Finance mortgage one

This event will also mark the beginning of an era of hospital capital finance equivalent to the inauguration of the Hill-Burton hospital construction program in the mid-20th century.

With some luck, local media coverage of the ceremony will be picked up by a national news service and propelled into the business pages of the money-center cities major newspapers. Whatever the coverage, however, it could be strongly argued that any retrospective analysis of hospital development in the United States from here on out would be incomplete without a chapter acknowledging this grand opening.

It's Not Easy Being Small

Hospitals like Rio Grande, Shoshone Medical Center in Idaho, and Drumright Hospital in Oklahoma pass under the radar screens that identify prospective clients for the largest and most experienced investment bankers. You won't find them in the databases of the national credit rating agencies, letter-of-credit, providers, and bond insurance firms. They have the dubious distinction of being among the "great unwashed" of the hospital credit world by virtue of their size. Let's face it: these organizations are not just small--they're tiny. Rio Grande has just fourteen beds (no, not forty--fourteen). Such hospitals, if "hospitals" is even the right word, don't begin to compare with the medical facilities in cities like Chicago. New York, and Los Angeles.

But be assured these hospitals are important to organizations like HFMA, the American Hospital Association, and JCAHO. Regardless of whose numbers you use, hospitals with fewer than 50 beds constitute more than half of the nation's hospitals. Raise the bar to, say, 80 beds or fewer, and you are talking about 7 out of 10 hospitals.

As a group, the common credit concern of small rural hospitals is simple: it's virtually nonexistent. In fact, if any of these facilities were to call one of the big portals of capital access (money-center banks, rating agencies, bond insurers, or portfolio managers for hospital bond funds), the conversation would unquestionably have been brief and disappointing: "You're too small--and because size is indirectly proportional to risk. small is too risky for us. Have you talked to your local bank?"

Not a Pot of Gold at the End of the Rainbow

The "new era of capital finance" in the title of this article should not be construed as referring to the discovery of a vast new source of dollars for rural hospitals. Rather, this "new era" will emerge as several key elements--each of which has been around for a while--come together to give small rural hospitals an opportunity they never had before:

* The CAH designation

* Cost based payment for Medicare services

* The FHA-24,2 hospital mortgage guarantee pro gram, administered jointly by HUD and HHS

* Acknowledgement that small rural hospitals are a different species of medical facility from urban medical centers

* A rural hospital management environment characterized by rigorous strategic planning like that practiced at the most successful large U.S. hospitals

* The same public finance bond market that has bought, sold, and traded hospital debt obligations for half a century

* Credit ratings in the AA to AAA categories

The combining of the first five elements reflects a change in attitude and policy at the federal and local levels that--if it's not pure chance--could be characterized as inspired genius. The credit for this change ultimately must go to the managers of the mortgage guarantee program in Washington, D.C., administrators in small hospitals with the courage and determination to take steps to change their fortunes, and consultants who are encouraging the development of cutting edge, long-term strategic planning and management.

Not all small rural hospitals can obtain designation as CAHs, but those that do meet the criteria obtain a virtual franchise as facilities that are indispensable to their service areas. The services these hospitals provide are what classic economies calls a public good.

Not all rural hospitals should want CAH designation, either; it can mean downsizing and service changes that some communities and facilities simply won't tolerate. But facilities that obtain CAH designation gain a powerful financial reward: good old-fashioned cost-based payment for Medicare services. This high-test grade of revenue can turn red bottom lines to black, turning former financial losers into profitable facilities.

FHA-242 program administrators had the vision to recognize that CAHs, with their service area "franchise" and cost-based payment powered financial forecasts, create a pool of attractive candidates that could help the FHA-242 program fix one of its own financial concerns: how to diversify its portfolio geographically outside of New York and New England. They streamlined the length of the application process for CAHs by an order of magnitude, from years to months.

Simultaneously fixing a local financial problem and a federal financial problem--what a concept! Charles C. Ervin, Jr., managing director of the rural hospital program for Columbus, Ohio-based Red Capital Group, financed the Rio Grande Hospital project as a banker with PNC Capital, and will host the opening ceremony this month. He says, "Access to the FHA-242 program is the best thing to happen to rural hospitals since Hill-Burton."

The Crucial Role of Strategic Planning

It must be stressed that the CAH designation, cost-based payment, an out-of-date physical plant, and FHA-242 financing cannot by them selves assure a hospital of a better future. Hospital managers and board members must commit themselves from the outset to a rigorous and continuous process of strategic planning. In the words of Brian Haapala, senior consultant with Portland, Maine-based Stroudwater Associates: "Those who succeed will be those who can integrate their facility imperative with hardnosed strategic planning." Indeed, strong hospitals and systems see making such a commitment to strategic planning as a fact of life.

But rural hospitals could rightfully regard strategic planning as a frivolous luxury. After years of cutting costs, deferring necessary capital projects, cutting services, and defining crises as keeping the ceilings from falling, managers can be forgiven a predilection for "managing their physical plant" rather than "managing their services." That said, these managers must also recognize that professional staff can't be easily retained by or recruited to a physical plant that's a shambles.

Without a sound strategic process, small rural hospitals risk wasting large amounts of new capital on the same old business as usual By embracing the discipline of reinvention, a small rural facility can apply its newfound access to capital toward invigorating its mission for another half-century. If rural hospitals everywhere rise to effectively meet this challenge, it is they that will create the new era of capital finance, forcing bond underwriters, credit enhancers, rating agencies, and bond fund analysts to sit up and take notice of a new species of hospital.

WHAT IS FHA FINANCING?

FHA financing is a form of public offering available through the U.S. Department of Housing and Urban Development (HUD) that has been rarely used until recently. FHA-242-insured loans are offered to acute care hospitals for construction financing, refinancing, remodeling, or expansion. Rates are fixed for the length of the mortgage, but variable-rate swap structures may be considered. The permanent loans are fully amortizing for up to 25 years after completion of the project. The financing process is rigorous, with multiple requirements and steps that can take 18 months to complete.

Excerpted from Wareham, Therese L., "A Capital Idea: Bonds and Nontraditional Financing Options," hfm, May 2004, pp. 54-62.

Kevin T. Ponton is president, SprainBrook Group, Hawthorne, N.Y., and a member of HFMA's Metropolitan New York Chapter. His e-mail address is kponton@mac.com.