The Outlook for Skilled Nursing Facilities
This episode of Point By Point was produced prior to the combination of Waller and Holland & Knight.
On today’s episode, we are talking about financing transactions involving skilled nursing facilities. Lenders in particular have been analyzing the impact of reimbursement changes and stimulus/relief programs for SNFs. But, what can we expect to come in the immediate future as these funds dry up? How is the sector positioned for the future? Today's guests are Daniel Flournoy and Abbey Ruby, partners in the firm’s finance and restructuring practice group, and Tonya Scharf, a partner in the firm’s real estate practice group.
Morgan Ribeiro: Welcome to PointByPoint. This is Waller’s Chief Business Development Officer and the host of the podcast, Morgan Ribeiro. On today's episode, we are talking about financing transactions involving skilled nursing facilities (SNFs). Clearly, this sector of the healthcare industry has been directly impacted by the COVID-19 pandemic, and lenders, in particular, have been analyzing the impact of reimbursement changes and stimulus relief funds coming toward SNFs. But, what we can expect to come in the immediate future as these funds dry up and how is this sector positioned for the future?
With me today are a few partners from Waller who focus their time working with lenders to and operators in the skilled nursing space. Daniel Flournoy and Abbey Ruby are partners in the firm's finance and restructuring practice group, and Tonya Scharf is a partner in the firm's real estate practice group.
First, let's talk about where we were at the beginning of this year before COVID. What were some of the trends underway in SNF financing transactions? Abbey, I'll start with you.
Abbey Ruby: I was seeing a lot of acquisition activity with some large operators divesting of skilled nursing facilities, and some smaller, more regional operators growing their footprint. I will say that has continued since the pandemic began, but the time to closing has slowed a bit with complications surrounding COVID. There was also a lot of discussion by both lenders and operators around PDPM, the patient-driven payment model for Medicare reimbursements, and how that would impact existing operators. That certainly continues to be a point of discussion but has been overshadowed by COVID.
Morgan Ribeiro: Daniel or, Tonya, anything to add to that?
Daniel Flournoy: We saw generally what Abbey was seeing pre-COVID. There were still fairly robust credit market deals. A lot of loans were closing, even in fall of 2019 and January of 2020, before people really understood what the total impact of COVID would be on the economy.
Morgan Ribeiro: Daniel, along those lines, once the pandemic really hit the U.S. back in March and we went into lockdown mode, what have you seen since then, over the last six months?
Daniel Flournoy: February, March, April—it's kind of hard to put a pin on exactly when people really started to take notice. I know Abbey and I were out at the spring NIC conference in San Diego, I guess that was early March. And it was really just starting to be a point of discussion at that point about what's this going to look like and what's the impact going to be. I think that was the first time I actually was introduced to the elbow bump instead of the handshake. So that's kind of a defining moment for me of when this really took off.
And at that point, the first couple of months, I think lenders were still largely in a wait and see mode. They didn't really know exactly what the impact was going to be. There were some localized facilities that had high infection rates, some up in the Northwest, some out on the West Coast, some up in the Northeast, but it wasn't something that most operators were largely concerned with at that point.
By April, we were starting to see some declines in occupancy. Still, those were pretty localized. And then, oddly enough, it wasn't the initial concern that I think a lot of people have at, oh, we're going to have these large infection rates hit and run through specific facilities or specific regions. I think a lot of the occupancy declines, at least anecdotally, were tied to fewer hospital discharges as hospitals started to defer elective surgeries that normally would end up with 20 or 30 day rehabilitation stays. We weren't seeing those to the same extent.
Abbey Ruby: We definitely saw that as well. The suspension of elective surgeries at hospitals that happened in March and April trickled through to occupancy rates in skilled nursing facilities in the weeks and months following that. And even now, as surgeries have picked back up, a lot of those are outpatient procedures, and they're still not doing inpatient procedures as much and therefore have less need for rehabilitation.
And on that point about declines in occupancy, I think that there certainly is some fear, and there was bad press as a result of COVID outbreaks in facilities, but anecdotally, I think more people are home, people have lost their jobs or are working remotely. And when you couple that fear with their being in the home, maybe there is more ability for people to provide care for someone who would otherwise need skilled nursing care at home. So all of that has combined to, over the summer and now in the fall, have an actual impact on occupancy that will probably continue for a while.
Tonya Scharf: I would chime in there as well to say you also have the flip side of that where the facilities themselves are reluctant to admit new residents for fear that resident could bring in the virus. So you've got this pressure on both sides.
Daniel Flournoy: Just within even the last couple of weeks, Tonya, and you may have seen this as well, we're starting to see some of those restrictions on admissions that obviously vary by region and are varied by even different metropolitan areas based on the spread and COVID rates and things like that, but we are starting to see even some of the harder hit areas with higher infection rates starting to ease up on some of those admission restrictions.
Morgan Ribeiro: Was there anything that you wanted to note in that about the PDPM (Patient-Driven Payment Model)?
Abbey Ruby: So as I mentioned, that was something that we were all talking about before COVID. And the interplay with PDPM and COVID is certainly interesting. I saw at least one analysis that the financial picture for SNFs would have been worse under the old Medicare reimbursement model. But COVID has certainly impacted the new PDPM model. One example is for group and concurrent therapy that was emphasized under PDPM. And a lot of operators were poised to really focus on group therapy as a driver of savings for facilities, and, of course, that's all but impossible with the pandemic. CMS very early on in the pandemic suspended group activities. And facilities, as part of their safety protocols, have really restricted that even as restrictions from the government might start to loosen up. So that has certainly been interesting. That's offset by some of the other stimulus relief programs, the PPP loan money and accelerated payment programs that have come into these facilities.
Morgan Ribeiro: Well, that's a great segue into our next topic. You’ve mentioned the stimulus relief programs, and there's been suggested reimbursement rates; anything in particular that you would note, Abbey, about some of those programs and adjusted rates?
Abbey Ruby: The government funds have certainly been a great help to a number of skilled nursing facilities. I largely represent lenders in the space, so one thing that we're focused on a lot is trying to discern the financial performance of facilities with the stimulus relief programs that have come in and the dollars that have come in, in particular lenders who rely on financial covenant testing on a monthly or quarterly basis, to ensure the underlying health of the borrower and the facilities that they operate are still processing and working through how to adjust their tests to account for what are essentially really lumpy financial statements and get to the actual performance. So that's something we'll continue to see in those conversations as banks and their credit committees think about those issues and as the guidelines and regulations around those funds, PPP funds, accelerated payment programs, change. They change constantly. That's something that we are really on top of with our healthcare regulatory team here at Waller to always have the up-to-date answers on how those programs are shifting and how the rules are shifting under them.
Morgan Ribeiro: Tonya, from your perspective on the real estate front, what are you seeing in terms of real estate assets in the SNF space right now?
Tonya Scharf: My perspective comes more from an owner-operator side, although I do represent lenders as well. But being an owner-operator myself of memory care facilities here in Tennessee, I come at it from more of that perspective. And most of my clients are in that vein. I think taking a step back and thinking about the overall impact of COVID, that we've lost people in senior housing facilities across the country, accounting for 35 percent of COVID deaths, that doesn't even factor into all of the people that became sick with the virus. Those are just the deaths that resulted from it. Obviously, loss of residents is an integral part in the nature of business of senior housing. While skilled nursing facilities and senior housing facilities continually face economic impact of the loss of residents on a regular basis—think of the flu season every year—those losses are generally offset by an influx of new residents in the pre-COVID era. In the COVID era, it's extremely challenging, as we mentioned earlier, to offset that loss for multiple reasons, including, like we mentioned earlier, reluctance of family members to bring their loved one into the facility for fear that they will catch it at the facility. And then as we mentioned earlier, the reluctance of the facility itself to bring in a new person that could actually bring the virus, and in the facility’s own inability to potentially bring in new residents due to regulatory matters, or the fact that they're diverting all resources to combating the virus already.
Owner-operators are facing so many different problems in light of the COVID era, including employment matters, thinking about it from that perspective. Retention of employees has long been an issue for senior housing facilities, and that coupled with a shortage of qualified applicants right now is creating a payroll nightmare for operators paying massive amounts of overtime to current employees in an attempt to combat the virus’s infiltration of the facility, and all of the measures that have to be taken in connection with the isolation of existing residents that may have the virus.
You've also got increased costs and the sheer volume of PPE that's needed to ensure the health and safety of residents and employees alike. Specifically the use of the N95 masks has caused so much of a further burden on these facilities. I would also call out the increased costs of CGL (commercial general liability) insurance specifically. I've seen our operators in certain instances having their CGL coverage premiums increasing by up to 200 percent. We've had clients lucky enough to have certain baked in caps in their annual increases in their insurance policies, but we've also seen that not be the case. So on the lending side, lenders may be wanting an increase in their insurance reserves as a result of these higher premiums coming out.
Regarding the real estate assets themselves, your senior housing property valuations are declining, as Abbey mentioned a little bit ago. In addition, since that's just from an appraisal perspective, real property tax rates are on the rise. The foregoing coupled with all the other financial pressures presented by COVID has resulted in widespread requests by my clients and others for relief from rent payments in the event they're in a leased facility, and loan forbearance requests. Based on my experience, landlords have been willing to offer a few months of rent abatement, and rent deferral payment plans are actually more than norm right now. And on the real estate financing side, my clients have been requesting relief from financial covenants as a direct result of the decreased valuations that I noted a second ago.
With lenders being somewhat amenable to loan to value covenant holidays, I've been seeing six months to potentially a year on that interest forgiveness period, some clients have been able to offer up equity cures for financial covenant breaches and requesting relaxing of repayment penalties, prepayment penalties. In exchange, I've seen lenders asking for enhancements to informational covenants. Others are more flexing their rights to block distributions to investors or limit those distributions to only after certain thresholds are met utilizing cash sweep structures and other avenues to reserve cash in the borrower structure. Just a lot of pressure on operators right now.
Abbey Ruby: One thing that is different, we do on the real estate side and we also do on the asset base or revolving loan side, and a lot of those operators right now do have funds. They have funds from the government stimulus programs in their pocket, and they're going to their lenders. When we looked at this coming down the line in February and March, we prepared on both sides to be looking at a lot of forbearance agreements, amendments, extensions, waivers, all of those things. And we've seen that on the real estate side. But more on the AR side, we've seen zero balance letters, we've seen borrowers saying, “Well, I don't want to pay a unused line fee, because I have plenty of funds, and I'm not using your line at all,” who then are potentially going to just want to terminate their lines. And Daniel, I'm not sure what your thoughts are on this, but they might come to regret that decision in 6, 12 or 18 months.
Daniel Flournoy: We've certainly seen the same thing where everybody expected, the operators especially, to take a huge hit to their bottom line. But because of the various stimulus and reimbursement programs and accelerated payment programs that have come in, we're seeing the same things where operators really are flush with cash. And, without getting into too many details regarding what our specific lenders are doing, we have seen our lenders successfully get creative with their loan terms and their pricings and their covenants. And, they've been able to hold onto some borrowers that might otherwise be looking to either pay their loans off, or refinance them out, because they're so flush with cash at this point. And so I think the lenders that we're seeing be successful through this are the ones that are flexible, and the ones that aren't too rigid and are willing to think outside the box as to what they can offer their borrowers in what is clearly a completely unexpected situation from a societal, economical, regulatory, but also just underwriting standpoint. So, that's an important point to make.
Morgan Ribeiro: Looking into the future, I'd be curious to hear from all of you. Daniel, I'll start with you, just in terms of the expectations and challenges that we foresee over the next 12 to 18 months.
Daniel Flournoy: The big question is, when exactly is the government money going to run out? I mean, is it going to last 6 months, 12 months, 18 months? Who knows? Obviously, I don't think anybody's expecting this current situation to continue indefinitely. And certainly there's the question of the looming election and what impact that's going to have on the various stimulus and relief programs. So it's a little bit tough to say. Obviously, we have seen some operators that have chosen to go without working capital lines in the short term because they are so flush with cash. I think a big question could be if, when the money runs out, what is that going to look like? Is there going to be a new wave of ABL lending or all of a sudden lenders going to be back into the driver's seat with more borrowers to choose from? Or is it going to be harder to get an ABL loan at that time for these working capital lenders and the operators that need those funds to kind of bridge the ups and downs in their AR?
Another big question is obviously, for the facilities that have HUD mortgages, and they require approval for working capital loans for those facilities. As I'm sure you guys have seen, HUD can get backed up, and it can take a minimum of three months, sometimes up to a year, for working capital line to get approved through HUD. And so all of a sudden, if we've got a number of facilities that have paid off their working capital lines, and all of a sudden have to now go back to HUD, is there going to be a big push? Maybe we'll start seeing some liquidity crunches for different operators as these loans get backed up with HUD.
Tonya Scharf: Expanding on Daniel's point about when will the government money run out? Conversely, when will the government run out of money and come back and be looking to fill their coffers, if you will. And we're going to start seeing a continued increase in property taxes, putting additional pressure on operators, and then in the very near term, what everyone's looking at is the pending flu season coupled with COVID. How's that going to go? And how detrimental is that going to be? Operators are going to need to take a very proactive and thorough approach; that'll be imperative to keep the facilities in operation. But that comes at a very high cost harkening back to what I spoke about earlier about over time utilization of even more PPE, retention of existing employees, and then, getting their project stabilized, getting people back in the facility.
Morgan Ribeiro: Getting practical: How are you advising your clients right now? How do they prepare for this? I think, again, there's just so much uncertainty, everyone's having to be extremely flexible and adaptable, and deal with the unknown at a level we've never seen before. But if you're offering them up some tips and advice, Abbey or Daniel, from the lender perspective, and Tonya, from the operator perspective, anything you'd share with our listeners?
Daniel Flournoy: The biggest help that we provide to our clients right now is staying up-to-speed on the latest reimbursement and stimulus and relief changes. I think that's one of the best values that we can provide you both for our financing team, but also through our healthcare regulatory team. We've got several folks there that are following the government releases and advice on reimbursement and what they have to comply with from a regulatory standpoint, and helping our lenders understand the exact impact, not only of these programs and the advanced payment terms as they're released, but then almost more importantly, as they're amended. Obviously, the PPP loan program that everybody saw at the beginning of the year looks vastly different now, based on the continuing guidance, than it did at the beginning. Watching that, and helping our lenders both stay up to speed on those terms, just because there are so many, and they're dealing with their own issues related to COVID in the current economic climate. So staying up to speed on those, and then also helping them navigate what comes next, staying abreast of the changes and staying on our toes is probably the most important thing we can all be doing right now.
Abbey Ruby: The other thing that I'll mention, too, and we certainly saw at the end of last year and beginning of this year, that there were some facilities that were probably headed for bankruptcy or receivership that have been able to stay out thus far in part with support of the stimulus funds and things like that, but for some of those, especially as we do think that money will not last forever, that is probably inevitable for some facilities. And so we're even now working really closely with our restructuring team, we actually have our restructuring team as part of our same group as our front end lending lawyers, and we all work really closely together at all cycles of the economy. But just to make sure that our lender clients and our operator clients are not caught off guard if and when those funds do dry up, that they're well positioning themselves now to best navigate through that circumstance. And there are some unique things about the healthcare space in the SNF space that makes our team really well poised for those in partnership with our regulatory colleagues, different than just a traditional bankruptcy group. So making sure that we're ready for that if and when it comes.
Morgan Ribeiro: Absolutely. Thinking about that well in advance before there is truly a troublesome situation on our hands for both, like you said, our lender clients and for our operators. Tonya, anything that you would add to that?
Tonya Scharf: I would just close the loop regarding our clients requesting assurances that their loan is going to be forgiven and closing that loop and making sure that they have what they need to give to their lender, the evidence that loan has been forgiven, and that the PPP money can be counted on their balance sheet.