Receivables financing as a source of working capital.

Recent developments are helping nursing homes surmount traditional obstacles

Nursing homes, like all businesses, need working capital financing. Typically, the most important asset against which they can obtain working capital financing is their receivables. Banks and finance companies are one common source of working capital financed against receivables, and factors are a second. By far the largest payor to nursing homes is the government, under Medicaid, and to a much lesser extent, Medicare.

However, a couple of peculiarities in regard to Medicaid and Medicare make it hard for nursing homes to find lenders who will loan against their receivables and factors who will purchase them. The government has specified that, while these receivables can be pledged or even sold, payments have to be made directly to the provider or deposited to a bank account of the provider over which the provider has full control. In other words, the provider must be without liens from creditors. Secondly, the government pays once a month, creating an uneven cash flow for nursing homes, which must make payments every day.

Assuming that these obstacles are not insurmountable for the nursing home, banks and finance companies are the most obvious source of receivables financing. Their lending decision is generally driven by an analysis of a borrower's financial statements. Consequently it is common for a company's line of credit to be limited by how its debt compares to its equity base (the ratio of debt-to-worth) or for the lender to set minimum levels of solvency for the company (the current ratio or acid-test ratio).

Under these covenants, a lender limits his willingness to lend funds beyond a predetermined point at which the company would be deemed either excessively indebted or too short of cash for the payments it must meet. The receivables function as part of the total collateral that the company pledges in order to strengthen its corporate commitment to eventually repay the loan. In support of this, the company usually must periodically produce a report (the borrowing base report) showing how much in receivables it carries on its balance sheet. Because Medicaid and Medicare receivables cannot have a lien placed against them, a lender will consider a line of credit collateralized with these receivables as tantamount to an unsecured loan.

Thus, the dilemma: On the one hand, monthly collection patterns tend to put nursing homes in a recurring cash squeeze. On the other, banks and finance companies are reluctant to accept a large part of their receivables as collateral.

Factors are a different breed of lender, but pose their own difficulties. An outgrowth of collection agencies, factors specialize in collecting receivables. They buy a company's receivables and then bet on their ability to collect more of them at a faster rate than the original owner. Personal claims such as car loans are often sold to factors, as are trade receivables from small suppliers that sell to big companies. (In fact, factoring in this country was born out of the apparel business at a time when the big department stores were a financially solid risk and their suppliers were small garment manufacturers.)

Factors are not keen on nursing homes because nobody, least of all they, can rash the government when it comes to paying up. As a result, factors are not major players in the working capital market for nursing homes.

With nursing homes viewed as a less than attractive alternative by the two most traditional avenues of receivables financing, a new approach was needed. This has led to the development of a third type of funding source, asset-backed securities (ABS). It is the most esoteric of the three.

To understand how ABS came about and operate, we must look back more than 20 years to when the government decided to make residential housing affordable by making investments in mortgages attractive to investors, thereby increasing the availability of mortgage financing. The government guaranteed these loans, provided they met certain requirements. This allowed for the creation of pools of "conforming" mortgages that ultimately were guaranteed by the government. They became very attractive collateral for investors. These investment instruments are commonly known as GNMAs (Ginnymaes), FNMAs (Fanniemaes), and other more esoteric, less recognizable names.

This was the beginning of a very important trend in U.S. capital markets. Both lenders and investors realized that sometimes an investor is better off in terms of risk if he buys a pool of loans than if he lends money directly to the company that booked the loans.

Nowadays, investors invest directly in all kinds of grouped assets: mortgages, student loans, car loans, credit card receivables, leases, even franchise dues or insurance premiums. They do this by buying ABS, notes or bonds issued by a special purpose company, the sole function of which is to hold the receivables which are the assets that back the securities. ABS have become so much a part of our financial markets that, in 1993, more ABS were issued than corporate bonds.

These special purpose companies are hybrids: like banks and finance companies in the sense that they are interested only in earning interest on a financial transaction, and like factors in that they purchase receivables.

Companies specialized in raising money through securitization have started to focus on financing health care providers in general and nursing homes in particular. These ABS companies typically will buy a nursing home's receivables but leave the collection and whole receivable management process in the hands of the nursing home. ABS companies are highly experienced in an extremely narrow field. They can derive a greater amount of confidence than a bank from the assets they finance. Consequently they do not focus on a company's financial standing as much as a traditional lender does. But these are not the only reasons they can be an attractive alternative to traditional lenders for nursing homes.

Financing through a securitization of receivables does not create a liability. An asset--the receivables--is sold for cash; no loan has been granted. Another way to look at it is that the money is never due back to the ABS company. We often forget that a line of credit, like any loan, is due back at some point, and that point may come at a very unpropitious time. If a company has other loan agreements with financial covenants, often the deleveraging effect of selling an asset for cash rather than obtaining another loan greatly helps companies trying to remain in compliance with debt-to-worth ratios.

The ABS company, or securitization sponsor, typically takes some economic risk in the receivables. This removes from their customers, albeit in different degrees, some of the risks of owning the receivables. This comes from the fact that a true sale must have occurred between the seller and buyer and a legal requirement of a true sale is that the buyer take some of the economic risks associated with owning the receivables. Furthermore the financial reports due to the sponsor are minimal, since the sponsor generates the statistics needed and the transaction typically requires no covenants.

A securitization program is therefore a viable financing source for a nursing home. The extent of its viability varies, however, depending on the individual program. The better programs in the industry can advance funds even if a receivable has not yet been billed. This works to the monthly billing and paying cycle of much of a nursing home's receivables. Another important feature of a securitization program is that each nursing home should not have to cross-guarantee the financing by funding some reserve that is available to the securitization sponsor to protect against cash-flow problems that may develop because of some other customer.

Finally each securitization program quotes fees in a different way. In order to make good comparisons, a nursing home should insist on getting a complete disclosure of all costs. The mechanics of each program and the sponsor's ability to deliver should also be kept in mind. A sponsor which is a subsidiary of a large, financially solid institution will be able to better weather worsening financial conditions than a small sponsor with no institutional backing. Also the sponsor's information-processing and reporting systems should be studied in depth in order to determine whether they will be able to efficiently process all the data they will receive. An inefficient sponsor may delay payments and create serious bottlenecks in the flow of cash to the nursing home -- a problem that most nursing homes definitely don't need.

ABS companies can, in short, help solve nursing homes' receivables financing problems. As in any other transaction, though, much depends on the seller's analysis of the buyer with whom it plans to do business. One that passes the test can prove to be an excellent source of working capital.

Dr. David Mamo, M.Phil., MBA is President of LINC Financial Services, Inc., Chicago, IL, one of the latest of several companies engaged in receivable financing through a securitization. It is a joint venture of the LINC Group, the largest independent lessor of medical equipment in the United States, and MeesPierson, merchant banking arm of ABN-AMRO Bank, a major European financial institution. One of LINC's largest customers is Life Care Centers of America, whose CFO, John O'Brien, has called it "a very viable alternative to traditional lending sources."