.
Number three, they will assess the overall creditworthiness of the potential borrower
based on their analysis. It will determine to them if the loan has acceptable quality
to bear the risks of credit. They will test the potential borrower’s capacity to repay
the loan, obviously. They’re not going to make a loan unless there’s a good chance
that they think it’s going to be paid back, and it obviously has to comply usually with
the bank’s internal policies. The next step, as I mentioned, is that they
will begin to collect background information on the hospital and its owner. What will follow
is the last three annual financial statements, as I mentioned: balance sheet information,
income statement information, and cash flow information. A lot of times if you’re in
the middle of the year, let’s say if we’re in the summer and they have your last fiscal
year-end, let’s say that your fiscal year-ends on a calendar again, so your fiscal year-end
period is December 31st. And they will ask for interim periods since that point in time.
Usually they will ask for the most recent interim statement. That’s usually on a quarterly
basis, with statements from the same period, the last three years. What I mean is if you
have a March 31 statement for 2013, they'll want to see what your March 31 statement was
for 2012, and maybe even at 2011. And the reason for that is, you might have had a mediocre
fiscal year-end in 2012, but all of a sudden the first quarter shows that revenues have
skyrocketed and income has skyrocketed. Well, a bank doesn’t get overly excited about
whether the provider is suddenly -- has improved their performance. What they like to see is
that they do the same thing the previous year in March, but ended up kind of on a mediocre
full year, and how they do that is they ask for the same interim period as the previous
year. Supporting schedules are often asked for.
That would be account receivables aging. Obviously with HIPA requirements, they will only ask
for your payee -- I mean payor. If it’s Medicare or Medicaid or commercial payors,
they will ask for your accounts payable aging, making sure that you don’t have a lot of
vendors that are significantly past due. They’ll ask usually for schedules of existing debts
and monthly payments, your capital structure, if you have a mortgage on your real estate,
if you have a lot of equipment leases. Essentially, what are the terms that you are being asked
to pay that back? Operating reports are required for the historical
periods covered by the financial statements, so they can reconcile the gross revenues versus
the net revenues. For a health care lender like ourselves, we like to dig a little deeper
to understand the nature of the revenues. We ask for the net revenues by specialty and
by payor type: Medicare, Medicaid, commercial insurance, private pay.
And then, after you get the historical information, this is where sometimes it gets to be a challenge
is to ask for projected financial information. You know, sometimes hospitals have readily
available five-year projections and sometimes they only have one-year projections, but it
really helps a lender understand the direction that the hospital provider is anticipating
will be in one year, two years, three years. With all of the regulations and the pressure
from Washington, D.C., upon health care providers across the country, we want to see how the
provider is dealing with those issues and where they see themselves down the road. That’s
where a lot of guidance from the lender is often -- a lot of discussion back and forth
helps with the provider putting the financial package together.
We want to know what their capital spending budget is. You know, sometimes an older hospital
can have a lot of old equipment that is in need of replacement, and that will have to
be factored into what their capital needs are in the future. So we will ask them if
their -- you know, if we see on their balance sheet that their equipment is essentially
depreciated down to nothing, the question will arise, "Well, is there going to be a
need for equipment to be put in at some date, whether it’s financed or paid out by cash?"
And that’s usually factored into the projections in the future.
The next thing -- and we’re assuming that this hospital provider enters into the bank
asking for an EHR loan, and there will obviously be questions from a lender to ask for information
on the purchase, the implementation, and the upgrade of the EHR system itself. Obviously
we’ll want to know who the vendor is. Some institutions are not as in-depth in health
care lending as MidFirst Bank is, so some may ask and want to know the historical performance
of the vendor itself, what their backlog is, "Are they going to be able to get this implemented
in a timely fashion?" They’ll want to know representations that the system is a certified
system, the estimated reasonable cost of the system, obviously, and the timeline for the
purchase and implementation. If they’re up to date and knowledgeable about EHR, they’ll
want to know the expected date, the first attestation of meaningful use, and then obviously
the expected date of receipt of the incentive payment or payments.
Formulating the terms and conditions after the financial information is obtained is usually
the next step, and it’s known as the structure of a potential loan. That’s where you get
into the terms and the payments and the interest rates, whether it’s going to be a revolving
loan or whether it’s going to be a term loan. If it’s a term loan, you will determine
what type of amortization period. What that means is, "Is it a two-year loan or three-year
loan, five-year loan?" and then what the maturity date is. EHR loans are probably going to be
a term loan, but there is generally -- I think there will be some period of time to allow
the health care provider to get through the point of implementation and attestation before
the principal is due, but each lender may have a different format to go by and internal
policy. So there probably will not be a revolving loan, which usually is associated with working
capital or accounts receivables, where there’s no principal payment, but interest. And on
an EHR loan, I would tend to think that it would be a term loan with a set maturity.
And then all of those elements are going to factor into the monthly payment. And the monthly
payment, on an annual basis, is what determines what the debt service requirement. Debt service
requirement is a term that’s used often in banks, and that is just how much principal
and interest has to be serviced on that debt. Sometimes the bank will ask for guarantees
of the full amount of the loan or specific guarantees. All that is negotiable. If it’s
a nonprofit organization, then obviously full guarantees would not be available. But guarantees
is a form of enhancement if there are certain risks inherent in the borrower that’s requesting
the loan. That would also factor into collateral coverage if there is additional collateral
that could be pledged apart from the EHR software. This is where the fun begins, where the bank
then begins to examine the trends and revenues and expenses and profit margins over the years.
It’s the job of an analyst in a bank to objectively look at the information that they
just received from the critical access hospital and determine, "Okay, are revenues stable?
Are they increasing or are they decreasing? And if they are decreasing or increasing,
what’s causing it?" And it all drills down to the bottom line, which is the profit margins
and cash flow, which is the source of repayment of any loan that’s going to be made by the
bank. So they will look at the trends. They will
probably have questions throughout this process. An analyst may call the hospital one, two,
or 10 times during a month, and ask for explanations or more detail or clarification on what their
finding in their analysis. The bank will then compare the most recent interims to the prior
years’ interim periods, as I mentioned before, just to see, are things relatively stable,
or are they going in one direction or another, and why. I mean if there’s a slight increase
this way or another, it’s not going to be much of an issue. If there is a jump from
one direction to another, it may not mean anything. Then again, it might, but usually
it’s a question that deserves an answer. The bank will assess the liquidity and leverage
of the hospital’s balance sheet, how much cash and liquid assets they have versus how
much debt, and what we call leverage. You know, sometimes when an analyst would look
at a hospital’s financial statement, they can see that on the income statement, they’re
making all kinds of money. Their revenues look strong and their net income looks great.
But when they look at the balance sheet, they see there’s hardly any cash, and there’s
not much liquidity. And actually this has happened a couple of times in my experience.
And what that usually means is, although they’re recording revenues and income, they’re not
collecting it from the accounts receivables, which could be a red flag as far as what they’re
-- are they having problems in their revenue cycle management?
The next page is assessing creditworthiness, and that is the next stage of where the bank
really zeroes in on the ability of the borrower to pay back the loan. This is very important.
And it’s got a lot of terms to it: cash flow, or EBITDA, which stands for earnings
before interest, taxes, and depreciations. Available cash to service, that is another
term that -- it all zeroes in on the same component as far as after all is said and
done with revenues and expenses and salaries, how much money is left over to meet the obligations
of the hospital? A lot of banks use a lot of different calculations.
And usually, if you had a net gain -- let’s say you sold a parcel of land next to the
hospital and it gave you $500,000 in proceeds -- that’s going to be taken out because
that’s not really considered recurring. It’s not really considered core operations.
Now, on the flip side, if you sold a piece of land and actually lost money -- let’s
say you lost $250,000, which depressed your income for that year -- they will add that
back in to try and arrive at what is called the poor recurring earnings of the hospital.
Cash flow available to service the debt usually begins at a measurement where it adds back
non-cash charges. There’s an example down here of an income statement for hypothetically
year ending December 31st, 2012, where depreciation and amortization is obviously an expense from
the hospital, but it’s not cash. So that’s added back to get at a level of cash flow
available to service debt. You also add back the interest expense, because that’s part
of the debt service. So, if you wanted to start from the bottom, as this example shows
net income of $580,000, you add back the taxes, because sometimes taxes are different versus
what they file on their income tax versus not, and then you add back your interest expense,
because, as I said, it's part of the debt service. It’s the interest charged. And
you add back amortization of intangible assets, and then depreciation of their capital assets,
because those are really non-cash charges, or they might be considered reserves. And
in this case, a $580,000 net income figure becomes $800,000, which is available to service
other -- their ongoing needs such as principal payments and interest expense. The banks will
examine the leverage or the amount of debt compared to the income at the financial ratio.
We’re getting down to the real nitty gritty of what they’re going to determine if this
hospital qualifies for a loan. And also, in addition, to look at the leverage.
Does this hospital have a lot of debt on its balance sheet? A typical, easy-to-understand
ratio is, take your total liabilities to total tangible net worth. We don’t have it here
because every bank has a different sense of how leveraged a borrower should be. If you
had $20 million in assets, and you had $10 million in liabilities, you would have $10
million in net worth. That’d be pretty healthy. That’d be 1-to-1. If you have more net worth
than liabilities, you’re really in a good leverage position. In fact, you're probably
-- one would say that you’re not leveraged. When you get above 3-to-1 or 4-to-1, then
you are really -- it’s considered to be fairly leveraged. And any higher than that,
it does create a red flag. It doesn’t necessarily disqualify anybody, but it is a question that
needs to be answered regarding the leverage of the hospital and all of that debt on their
books. So, if you had $40 million in liabilities to $10 million in net worth, you would be
considered highly leveraged. Now I am on page "access capacity to repay
the loan." This is where it gets down to probably the most important ratio, and there’s a
lot that factors into determining whether a borrower would qualify for loan. Leading
up to the determination of cash flow, that calculation that I did on $800,000 EBITDA
available to service debt comes down to a ratio that banks typically use called debt
service coverage ratio. And it’s really simple. It’s just taking what I described
as earnings before interest, taxes, depreciation, amortization, which is commonly referred to
as EBITDA, by the debt service. And debt service is defined as the total of all monthly principal
and interest payments on all loans, as well as capital leases if you have capital leases
that are on your balance sheet and not run through as an operating lease expense.
So, if you had your EBITDA, which in our example was $800,000, and let’s say your total debt
service was, say, $666,000, you would have a debt service ratio of 1.2, which is really
-- it’s a common standard minimum of what is considered to be a healthy operation. Anything
below that, you get into kind of a yellow light. Anything above that is a green light.
And if you get down to 1-to-1, you really start getting to a red light, because that
is break-even. And if you’re below 1-to-1, that calculation shows that the hospital does
not generate enough money on an annual basis to meet dollar-for-dollar their obligations,
which is obviously a red flag. But as I said before, each bank may have a
different standard. One may have 1.15, or 1.1, or other banks may have 1.3 to reach
that threshold of what they consider to be healthy. And not reaching that threshold doesn’t
necessarily disqualify somebody immediately. It just takes a little bit more work to mitigate
that red flag. Then there’s obviously the collateral, evaluating
the collateral, but before I get to that, I made some calculations today that I thought
would be a little bit more insightful as far as what I just said about the EBIDTA and the
debt service coverage ratio and how it’s important with EHR lending requests. If we
went back to our example of EBITDA of $800,000, and if you had, as I said, $666,000 in debt
service on an annual basis, you’d be 1.2. Well, let’s say that your debt service is
$500,000. Well, that’s a 1.6 debt service coverage ratio. That’s very strong. Well,
now let’s say that you do walk into the bank and you say, “I want $750,000 from
my EHR loan." The bank says, “Well, I can probably give you that on 60 months at 5 percent.”
Well, if you calculated what the debt payments would be on a $750,000 loan for five years
at five percent, that would be $14,000 a month. That would be $170,000 a year. So, back to
my example of EBITDA is $800,000. Debt service is $500,000. Now you’ve got to add another
$170,000 to the $500,000. That means you would be $670,000 in debt service. Your debt service
coverage ration goes from 1.6 to 1.19. It’s below the 1.2, which a bank may start to be
a little bit uncomfortable. However, you’re going to also say, “But,
of that $750,000 loan, I’m going to get $600 or $650,000 back from Medicare and Medicaid
to offset my capital cost to the EHR." If you factor that in to an outside source of
income that is going to be coming from something other than core operations and that amount
is used to pay down that EHR loan, well, then you’re -- and let’s say you had $100,000
left over that you had to have to pay out over five years. Your debt service coverage
ratio goes back up to 1.53. And I can provide the calculations if I went too fast, but what
I’m trying to get across is, your debt service coverage rations that a lender is going to
look at is, he’s going to look at the revenues and the cash flow being generated on a recurring
basis, is what we commonly call core operations, compared to the weight of the debt that it
must service, and if it’s over 1.2, it looks pretty good.
When you lay on another amount of debt for EHR without factoring in the incentive payment,
it would depress that figure to a point where it might not look attractive to a lender.
And that’s why you are really enhancing the prospect of getting that loan when you
factor in that, well, the majority of that is going to be offset by the government’s
program and their incentive payment. So all that has to be presented to the lender if
he doesn’t understand that. Otherwise he will just say, “Well, if you factor in that
new debt, that gets your ratio down below 1.2.”
Now, if they don’t understand or if they need to be convinced a little bit more on
how to enhance the loan, they would probably look at collateral, "Is additional collateral
to be had. Is there some land? Is there some equipment that’s been paid off, and are
there some guarantees that can be provided?" All that could be used to enhance the position
of the lender that could get him over the threshold of granting that loan.
DARIN SIMMONS: Thank you, Hal, and thank you all for participating today. We really do
hope that you enjoyed the session. Please email the HITRC training team if you have
any questions, and thanks again for joining. We look forward to seeing you again on future
webinars. [end of transcript]
HHS: 091010 More Magazine Interview 2 11/14/13
Access to Capital Rural Hospital 1 11/14/13
Prepared by National Capitol Captioning 200 N. Glebe Rd. #1016
(703) 243-9696 Arlington, VA 22203
Prepared by National Capitol Contracting 200 N. Glebe Rd. #1016
(703) 243-9696 Arlington, VA 22203