Hospitals eye peddling shares in pools of receivables: investment banks would buy, package hospitals' bills.

Investors looking for better yields than they can get on time deposits or tax-exempt bonds may be able to buy up to $200 million in accounts receivable from Los Angeles hospitals in 1993, said investment bankers.

Finance companies have bought accounts receivable from Los Angeles labs and individual doctors for decades. And last year, Wall Street brokerages "securitized" about $500 million worth of hospital bills nationwide. But securitizing hospital bills, which involves pooling hospitals' receivables and then selling shares in those pools to investors, is just starting in Los Angeles.

The new trend involves investment bankers buying the receivables of several hospitals at a pre-determined discount, usually 15 to 20 percent below what the patients owe. Hospitals agree to those discounts because selling the receivables outright lets hospitals get cash three to nine months sooner than if they were to wait for payment from a patient or insurance company.

Investors buying into the pool can then realize returns based on the discount.

For instance, if $115 million in hospital bills are sold to an investment bank for $100 million, and all the hospital bills are subsequently collected, investors in the pool would collectively get a $15 million or 15 percent return, less underwriting fees and related charges.

Mortgage brokers and banks have created similar debt pools through "securitization" for decades and have standardized loan and credit reporting forms. These forms provide standardized information on each loan applicant's credit history, indebtedness and income. That information can then be used by underwriters to evaluate the riskiness of each debt pool. Loans are assigned an A, B, or C rating.

In general, "A" credit applicants can borrow money at lower interest rates than "B" or "C" applicants. And B or C debt pools provide investors greater quoted rates of return, due to their higher risk of default, than A debt pools.

Unlike mortgage brokers and banks, the medical profession has not yet standardized its debt because health care is paid for in so many different ways. Sole practitioners extend credit to some of their long-time clients on a handshake. Medical insurance companies do not all use the same forms, pay the same percentage for care or pay in the same length or time. As such, investment bankers have a much harder time rating hospital bills and other health care receivables, said financial experts.

Without standardization, investment bankers must spend more time rating the debt it is packaging so it can accurately project the timing and likelihood of the debt being repaid. Ascertaining the relative risk and returns of "securitized" hospital bills is even more important to investors than ascertaining risk and return of other types of debt pools. That is because investors are buying the hospital debt outright. Unlike car loans, mortgages and other debt that is frequently securitized, hospital bills typically do not have a firm repayment term, stipulated late fee penalties or interest rates. Therefore, the discount the brokerage negotiates on the hospital accounts receivable, less any administrative expenses of the offering and collecting payment, determines the investors' yield.

As a result, investment bankers are trying to work out a rating system to increase investors' ability to gauge risk vs. return and, thereby, increase the pools' attractiveness to investors.

Investment bankers, as a rule, do not like to package public offerings for less than $100 million. That is because there are basic fees to register a public offering with the Securities and Exchange Commission that are the same no matter how large the offering. Consequently, the expense of packaging the offering as a percentage of the funds raised declines as the size of the offering rises.

Once an underwriter and broker put together and sell all the shares in a $100 million public offering of medical receivables, the underwriter typically arranges with the hospitals or an independent financial services company to collect and process the debt on a for-fee basis.

"There is no doubt in my mind that Southern California health care providers who securitize debt can speed up collection of (at least) $200 million in accounts receivable in 1993," said Gary R. Hutson, executive vice president of Heller Healthcare Insurance Services, a Dallas-based buyer of medical receivables. That would be equivalent to 40 percent of the $500 million in "securitized" hospital-bill accounts Wall Street brokers claim to have sold throughout the U.S. in 1992.

"The California health care accounts receivable market is very active right now," Hutson said, adding that Heller is negotiating with an undisclosed Los Angeles hospital to buy its accounts receivable on a continuing basis.

"Last year, the (U.S.) health care industry provided services totaling $883 billion, that is about 20 percent of the gross national product," Hutson claimed.

He predicted rapid growth of securitized hospital debt investment in Los Angeles because "Southern California is one of the five largest health care markets in the country."

But financial experts said hospitals could sell more of their accounts receivable though brokers if the health care industry would standardize its billing and bookkeeping procedures and forms.

Investors typically experts prefer to buy accounts receivable to be paid by health insurance companies because such receivables are perceived to have a more-favorable risk-vs.-return ratio than receivables owed by individual patients.

If securitizing hospital accounts and selling them through the brokerage community has any merit at all, it will be successful in Southern California, said Joe Lehnen, a broker at J.P. Morgan & Co.'s San Francisco office who sells health care-related investments. J.P. Morgan is a securities brokerage.

"The need for Los Angeles hospitals to enhance their cash flow by selling their accounts receivable is higher than in most other regions in the U.S.," asserted Lehnen.

Eric Bronc, an independent attorney in Newport Beach specializing in securities law, also sees a big market for "securitized" Southern California hospital bills.

"Here you have an industry that needs money, but for some reason is not credit worthy to banks," Bronc said.

"But the market for hospital accounts receivable to investors must be proven (on a smaller scale) before we'll see a securitized $100 million deal in Southern California," Bronc continued. That initial "smaller scale" would be in the $5 million to $10 million range.

Mike Perrigue, a broker at the Los Angeles office of Smith Barney, Harris Upham & Co., is not as bullish as Heller, Bronc and Lehnen. In fact, Perrigue said he doubts a public offering of Los Angeles area hospital accounts receivable will happen any time soon. And he is especially bearish about securitization of nonprofit hospital receivables.

"Why would an investor want to buy accounts receivable from a nonprofit hospital that is having trouble bringing in enough money to stay open," scoffed Perrigue.

Tom Kelly, the Long Beach-based national director for accounting firm KPMG Peat Marwick's health care practice, insisted the financial community is expressing a lot of interest in buying hospital accounts receivable.

"There are lots of investment bankers in Los Angeles right now trying to make deals. But the only hospitals that will pay the interest they (the investment bankers) want, generally prime plus 3 or 4 percent, are the nonprofits that already have exhausted all other means of raising money," Kelly claimed.

Prime is the interest rate banks charge their most credit-worthy borrowers.