The deep freeze

There’s no denying that 2008 was the worst financial year that anyone born after World War II has seen. Coming off one of its best years in 2007, the long-term care industry saw its financial situation plunge like a Coney Island roller coaster.

The repercussions are expected to linger into the year ahead, but no one can say for sure whether the economy has bottomed out, or when it might turn the corner.

“It’s very difficult to predict— 2008 was so uncertain,” said Dan Biron, senior vice president and director of healthcare programs at Columbus, OH-based Lancaster Pollard. “My guess is that 2009 will be a continuation of ’08, with no drastic changes in store.”

If there’s good news to be found, it’s in Biron’s belief that long-term care will probably fare better than other sectors when it comes to mortgage defaults. While he concedes that residential mortgages have probably endured the worst, Biron says commercial mortgage-backed securities loans for commercial real estate are due for a wave of defaults.

“I haven’t heard of any defaults in long-term care, though independent living facilities may face some risk because potential residents need to sell their homes before they can move in,” he said. “Skilled nursing and assisted ­living are need-driven sectors and that need is not going away, so they should manage okay.”

Some believe 2009 will be a bridge year between the turmoil of 2008 and the promise of 2010.

“There is a great deal of work that needs to be done in 2009 to reach 2010 with optimism rather than the uncertainty that currently clouds the market,” said Jeff Binder, managing director at St. Louis-based Senior Living Investment Brokerage.

“The impact on the seniors housing industry has been widespread, from plummeting stock prices and market capitalizations for some industry bellwether companies to lagging occupancy rates and a severely restricted flow of capital. The question is, where do we go from here?”

Defrosting outlook

One of the toughest aspects of the 2008 financial crisis has been the credit freeze. The absence of capital liquidity has paralyzed transactions of all kinds, leaving the industry in widespread limbo.

Though it probably will be slight, Binder expects some improvement over the next year, depending on what happens in the White House and on Capitol Hill.

“While transaction volume in 2008 was clearly below 2007 levels, we do anticipate 2009 to show a slight increase,” he said. “We believe this for a couple of reasons. Our [company] volume is increasing as we head into 2009 and the reconciliation of seller expectations and the buyer’s pricing will continue into the new year. We do anticipate a slight thawing of capital in 2009, but the failure of any stimulus package to stabilize the economy could derail this prediction.”

Moreover, Binder believes any increase in the availability of capital in 2009 will be accompanied by an extremely high level of scrutiny and due diligence.

“While the trend for more transparency evolved late in 2007 and throughout 2008, we anticipate lenders will continue the trend in earnest in 2009,” he said. “We urge any potential seller to be organized, accurate, efficient, and timely—any limitation in one of these areas can be detrimental in a borrower’s efforts to secure financing. Without question, we do not anticipate any softening in the reluctance to lend based on pro forma budgeted numbers unless the borrower has a strong lending relationship and equally strong operating history.”

A capital strategy

Operators should take a four-pronged approach to seeking capital, believes Doug Korey, managing director of Shrewsbury, NJ-based Contemporary Healthcare Capital. He advises starting with focusing on operations and census, initiating and building relationships with lenders, strengthening financial reporting ability and using net cash flow to make capital improvements or pay down debt.

“It may be stating the obvious, but this is no time to take the eye off the ball from an operational perspective,” he said. “I have seen too many financial statements in the past 12 months that show erratic expense management or unexplained dips in the census/quality mix. Since most lenders will now solely focus on historical performance rather than pro forma, it is imperative to be able to show consistent operational trends.”

Korey also urges operators to be proactive with lenders. Instead of waiting for the lender to spot a negative trend on a loan performance, the operator should pick up the phone and explain what occurred and what will be done to fix the issue going forward.

“Call the lender quarterly and take the temperature of what’s going on relating to the lender’s internal business model,” he added.

Lack of adequate financial reporting is “one of the weakest components of long-term care companies,” Korey contended. “Many companies are slow to prepare and submit financial statements to their lenders. Others don’t provide adequate detail, which raises questions for lenders. It is important in this environment and during any ‘rough patch’ to make sure you know what format the lender wants in terms of financial statements and to send the statements to the lenders on time.”

Finally, Korey recommends operators look forward to their financial obligations.

“Don’t assume that the market will ‘correct’ itself in time to take out your loan at maturity,” he said. “Be conservative and either enhance the value of the facility or pay down your loan in advance. This capital market will remain on the conservative side for at least the next few years and providers must be prepared to deal with that reality.”

Minding the details

In order to protect revenue streams and stabilize cash flow, long-term care  providers should diversify their payer base, said Francine Machisko, senior principal with the Falls Church, VA-based Noblis Center for Healthcare Innovation.

“If you rely strictly on Medicare, you’re putting yourself at risk if there is a hiccup,” she said. “It is very important to make sure you have effective marketing campaigns to attract the highest volume and the right type of patients as possible, so work closely with discharge planners at hospitals. It has become increasingly important in this economy.”

For the post-acute sector in general, the margins for Medicare have remained positive and in many cases, are higher than acute care, Machisko noted.

“There are opportunities to make money in this industry if you do things right,” she explained. “That’s if you get the right mix of patients and watch your financial Ps and Qs.”

Getting deals done

The financial clamps may loosen for long-term care providers in the upcoming year, but credit availability will be a far cry from just two years ago, Biron said.

“Choices will be very limited in finding capital debt structure,” he said. “One of the strongest debt structures is FHA and HUD, which have seen a tremendous increase in our pipeline. HUD is one of the few games in town that provides debt and capital for the market.”

Keep in mind that local and regional banks are continuing to provide capital. They are, however, “using extreme diligence and scouring the market,” Biron said. “Deals are getting done, but far fewer than in the past.”

Meanwhile, Biron maintains that national banks “have put their pencils down. They are not actively out there looking for new transactions … they are waiting for the outcomes.”