About the author: Peter Hartheimer serves as the lead principal in General Capital Partners LLC in its New York office.
How the world has changed. There was a time when, if a nursing home was experiencing financial difficulty, they went to their current lender and asked for an extension or additional capital. If they had to file for chapter 11 protection, they would secure debtor-in-possession (DIP) financing from the current lender or choose from a bevy of alternative lenders and factors.
Today, CFOs and CROs are faced with a shrinking pool of resources to secure DIP and/or exit financing from chapter 11. The needs of the nursing homes have not changed—only how they will be fulfilled. Skilled nursing facilities have always required a form of working capital, which stems from a few factors:
- reimbursements from insurance companies and state agencies need to be received on a monthly basis because cash is needed weekly, especially for payroll, which makes up 70 percent of the cost structure.
- The lag time between the submittal of annual cost reports and updating rates can be months.
- Many lenders disallow Medicaid receivables as part of the borrowing base, as more states have had to impose withholds.
- In many states, the capital component of the rate has been reduced or eliminated, and many nursing homes across the country are in need of investment to cover the difference.
To meet these needs, CROs or CFOs must be prepared for a strenuous process, including more work than was previously required and some tough calls. As financing options have decreased, the amount of due diligence has increased with lenders significantly escalating their requirements. Gone are the days of a generic due diligence package with lenders lining up for a veritable beauty pageant. In the current environment, lenders are dictating the types of collateral and other requirements necessary to complete a financing package. For nursing homes that own real estate, it has become commonplace to collateralize loans with both real property and receivables, thus creating a collateral position with significantly more value than the amount of the debt level. With the shrinking pool of lenders and supplemental constraints, management will have to determine its resolve for the lengthy and challenging process for obtaining financing— how many lenders to engage with, whether existing debt is to be primed and what cost level the can facility support.
In addition, the lender who ultimately assumes the loan will most likely have consulted a financial advisor, which will add another dimension to the process. This often means increased reporting requirements, additional diversion for management and greater overall cost of doing business, which is not realized in the daily rates. Management must take all of these factors into consideration and decide whether it can continue providing the same level of service, including noncritical care staffing. This new cost structure has to be compared against the daily reimbursement rates they currently receive.
Financing Alternatives in Today’s Marketplace
Though liquidity is scarce and the new economy has considerably narrowed options for borrowers in search of DIP and exit financing, options do exist in the form of high-yield debt funds, specialty institutions, loan-to-own opportunistic investment groups and strategic industry buyers. Traditional commercial lending institutions were once players in this arena, but given the current economic climate, it is proving unlikely that these lenders will step into a distressed situation. In some cases, an existing commercial lender may extend DIP financing to remain in a first position, protect itself and avoid the risk of the debt being subordinated.
Because the debtor’s liquidity needs vary so greatly, based on the existing management’s strengths and desired outcome, the debtor must be aware of how motives amongst the potential capital sources differ. A debt fund that is not interested in operating or owning a majority interest in the business will be focused on yield, and obtaining a first position in the collateral will be the paramount objective. Though they may be willing to extend their exposure beyond collateral, it will carry a significantly higher interest rate. A potential strategic or friendly acquirer may be a perfect nontraditional lending source, since its ultimate motivation is the health of the organization and management retention as it compliments the existing operation. It may be willing provide the lowest cost option as it anticipates assuming the entire debt structure. In contrast, a loan-to-own group may be adversarial to the management and will be looking at how it can take over the assets. These alternative funds will provide financing as only a vehicle to gain ownership of the property.
Specialty institutions, such as business credit groups and its factors, may be very attractive. Though they come at a premium, they advance against receivables that only allow the debtor to monetize the remaining asset through other venues. Conversely, a debt buyer may also be a worthwhile party. Cleaning up older debt and selling a portion of the current book of business can create instant liquidity without risk of a management takeover.
Another area for consideration is the level of support each lending source is willing to provide. Private equity firms will be more willing to work with management to provide turnaround assistance, especially if the private-equity firm targets distressed businesses. Often, they have already completed a situation analysis and know what steps should be undertaken to return the company to profitability. This is a strong contrast to the attitudes of opportunistic funds, which lean more on the value of the assets rather than the value of the enterprise as a whole.
Time is of the essence in any distressed situation. Lender fatigue and mounting debt will only further erode any salvageable solutions. Although financing is tricky to locate, there are new potential lenders coming online on a regular basis. Frequently it is prudent to retain the services of an intermediary that has expertise in the health care industry and distressed landscape. These groups are well suited to assist all parties in ascertaining realistic financial goals in the most expeditious manner.