Health Care Equipment Leasing

Where We've Been

Uncertainty is a term often used in business commentary in recent years, and nowhere could it apply more aptly than to health care finance. The complexity of the ACA, its staged rollout of new regulations and mandates, and the political vitriol surrounding its implementation, give hospitals, doctors' practice groups, and care centers reason to approach new equipment acquisitions with caution.

Patient populations served by a given facility may change drastically in needs and number over the next few years. Yet the source of revenue to support increased demand is questioned. Of particular concern are patients covered by Medicare and Medicaid. These patients' bills are covered by state and federal government reimbursements, but how much these reimbursements will increase commensurate with expanded service is unknown. Further, payment evaluation procedures are moving toward a quality-of-care model from traditional fee-for-service and are yet to be standardized. It is part of a larger process of hospitals adjusting to serving more insured patients while patients slowly adjust behavior, increasingly visiting the doctor's office for preventative care, rather than seeking acute treatment at an emergency room. The transition is slow as previously uninsured patients join Medicare, Medicaid or private insurance. We have seen over the last couple years, and likely will see in the near future, delays or cutbacks in capital expenditures until the new landscape becomes apparent.

Through recent years' policy debates and the accompanied politicization of health care, analysis of the industry's financial trends often loses focus on fundamentals that have always set the sector apart. Number one and coincidentally, like politics, all health care is local. It is an industry that largely cannot be outsourced. A patient receives treatment in person from local doctors. Notably, location matters as well: A suburban outpatient clinic has different equipment needs than an urban trauma center. Regardless of the nature of the facility, however, health care equipment leasing has stayed fairly steady over the last few years while other industries, notably manufacturing, have mirrored the economic downturn.

Though the localism of health care and the leasing that follows is relatively stable, it does not necessarily signify that health care is “recession-proof.” True, hospitals have a unique mission that prohibits refusing treatment to a patient and, in turn, state governments provide tremendous subsidies to ensure this service. Even so, high unemployment, and therefore lack of access to private health plans, may dissuade patients from coming for all but the most severe treatment. Additionally, elective surgery and pre-emptive care have dropped precipitously in the last few years. The result is falling hospital revenues and lower margins resulting in some hospitals' inability to access capital to pay for new equipment or technology needed to compete or comply in the health care market. The ACA may change this. If it works as envisioned, more patients will be insured and will be more likely to seek care. Despite the uncertainty surrounding government reimbursements, this is additional revenue converted from what had been the cost of uninsured patients visiting emergency rooms. Crucially, the health care industry has a unique drive toward new technology. New systems and equipment often make great strides in a short amount of time, and their purpose ' extending lives and relieving suffering ' is universally supported. A high replacement rate means the usage of equipment leasing is often higher than in other industries. It will likely stay that way, though not without challenges.

The Road Ahead

The HITECH Act will continue to create additional opportunities for the equipment leasing industry. The HITECH Act, passed as part of the American Recovery and Reinvestment Act of 2009, was legislation propelling significant expansion of technology in the health care industry. Chief among the regulations was incentivizing the “meaningful use” of electronic health records (“EHR”) among doctors and hospitals. The Act also tightened enforcement of HIPAA privacy provisions and disclosure requirements.

Since its passage, institutions have spent considerable resources plotting the timeline and effective budgeting toward implementing its directives. Significant among the requirements is the full incorporation of EHR in hospital systems, and eventually smaller doctors' practices. If completed before 2014, government subsidies are available to these institutions, partly reimbursing the investment in EHR. Challenging the process, however, is the squeeze between a need for speed ' 2014 isn't that far off ' and the need for perfection. The IT infrastructure of a health care institution is as essential as the plumbing of the building itself. The wrong system, or the right system poorly implemented, can lead to messy, costly results. In any case, if a hospital does not comply with EHR Meaningful Use criteria required under HITECH, it may be subject to financial penalties (reductions in Medicare reimbursement) scheduled to begin in 2015.

The relatively new importance of EHR presents a problem for a leasing institution. While an MRI machine is relatively easy to evaluate ' it's revenue generating and is hard collateral ' an IT system supporting EHR is neither. The system is essential use equipment: Without it, the hospital cannot function, even though it does not directly generate revenue. Additionally, the system is a soft asset with little residual value. Servers and computer equipment lose value and go obsolete quickly. Instead, the true worth of the EHR system, and where its success or failure lies, is in the staff training and implementation at the hospital from patient check-in to treatment room to pharmacy. An installation by a top-tier IT vendor helps a bank evaluate the lease, but the success of implementation, and therefore suitability for a lease, runs unevenly from hospital to hospital. Evaluating such soft assets on a large scale is relatively new for equipment lessors, where there are few ' if any ' precedents in health care.

The importance of a highly functional IT system is a relatively new focus area for banks and other leasing institutions. To continue the plumbing analogy above, it would be difficult to evaluate whether management has made an investment in “good pipes” until the system is turned on. Should operations head south, it is similarly difficult to ascertain whether a solution is to spend an additional $3 million for patched fixes, or another $20 million to overhaul and start again. As few EHR systems have been implemented on such a broad scale in the past, the frequency and severity of such fixes is an open question. In the current state of health care leasing, uncertainty is on all sides while all parties simultaneously feel pressure to jump into the abyss.

Another factor that has contributed to increased usage of equipment leasing in the health care marketplace is the 50% or 100% bonus depreciation eligibility for new equipment purchased during 2011 and 2012. Unfortunately, this turbocharged accelerated depreciation method is set to expire at the end of this year. This may particularly affect not-for-profit health organizations. Not-for-profits, which by their nature, cannot directly benefit from tax depreciation, will be without the opportunity to have the tax benefit passed through to them in the form of lower interest rates by their equipment lessor. What had been a method allowing 100 to 200 basis points off the all-in effective yield to the customer may drop to 50 to 100 basis points. Not-for-profits are not provided unique advantages in HITECH or ACA legislation and are without the ability to take advantage of other tax incentives, so this loss is particularly impactful.

In addition, the proposed change to standards in accounting for leases by IASB/FASB has caused concern over the use of operating leases. Many CFOs are hesitant to utilize this popular lease structure for health care equipment due to its negative impact on their ability to finance debt. The change, which may come online as early as 2014, though more likely in 2016 or 2017, will include operating leases on a lessee's balance sheet, where they were previously absent. For-profits and not-for-profits alike carefully watch their balance sheet to manage financial ratios and their ability to finance debt. Following implementation, the shift will adversely affect debt ratios, and could create a bank covenant violation for some lessees overnight. As a result, borrowing rates could become more expensive and prohibit any new equipment leasing.

In response, health care may move away from operating leases. We may see increased usage of tax-exempt leases that provide lower rates than taxable fixed-rate financings. Many state or local authorities offer these programs. Typical transaction sizes range from $1M to $10M and can include various types of equipment, including EHR systems. For-profits may move into capital leases ' or we may see a slight downtrend in leasing as standards shift.

Truly, uncertainty and a changing landscape provide an environment in which lenders, health care CFOs, and corporate counsels must stay on their toes. What remains unchanged is the inherent suitability of equipment leasing to the health care market because it remains equipment intensive with a continued need for new technology to improve patient quality of care. More than ever, to be successful in the health care space, equipment lessors need to stay informed and understand the changing regulatory environment and its impact on them and their customers.

Carl Boccuti is Vice President ' Senior Regional Director for TD Equipment Finance. Based in Cherry Hill, NJ, Boccuti focuses on equipment leasing in the health care industry. He can be reached at 856-470-5261 and [email protected].

Equipment leasing in the health care sector typically stands apart from leasing in other industries. This is a notable point even in stable times, but is especially important to acknowledge as the political and economic environment has provoked an out-of-the-ordinary shift in the U.S. health care market. Reviewing several major developing areas may provide a fuller picture of health care equipment leasing's recent past and lends insight into what lies ahead.

Federal health care reform is the obvious engine behind part of this shift. The Patient Protection and Affordable Care Act (“ACA”), though upheld by the Supreme Court in June, has many lingering questions regarding its effects. By increasing the rolls of insured patients, the ACA could be considered a boon to doctors and hospitals via increased demand. In serving more patients, equipment needs may likely increase. Despite the market's expansion, the cost of implementing related regulatory overhauls could offset increased revenues.

The ACA has provoked businesses in all parts of the health care industry ' equipment lessors included ' to examine their fundamental business practices. Significant regulatory changes like the mandates of the Health Information Technology for Economic and Clinical Health Act (“HITECH Act”), plus other factors like tax and accounting rule changes will also influence the health care leasing environment. Tax benefits allowing bonus depreciation are set to expire, particularly impacting not-for-profit institutions that receive this benefit in the form of favorable lease terms. Additionally, accounting standards boards are modifying how leases will be viewed on hospital balance sheets, affecting institutions' debt ratios and therefore ability to secure leases. It is a time of flux in an expanding industry, and this ambiguity affects the outlook as much as pure demand for new equipment.

Where We've Been

Uncertainty is a term often used in business commentary in recent years, and nowhere could it apply more aptly than to health care finance. The complexity of the ACA, its staged rollout of new regulations and mandates, and the political vitriol surrounding its implementation, give hospitals, doctors' practice groups, and care centers reason to approach new equipment acquisitions with caution.

Patient populations served by a given facility may change drastically in needs and number over the next few years. Yet the source of revenue to support increased demand is questioned. Of particular concern are patients covered by Medicare and Medicaid. These patients' bills are covered by state and federal government reimbursements, but how much these reimbursements will increase commensurate with expanded service is unknown. Further, payment evaluation procedures are moving toward a quality-of-care model from traditional fee-for-service and are yet to be standardized. It is part of a larger process of hospitals adjusting to serving more insured patients while patients slowly adjust behavior, increasingly visiting the doctor's office for preventative care, rather than seeking acute treatment at an emergency room. The transition is slow as previously uninsured patients join Medicare, Medicaid or private insurance. We have seen over the last couple years, and likely will see in the near future, delays or cutbacks in capital expenditures until the new landscape becomes apparent.

Through recent years' policy debates and the accompanied politicization of health care, analysis of the industry's financial trends often loses focus on fundamentals that have always set the sector apart. Number one and coincidentally, like politics, all health care is local. It is an industry that largely cannot be outsourced. A patient receives treatment in person from local doctors. Notably, location matters as well: A suburban outpatient clinic has different equipment needs than an urban trauma center. Regardless of the nature of the facility, however, health care equipment leasing has stayed fairly steady over the last few years while other industries, notably manufacturing, have mirrored the economic downturn.

Though the localism of health care and the leasing that follows is relatively stable, it does not necessarily signify that health care is “recession-proof.” True, hospitals have a unique mission that prohibits refusing treatment to a patient and, in turn, state governments provide tremendous subsidies to ensure this service. Even so, high unemployment, and therefore lack of access to private health plans, may dissuade patients from coming for all but the most severe treatment. Additionally, elective surgery and pre-emptive care have dropped precipitously in the last few years. The result is falling hospital revenues and lower margins resulting in some hospitals' inability to access capital to pay for new equipment or technology needed to compete or comply in the health care market. The ACA may change this. If it works as envisioned, more patients will be insured and will be more likely to seek care. Despite the uncertainty surrounding government reimbursements, this is additional revenue converted from what had been the cost of uninsured patients visiting emergency rooms. Crucially, the health care industry has a unique drive toward new technology. New systems and equipment often make great strides in a short amount of time, and their purpose ' extending lives and relieving suffering ' is universally supported. A high replacement rate means the usage of equipment leasing is often higher than in other industries. It will likely stay that way, though not without challenges.

The Road Ahead

The HITECH Act will continue to create additional opportunities for the equipment leasing industry. The HITECH Act, passed as part of the American Recovery and Reinvestment Act of 2009, was legislation propelling significant expansion of technology in the health care industry. Chief among the regulations was incentivizing the “meaningful use” of electronic health records (“EHR”) among doctors and hospitals. The Act also tightened enforcement of HIPAA privacy provisions and disclosure requirements.

Since its passage, institutions have spent considerable resources plotting the timeline and effective budgeting toward implementing its directives. Significant among the requirements is the full incorporation of EHR in hospital systems, and eventually smaller doctors' practices. If completed before 2014, government subsidies are available to these institutions, partly reimbursing the investment in EHR. Challenging the process, however, is the squeeze between a need for speed ' 2014 isn't that far off ' and the need for perfection. The IT infrastructure of a health care institution is as essential as the plumbing of the building itself. The wrong system, or the right system poorly implemented, can lead to messy, costly results. In any case, if a hospital does not comply with EHR Meaningful Use criteria required under HITECH, it may be subject to financial penalties (reductions in Medicare reimbursement) scheduled to begin in 2015.

The relatively new importance of EHR presents a problem for a leasing institution. While an MRI machine is relatively easy to evaluate ' it's revenue generating and is hard collateral ' an IT system supporting EHR is neither. The system is essential use equipment: Without it, the hospital cannot function, even though it does not directly generate revenue. Additionally, the system is a soft asset with little residual value. Servers and computer equipment lose value and go obsolete quickly. Instead, the true worth of the EHR system, and where its success or failure lies, is in the staff training and implementation at the hospital from patient check-in to treatment room to pharmacy. An installation by a top-tier IT vendor helps a bank evaluate the lease, but the success of implementation, and therefore suitability for a lease, runs unevenly from hospital to hospital. Evaluating such soft assets on a large scale is relatively new for equipment lessors, where there are few ' if any ' precedents in health care.

The importance of a highly functional IT system is a relatively new focus area for banks and other leasing institutions. To continue the plumbing analogy above, it would be difficult to evaluate whether management has made an investment in “good pipes” until the system is turned on. Should operations head south, it is similarly difficult to ascertain whether a solution is to spend an additional $3 million for patched fixes, or another $20 million to overhaul and start again. As few EHR systems have been implemented on such a broad scale in the past, the frequency and severity of such fixes is an open question. In the current state of health care leasing, uncertainty is on all sides while all parties simultaneously feel pressure to jump into the abyss.

Another factor that has contributed to increased usage of equipment leasing in the health care marketplace is the 50% or 100% bonus depreciation eligibility for new equipment purchased during 2011 and 2012. Unfortunately, this turbocharged accelerated depreciation method is set to expire at the end of this year. This may particularly affect not-for-profit health organizations. Not-for-profits, which by their nature, cannot directly benefit from tax depreciation, will be without the opportunity to have the tax benefit passed through to them in the form of lower interest rates by their equipment lessor. What had been a method allowing 100 to 200 basis points off the all-in effective yield to the customer may drop to 50 to 100 basis points. Not-for-profits are not provided unique advantages in HITECH or ACA legislation and are without the ability to take advantage of other tax incentives, so this loss is particularly impactful.

In addition, the proposed change to standards in accounting for leases by IASB/FASB has caused concern over the use of operating leases. Many CFOs are hesitant to utilize this popular lease structure for health care equipment due to its negative impact on their ability to finance debt. The change, which may come online as early as 2014, though more likely in 2016 or 2017, will include operating leases on a lessee's balance sheet, where they were previously absent. For-profits and not-for-profits alike carefully watch their balance sheet to manage financial ratios and their ability to finance debt. Following implementation, the shift will adversely affect debt ratios, and could create a bank covenant violation for some lessees overnight. As a result, borrowing rates could become more expensive and prohibit any new equipment leasing.

In response, health care may move away from operating leases. We may see increased usage of tax-exempt leases that provide lower rates than taxable fixed-rate financings. Many state or local authorities offer these programs. Typical transaction sizes range from $1M to $10M and can include various types of equipment, including EHR systems. For-profits may move into capital leases ' or we may see a slight downtrend in leasing as standards shift.

Truly, uncertainty and a changing landscape provide an environment in which lenders, health care CFOs, and corporate counsels must stay on their toes. What remains unchanged is the inherent suitability of equipment leasing to the health care market because it remains equipment intensive with a continued need for new technology to improve patient quality of care. More than ever, to be successful in the health care space, equipment lessors need to stay informed and understand the changing regulatory environment and its impact on them and their customers.

Carl Boccuti is Vice President ' Senior Regional Director for TD Equipment Finance. Based in Cherry Hill, NJ, Boccuti focuses on equipment leasing in the health care industry. He can be reached at 856-470-5261 and [email protected].