WHAT MAKES A NURSING HOME "INVESTMENT GRADE"?

INERVIEW WITH ROBERT WETZLER

What is it that gives these "magic few" such luster?

Nursing homes have no shortage of critics these days, and some of the toughest are in the investment community. Tougher regulations, Medicare PPS, liability insurance problems and competition from assisted living for private-pay residents are taking their toll on investor confidence. Fitch, the New-York-based international bond rating organization, is no exception. Focusing its long-term care analysis on the approximately 4,500-facility not-for-profit sector, Fitch has seen fit to give an investment-grade rating to only seven. And yet, even in these dark days, there are at least even long-term care organizations that apparently merit the endorsement of a conservative-minded ratings organization. What is it that gives these "magic few" such luster? Recently, Robert Wetzler, associate director at Fitch, tesponded to questions posed by Nursing Homes/Long Term Care Management Editor Richard L. Peck.

Peck: What are some of the key factors that would raise an investor's interest in a nursing facility these days?

Wetzler: Continued demand for its beds, quick turnover of emptybeds, reliable referral sources, payer mix leaning toward private pay, maximization of reimbursement rates and management's track record would be key factors leading to a look at the financials.

Peck: What specifically do you look for in a manager?

Wetzler: We look at experience, plus good access to planning and budgeting resources. Credentials are not as important. Some very qualified managers have no more than a high school diploma; we are not that impressed by MBAs or advanced degrees in this field. We look for knowledge of the industry and of the facility's market, what competitors are doing, what processes the facility uses for strategic planning and management's financial results over the past five years.

Peck: What sort of management style do you favor--the master of office procedures, or one who "manages by walking around"?

Wetzler: I would say the latter. On our site visits, we see if the residents know the administrator and he knows them. The same with employees--do they and the administrator look each other in the eye and say hello? That is often a sign of favorable working conditions.

Peck: You mentioned checking management's financial results over the past five years. These particular past five years have seen a lot of adversity for nursing homes in terms of staffing, medicolegal exposure and the Medicare PPS. How do you factor those into your calculations?

Wetzler: It's tough-in fact, these are some of the main reasons we've adopted a bearish outlook on the industry. In recent months, we've been breaking out salaries and expenses as a percentage of total revenues and have found this to be trending upward. This is not a good thing, because it translates to reduced profits or margins. The nursing homes that have achieved at least a BBB- rating are the ones that have been able to recruit and retain staff and provide consistently good-quality care. We've seen staff/resident ratios as low as 1 to 5. Of course, these facilities, being in the not-for-profit sector, have had access to large endowments that they've been able to invest to offset their operating losses.

Peck: What about nursing facilities' apparently growing medicolegal exposure, with liability insurers actually withdrawing from large markets in Florida and Texas, for example?

Wetzler: It's a definite red flag. There is a particular problem with this that is faced by not-for-profit providers that have tax-exempt debt because their indentures require them to have liability insurance. Loss of that insurance would be formally an event of default--perhaps one not as serious as missing payments, but a default nonetheless.

Peck: And, finally, the impact of Medicare PPS?

Wetzler: A facility's exposure to Medicare is the key. As it turned out, many not-for-profits did not bump up as much for post-acute care as some for-profit chains did and, as a result, didn't become overleveraged. Meanwhile, those facilities that secure a larger proportion of private-pay residents will continue to do well; that's still an important factor.

Peck: Regarding private pay, some nursing homes, recognizing the competition from assisted living for that market, have attempted to expand into assisted living themselves. Is capital readily available for that sort of diversification?

Wetzler: Yes, investors look favorably on providing for aging in place because it locks in those revenue streams. It is important, though, that the provider invest in a thorough market study beforehand, in light of the slower fill-up rates and market saturation that assisted living is seeing in some areas of the country. The same requirement holds true for Alzheimer's care facilities.

Peck: Your company's literature makes a point regarding the importance of computerized management information systems to an organization's bond rating. What sort of MIS capability are you looking for?

Wetzler: Basically, a system that gives you the information you need to make decisions on a daily basis--daily census reports, monthly financial statements and so forth. It should be remembered, too, that investors like timely information, and for that you need a good management information system. With a multifacility operation, we like to see the system integrated with a local area network (LAN) or wide area network (WAN).

Peck We've spoken a great deal about the problems that the industry is facing. Do you see a turnaround coming anytime soon?

Wetzler: Not really. It's true that staffing issues are partly a result of a booming economy, but I think the problem goes beyond that and is really more long term. I'm referring to the unfavorable working conditions in many nursing homes. That is going to take some work. Meanwhile, we don't know what's going to happen with Medicaid rates, which in most cases have been barely adequate at best. And there are the other problems we discussed earlier. I don't see anything happening in the near term that's likely to change our somewhat dark view of nursing homes these days.

The truth is, those seven nursing home organizations that we've rated as investment-grade are statistical out-liers in the industry. There is some considerable distance to go for other organizations to get to where they are. But providers who can effectively manage costs, maintain census and provide quality care will be on the right path to investment-grade status.

Robert Wetzler is associate director at Fitch, Inc.