How will America replace its rural hospitals?

Healthcare Financial Management, Feb, 2005

Many of the nation's 2,000-plus rural hospitals are aging. Some may be in immediate need of substantial renovation or replacement. Major construction projects have often been unaffordable for small hospitals. But the financial story for rural hospitals is not all doom and gloom. HFMA's Financing the Future series found that more hospitals with broad access to capital were rural than was expected. This indicates an improved capital access environment for rural hospitals and a greater market acceptance of rural hospital credit risk.

Recent regulatory changes have improved the financial viability of rural hospitals and increased their eligibility for capital financing options. Under the federal critical access hospital program, rural hospitals now can receive cost*based government reimbursement for their capital expenditures. This added reimbursement allows more small hospitals to qualify for 'AAA'-caliber financing rates secured by mortgage insurance and direct guarantees of the HUD/FHA Section 242 program and U.S. Department of Agriculture community facilities program.

Presented here are the thoughts of four professionals who have experience in the financing of construction projects--a banker and three executives from rural hospitals that are replacing facilities or have undertaken other construction projects.

ROUNDTABLE DISCUSSION

How critical is the need for America's rural hospitals to be replaced?

Richman: Over the past a5 years, operating losses at many small hospitals have left facilities in disrepair and with obsolete medical equipment. These factors contribute to the loss of patients and physicians to tertiary hospitals. Rural hospital closures jeopardize local economies and the health of residents. Yet there is new optimism for the financial viability of small hospitals. The critical access hospital program, growing political support for rural America, and improving hospital profits now make financing a construction project possible for many rural hospitals. Although loans to rural hospitals may still be considered risky, the federal government and, to some degree, the capital markets now recognize the credit strengths of rural hospitals and the urgent need to deliver affordable capital to rebuild these essential hospitals.

Moore: The physical state of our a5 bed hospital, built in 1959, can shed some light on the problem. You cannot get a wheelchair into a patient's bathroom unless it is folded up. The boilers, elevator, plumbing, and electrical infrastructures are antiquated and it is hard to find parts for them. The low ceilings in our facility wouldn't meet current air exchange ratios. All of these problems were only going to get worse with each year. So we decided to replace the whole facility with a new one, which opened in January 2005.

Hays: Many rural facilities are plagued with old and inefficient mechanical systems, code compliance issues, and the presence of asbestos. The layout is geared toward inpatient services at a time when outpatient services are on the rise. It can be difficult to expand these outpatient services if they are located in the core of the facility. All these factors apply to our facility, and made it impractical to remodel due to the high cost. Therefore, we decided to pursue a new replacement facility.

Kidd: We haven't replaced either of our hospitals, but are thinking of doing so eventually. In the next to to 15 years, if not now, a lot of rural hospitals are going to need major renovation or replacement. The alternative is to close them, but it's critical that they stay open. People in other areas of the country would be amazed at how far apart hospitals are in Idaho and other western states. To get from one Idaho hospital to the nearest regional medical center is a 142-mile drive over a mountain pass. That's a long drive, even in good weather.

What process would you undertake to calculate your borrowing capacity and an affordable project size?

Richman: The process differs for each hospital, but North Valley is a good example. An assessment of the financial feasibility of the proposed project was a must. An initial loan was sized from historical results without any demand growth factored in. It was based upon reimbursement changes, interest forecasts, and a rough budget. The hospital's market analysis and fore casts were then evaluated by service line. A final debt capacity analysis, including sensitivity forecasts, recommended that the hospital convert to CAH status. This became the basis for the maximum project budget and took precedence initially over the architectural and development phase. Although it's natural to want to get started designing the project, North Valley felt it should wait until the budget was set.

Moore: A hospital can spend a lot of money putting together big plans and then not be able to afford them. We had to go through a calculation process to see how much debt service we could cover--a variety of "what if'" scenarios, based on market and demographic studies and payer mix. That yielded a total replacement cost that fit our projections of debt service coverage. Then our management company developed a total project budget based on a prototype replacement that it had developed. We massaged the square footage we needed for continuing to do business over the next 20 years, with some projected growth in a few areas.