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Challenges in skilled nursing sector may force tough decisions in the months ahead

The skilled nursing space was facing economic challenges even before COVID-19 hit. Now, the pressures are even greater, and it's anticipated that a number of operators will be forced to make tough economic decisions in the months ahead. In this episode, Waller's Ryan Cochran, the leader of the firm's Finance & Restructuring practice, is joined by Derek Pierce, managing director of Healthcare Management Partners, for a deeper look at the sector.

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Here is a transcript of the conversation:

Morgan Ribeiro

Welcome to PointByPoint. This is your host Morgan Ribeiro. On today's episode, we will discuss the nursing home or skilled nursing facility sector and the pressures lenders to and operators in the space face today. With me are two advisors who offer decades of experience working in the senior living sector. Ryan Cochran is a partner in Waller's financing and restructuring group and has been involved in many receiverships over senior living facilities, representing either the indenture trustee or the receiver. Derek Pierce is a managing director at Healthcare Management Partners who has more than 25 years of professional experience focused solely in the healthcare industry, having served as chief financial officer, chief restructuring Medicare auditor, Medicare cost report preparer, forensic accountant and financial advisor. In the last five years, he has worked on 24 receiverships over senior living facilities.

Ryan and Derek, thank you for joining me today. Many nursing homes in the US are fighting against a number of crises, one being the pandemic that is sickening and killing residents, as well as the financial strains it is experiencing and ultimately the possibility of bankruptcy. Let's first talk about what was at play prior to the pandemic. This industry has been under financial pressure for a while now. And I think it's helpful to give our listeners a brief lay of the land as that definitely contributes to the current situation. So Derek, I'll start with you.

Derek Pierce 

Thanks, Morgan. For I would say decades now going all the way back even into the 80s, this industry has really been beholden to the payment system that is handed down by the federal government and state government. For those payments, they ask for a lot. They ask for different regulatory oversight surveys, lots of scrutiny that this industry is just constantly inundated with, unlike other sectors of the healthcare sector. So this is a group that is unique in the sense that they've always had a struggle with marginal revenues, ones where they're barely breaking even, but constant pressures from outside forces just constantly competing for their business. So these are the challenges we were facing up until February or March, and this pandemic has just exasperated that. It's made it much more difficult to operate, and we'll talk later about it, but just leading up to where we are or where we were earlier in the year, we find these nursing homes already under lots of pressure.

Ryan Cochran

Derek talked about the pressure that the nursing home industry has faced due to the payer system. I think there are two other issues that affected the nursing home industry before the pandemic. One is residents are coming to the nursing homes sicker and older, which means that the staff at the nursing home is required to give better quality care, which requires more training and more commitment out of the staff and really results in more expensive staff. So nursing homes are having to pay staff more to do a job that is more difficult now because of the higher acuity of the residents, and it's tough to find staff who are committed to the residents and will work for the prevailing wages. So I really think it's been difficult for nursing homes to handle the burden of increased wages and the competition for quality staff even before the pandemic hit.

Morgan 

You both have mentioned the pandemic. Derek, could you provide some background on the pandemic? This might help explain to our listeners how COVID-19 has adversely impacted the financial condition of many of these skilled nursing facilities or nursing homes.

Derek 

I think it's fair to say this industry, probably the world, was caught flat-footed by this pandemic. When you look back, there's a lack of PPE available for these caregivers to protect themselves adequately and a lack of training on basic infection control. What we have seen when things got started in March here in the States was not a full appreciation for how this virus was spreading. We heard wash your hands and isolate, but when it came to these caregivers coming in with the virus caring for these residents, it was just devastating. The New York Times has a database that suggests that half of the loss of life here in the US, or 40% of that, has been in the nursing homes, despite the fact that it's only representing 7% of the country's cases. So to give you some magnitude, we are talking about frail elderly residents who have comorbid type conditions. Add that to the fact that there are not good processes in place for infection control. There's a lack of PPE, lack of even oversight at the state level and federal level. And in a way shouldn't be surprised, it's just unfortunate what we're seeing.

Morgan 

Great, and Derek, when it comes to impacting the finances of a skilled nursing facility, you mentioned the preparedness and purchasing of PPE and other equipment, did COVID-19 mitigation and control result in increased operating expenses?

Derek 

The cost of the PPE, the gowns, the gloves, the face shields, these are expensive and have gotten more expensive. Nursing homes are competing with hospitals competing with other industries to get this equipment in place. So, from experience, having been in a building with COVID, you're burning through that PPE when you have to isolate certain residents and not isolate other residents, you're donning on and dawning off some pretty expensive equipment. And so that is number one. I think the testing part, the cost of those tests are part of our weekly expenses, not just monthly, because we're doing weekly tests in a lot of our facilities. Cleaning supplies, housekeeping, all of those costs are increasing just because of the need to sanitize everything. And training costs, we have in one of our buildings in Texas, we've had an educator there 24/7, educating the caregivers on proper hygiene and making sure that we're doing what we need to do in that in that building. So I think those are some of the some of the big costs that we're seeing at the nursing homes.

Morgan 

And Ryan, I think besides the additional operating costs that Derek has mentioned, are there also some downstream impacts of COVID-19 that will ultimately impact the financial condition of the sector?

Ryan 

I believe there are certain downstream impacts from COVID-19, and I put them in two big buckets. One bucket I say is census related. And the second bucket is staff-related.

First, census is what drives revenue at a facility, and many facilities are struggling to maintain census at the level that's necessary to generate sufficient operating revenues. The presence of COVID-19 either in the community or at the facility I think has a direct impact on census in several ways. One, there's a reduction in census due to fewer referrals from hospitals. Hospitals have not had as many cases during the pandemic that require a discharge to a nursing home. The general population has slowed the number of elective surgeries which often drive the need for placement in a skilled nursing facility. As a result, nursing homes are just seeing fewer referrals. Another reason is some residents are moving out, whether they're moving home with a loved one, or they're moving to another facility, those residents need to be replaced. And during the pandemic, many communities as a way to try to keep COVID out of their facility refused to allow visitors which reduced the number of tours that potential residents could take. So it slowed the facility's ability to timely replace residents who are no longer living at the facility.

Also, because of an awareness about the risk of COVID-19, the general population is putting off decisions about moving into a congregate living facility. Many people are putting off the decision to move into a nursing home for fear that living in the arrangement might increase the likelihood that they're exposed to COVID-19. In addition, to reduce the risk of COVID-19 spreading, many facilities, especially over the summer, had strict isolation and policies in place that just made it unappealing to move into a facility. So potential residents who were feeling the challenge of a first time move into a facility or were nervous or apprehensive about moving into a facility, they've put that decision off. And I think all of these factors together have made it difficult for facilities to maintain the census necessary to support their operating expenses.

The second bucket I mentioned is staffing, and to me, that's staffing costs. Staffing costs have risen during the pandemic. If there's a COVID-19 outbreak in a facility, the staff are ill as well as the residents, and the ill staff must quarantine, so the ill staff can't come to work. Well, as a result, facilities are going to have to pay higher overtime to staff to cover additional shifts, or they're going to have to hire outside staffing from an agency at a higher rate. Staffing agencies may charge $30 to $50 per an hour for work normally charged at $11 to $18 an hour. In addition, many facilities face the increased cost of pay. Certain staff may be getting hazard pay or hazard bonuses so that they're encouraged to come in during a COVID-19 outbreak at the facility. So in my opinion, these two buckets, census and staffing, are really affecting the ability of the nursing home to pay its operating costs.

Morgan 

Talk about HMP's role as a turnaround advisor. What trends are you all seeing in the SNF space right now?

Derek 

I think it's fair to say the optimal word for the space right now is cooperation. There's financial trouble, there's distress, we're all anticipating coming soon, but the government has provided a good amount of funding for these nursing homes to support them for the things we mentioned earlier, the additional costs or labor, the additional PPE costs. So that money we believe is being used for those areas. But those facilities that were distressed will continue to be distressed. And when they do go to the lender, they're seeing a lot more cooperation and understanding.

As you mentioned early, I do a lot of receiverships, and recently, we're being asked to engage in something we're calling receivership light. And what that means is something that is formerly a receivership, which is us being handed the entity, it's an agreed upon between the current operator and the lender, or whoever's brought the action, have come to an agreement that a receiver should be appointed. And those keys, if you will, are being handed to a receiver, but the receiver is being asked to hold back on the traditional route of maybe pushing towards a sale of the assets and waiting for some type of direction, either in the industry or from the lender. That is something I think that's in the spirit of cooperation. What we're seeing really from the lender side is receiverships, and I would also say if there is some type of push towards something other than a receivership, of a more friendly forbearance agreement. I would characterize it as something that gives them the runway to make it through this difficult time.

Morgan 

Based on all of these factors that are at play, based on prior experience, and trying to read the tea leaves, what do you all see to come over the next 12 to 18 months? What can lenders and operators anticipate to come and how do they really prepare for that? Ryan, can you maybe get us started on what we can expect to see over the next year to year and a half.

Ryan 

Derek mentioned that the government has provided a lot of support to the industry. And that's true. There has been a lot of financial support provided to the industry to help them get through this pandemic. But I think eventually those funds will run out and at that time, I do see a risk of increased defaults on loans and leases. You know, many operators will be battling a lower occupancy rate and the trailing effects of all the increased spending on COVID-19 mitigation and control. This likely means that cash will need to be maintained by the facilities for operations. And that will likely result in covenant defaults or payment defaults to lenders. And so I think we will see going forward in the next 12 months more defaults than we would have seen absent the pandemic. I'll add to that, too, though, in troubled times, there's always opportunity for those with cash and the stomach to engage in a turnaround process, I think there will be ample buying opportunities because of the number of operators who are either forced to sell, are willing to sell now because of the difficult times they had during the pandemic.

Morgan 

And Derek, you come at this more from a clinical perspective. Anything you'd add to that as to what we can anticipate over the next year to year and a half?

Derek

I believe it's going to be more oversight, I think it's going to be the carrot, I think it's going to be the stick from the government from the agencies that are overseeing, the Department of Health, the state surveyors, federal surveyors, in our buildings. I think we had no less than five different agencies, and some were consultants to agencies coming in to look at our hot wing at the building to see if it was adequate. And so I think it's going to be more of that. I think we're going to be calling on staff to do more, I think we're going to have to deal with this stress level from operators and the staff and give them some respite. Not just money, not just throw money at them, but good respite and education. And it's going to be that type of environment, to create, to keep from creating what we have right now, which is a lot of when a building gets COVID, it suddenly is a different ballgame from those caregivers and their stress level. I mean, their concerns about going home and taking this with them. So I think going forward, that'swhere I see this coming. In a recent CMS conference, they said kind of the carrot and the stick; they suggested these immediate jeopardy tags will come with fines, severe fines, that occur because of the infection control deficiencies that the building had. With that, I would expect more capital improvement needs. Now whether there'll be done because of the lack of cash to do it is one of the concerns.

Ryan 

Derek, you were talking about the clinical aspects being more difficult in a time of tight cash, but also just being more difficult because of the demands put on staff. It seems like the job of working at a skilled nursing facility has become more difficult during the pandemic because of the infection mitigation and control issues, but also the knowledge base that the workers have to have, and the fear that the staff has about how their chosen profession can impact their own families when they go home. And it reminds me of some of the recent difficulties we've talked about in rural hospitals, too. How in a rural hospital, it's getting more and more complicated to provide the care that's needed at the cost that's needed. Do you see any comparison between these difficulties for rural hospitals and skilled nursing facilities?

Derek

I do. We have a similar facility, in a way. A lot of our facilities are built around the same time when they received grants from the federal government to be built back in the 1960s. And so now we've got an aging plant, and we've got declining margins and declining occupancies. There's a lot of stress in what these rural hospitals are going through. I think where it turns is the fundamental business. There's a need for the service when these hospitals open up again when these loved ones are able to come in and visit and tour, when things return to some type of normalcy there. I believe there will be an increase in census then. So I'm hopeful that we'll see a little more return to normal. The rural hospital setting is, unfortunately, a different conversation, based on the fact that I'm not sure if they'll return those occupancies and margins since they have been on the decline for so long. And they may not weather through this favorably.

Morgan 

From a practical standpoint, as you are looking at this from a couple of different angles, one on the lender side, Ryan, do you have any practical advice for lenders that may have nursing homes in their portfolio?

Ryan 

Most lenders have the ability to obtain financial reporting from their borrowers. And I would recommend that lenders make sure they're receiving timely and accurate financial reporting, and that when they do receive it, they study it, and they review the financial reporting. You know, if a borrower looks to be at risk of a default, I suggest they start a conversation with the borrower earlier rather than later. This may give the borrower and the lender more options. I would say, a lender needs to be more creative about workout strategies.

For example, this receivership light scenario that Derek mentioned. In addition, lenders may need to come to grips with the fact that they may have to advance more operating capital to keep the facility open and operating so that there is a possibility for a restructuring or an orderly disposition of the facility.

Morgan 

From your perspective, any practical advice on how they might prepare for this storm that we see coming?

Derek 

I think they need to engage a consultant. And that's not a self-serving comment. This is not necessarily expertise that I would have. But I think a clinical consultant who lives and breathes infection control, if it's not already in the organization. Even if it is in the organization, bringing someone, an outsider perspective, to get ahead of what we're getting right now from the regulatory bodies. They're offering a lot of inconsistent information. In some cases, the Department of Health might be different than what the state is saying you should be doing for best practices. So I would hire a qualified consultant who really knows this space of infection control and can help you navigate. This is particularly helpful if you've already received immediate jeopardy in your recent survey, that might actually be a requirement for you to engage someone like that.

Morgan 

How can they ensure that they don't default on their loan? With the financial pressures that we've already discussed, what are some steps that they can do to ensure that?

Ryan 

In times of cash shortage, our concerns about cash availability, operators need to put an emphasis on managing their cash position. And that starts with a weekly cash flow forecast where you outline your specific sources and uses of cash. In the restructuring industry, people talk about building a 13-week cash flow forecast. Now this should help the operator identify potential vulnerabilities ahead of time and give them an opportunity to plan on when to spend and when to use cash. If an operator forecasts that its loan may go into default, whether it's a covenant or payment default, I suggest having an open dialogue with your lender. And if you're an operator that's maintained a 13 week cash flow, and you have a long history of showing your estimated expenses and then your actual expenses and comparing the two, it will help you facilitate a conversation with your lender about a plan or a roadmap for curing any defaults or getting a deferment so that you can continue to operate on some basis with your lender.

I also think that operators should consider engaging turnaround and restructuring professionals. These professionals have experience advising financially distressed businesses, and they can be both a source of ideas for the operator, but they also lend credence to an operator's plan when the operator is trying to negotiate with their lender. I think lenders feel more comfortable dealing with operators and borrowers that have engaged turnaround consultants.

Derek 

Let's end on a positive note. I do think this industry, we'll get through this. And having traveled many states recently, with a lot of infection control nurses, what I find interesting is listening to their level of confidence in that they're telling me, and these are nurses, old school nurses, and saying this is not the first infection control outbreak, this won't be the last, but we are going to get through this. We're going to be better for it, and we're going to learn how to care for our residents better. So that was inspiring to me. So that's what I would pass along to the audience here.




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Ryan Cochran
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Morgan Ribeiro
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