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High on ambition, low on cash, Twin Cities hospitals face choices

Second only to nurses claiming they will strike solely to save patients’ lives, the most repeated talking point in the Twin Cities these days is: Hospitals are besieged institutions that are at the mercy of a poor economy and uncertain healthcare reform laws. Well … not exactly. True, hospitals face a great deal of financial […]

Second only to nurses claiming they will strike solely to save patients’ lives, the most repeated talking point in the Twin Cities these days is: Hospitals are besieged institutions that are at the mercy of a poor economy and uncertain healthcare reform laws.

Well … not exactly.

True, hospitals face a great deal of financial pressure that is outside their control. A weak economy means patients who can pay are deferring treatment while patients who cannot pay are crowding emergency rooms. Throw in lower Medicare payments, and hospitals have a good deal to worry about.

But the hospitals are hardly blameless. Just a few years ago when the economy was healthy, hospitals borrowed hundreds of millions of dollars at cheap interest rates to fund ambitious capital projects. They also enjoyed healthy returns from investment portfolios that made big bets on stocks and real estate.

Beginning in 2008 when the country slid into the worst recession since the 1930s, however, hospitals watched credit dry up and wracked up huge losses on Wall Street. The result: Although local hospitals managed to boost revenue, it wasn’t nearly enough to cover faster-growing expenses, including debt payments and employee compensation.

The hospitals estimate the Minnesota Nurses Association’s (MNA) demand for set staffing ratios will cost them $300 million more.  “Hospitals are faced with difficult decisions,” said Matt Weekly, a former hospital chief financial officer who heads the healthcare practice at tax and consulting firm Plante & Moran.

Through GuideStar, MedCity News analyzed the 2008  financial documents of four of the six Twin Cities hospital chains that are trying to negotiate a new three-year contract with the MNA — Allina Health System, Children’s Hospitals and Clinics of Minnesota, North Memorial Health Care and Park Nicollet Clinic. (University of Minnesota/Fairview Hospital and HealthEast had incomplete or missing information.)

While the hospitals varied in performance, two major factors emerged from the financial documents: expenses far outpaced revenue, and once-lucrative investment income has dried up completely.

For example, Allina, the most financially secure of the bunch, reported revenue from services grew a healthy 10 percent to $2.28 billion in 2008.

However, the hospital’s investment portfolio lost $76 million compared to a gain of $27.2 million in the previous year. As a result, Allina reported a total revenue gain of just 4.5 percent to $2.26 billion, while expenses jumped 7 percent.

Children’s Hospital saw an even more drastic change. The hospital said revenue from services increased 8 percent to $540 million in 2008. But Children’s lost $52 million from its investment portfolio, knocking its total revenue to just $516.3 million, down 6 percent from 2007.

Meanwhile, expenses rose 8.4 percent, due mostly to salaries and benefits. Compensation now accounts for 63 percent of the hospital’s total revenue. Anything above 55 percent to 60 percent is “unsustainable,” said Jeff Nelson, a Minneapolis-based partner of Tatum LLC, which supplies interim CFOs to struggling hospitals.

The loss of investment income has especially hurt hospitals, depriving them of much-needed revenue to pay the bills. In addition to Allina and Children’s, Park Nicollet and North Memorial also reported portfolio losses of about $8 million.

While hospitals are hardly unique in losing money on Wall Street, they may be less able to deal with the consequences than other organizations, Nelson said. “Sometimes you’re right, sometimes you’re wrong” in investing, Nelson said.

Nevertheless, hospitals still need to find ways to replace the revenue. “There’s only so much you can cut [in expenses],” Nelson said. “If hospitals don’t manage their cash well, they can’t pay their suppliers, staff and debt.”

Paying off debt can be especially problematic for cash-strapped hospitals that are facing lower patient volumes and reduced Medicare payments. “Anyone who thinks hospitals are cash cows doesn’t understand the complexities of the system,” Nelson said.

Like most companies, hospitals took advantage of plentiful, cheap credit a few years ago to pay for major expansion projects. Now, many hospitals struggle to make interest payments on time.

Last year, Park Nicollet, which had borrowed heavily to finance its aggressive expansion plans, eliminated 7 percent of its workforce to preserve cash. It also closed an occupational health clinic near Minneapolis-St. Paul International Airport and a clinic in Hopkins.

“It’s a huge issue,” said Plante & Moran’s Weekly. “Many hospitals don’t understand debt service. Just 1 percent [interest] on a $50 million bond can make or break a hospital. [Debt payments] can eat up a hospital’s profit margin in a hurry.”

Not all hospital systems are having trouble paying on their debt. In 2007, Allina issued $125 million in bonds (on top of $325 million already borrowed) to help pay for a new hospital in Owatonna in a partnership with the Mayo Clinic, expansion of the emergency department at United Hospital in St. Paul and the expansion of a clinic in Northfield.

Last November, Fitch Ratings boosted Allina’s credit rating to A+ from A. “The upgrade reflects Allina’s improving operating profitability, the strategic benefits from Allina’s growing integrated delivery model, its leading market position, solid balance sheet indicators and light debt burden,” the Fitch report said.

However, Fitch said Allina has a little less cash on hand — $814 million, or 115 days worth — than the rating agency would prefer. Given the volatility on Wall Street and the hospital’s expansion projects, Allina has been trying to convert more of its investment portfolio to assets that can be quickly converted to cash.

The larger issue is whether all of these expansion projects will pay off, Weekly said. Hospitals in recent years have been trying to one-up each other by building new facilities and purchasing new technologies, especially for cancer, orthopedic and cardiovascular treatments.

In April, Children’s Hospital opened a new cardiovascular center on its Minneapolis campus — an all-in-one facility that allows patients to remain on the same floor. The addition is part of the hospital’s $300 million project to renovate its buildings in Minneapolis and St. Paul.

The competition has gotten so heated that some hospital lobbies “look like the Ritz Carleton,” Weekly said. “You have to measure and monitor the investments you make. Am I making my numbers? Do I need to make adjustments? Do I have to shut the facility down, increase marketing or partner with someone else? What’s the return on investment?”

Hospitals are not always good at watching investments, Weekly said. For instance, Maple Grove Hospital, which opened last December, is off to a slow start. Only time will tell if the hospital, owned by North Memorial and Fairview, will pay off.

“Hospitals have got to run this as a business,” Weekly said.