Capital Access—A Key to Survival

Abstract

IN THIS ISSUE of Frontiers, the two feature articles discuss the capital imperative: hospitals' competitive positions and, indeed, survival are inextricably linked to their ability to access capital. Clearly, access to capital is highly dependent on an organization's credit rating and overall creditworthiness, which is a function of many factors such as market position, profitability, liquidity, and debt burden. Highly credited hospitals are able to raise affordable capital. More poorly performing hospitals have limited access to capital, must pay a premium, or both, forcing margins to further erode. The result is additional closures, further consolidations within the industry, and an inability by some institutions to keep up with technology advancements, thereby impeding patient safety and quality. THE CLIMATE FOR ACCESSING CAPITAL Generally favorable conditions have prevailed in the healthcare market in recent years, such as increased utilization, lower interest rates, strong managed care rate hikes, market basket increases from Medicare, and supplemental payments from the states for tobacco lawsuit settlements. In addition, hospitals have implemented aggressive cost-control programs and divested themselves of noncore operations. Despite this friendly climate, many hospitals are still vulnerable and have had a limited ability to access capital. A review of the summer 2004 rating outlooks from Standard & Poor's (S&P), Moody's Investors Service, and Fitch Ratings shows a growing polarization of have and have-not hospitals with respect to operating performance and credit quality. Downgrades continue to outpace upgrades. For the weaker hospitals, a negative outlook is forecasted. Contributing to this potential downturn are burgeoning federal and state budget deficits that will likely result in reimbursement reductions or a tightening up of Medicaid eligibility. Reductions in coverage or higher copayments are also a likely result of a push back from employers that are no longer willing to accept double-digit rate increases. Add to this a growing burden of bad debt and charity care, shortage in nursing and allied health personnel, and unfunded government mandates (e.g., staffing ratios and quality initiatives), and hospital operating margins will be further pressured. Furthermore, stock market uncertainty has affected investment earnings and increased contributions to self-insurance plans and defined benefit pension plans. At the same time, hospitals are under tremendous pressure to make capital investments in major information technology systems (e.g., computerized physician order entry, electronic health records), infrastructure to update aging physical plants and expand capacity (e.g., emergency departments, operating rooms, outpatient areas and beds), and new medical equipment (e.g., digital radiology systems). Moody's contends that capital spending will continue to rise as hospitals strive to maintain their competitive position, resulting in higher debt levels or lower liquidity levels, both of which stress balance sheets. Affirming the importance of reinvestment in property, plant, and equipment and strategic capital allocation, the rating agencies recently introduced new ratios by which to measure capital expenditures: capital expenditures as a percentage of earnings before interest, taxes, depreciation, and amortization and as a percentage of total revenue. The authors of both feature articles lay out solid strategies for coping with these challenges during this difficult time. PLANNING FOR CAPITAL SPENDING As suggested, a financial and/or capital plan is clearly an integral part or outcome of an overall strategic planning process, especially given the multiple, often conflicting, demands on capital resources. One cannot overemphasize the importance of focusing on core service lines and maintaining strong operating margins to support any planned increases in capital spending. …