Bad Trend: Two California Hospitals Go Belly-Up

SAN FRANCISCO — The recent bankruptcies of two community hospitals in California show how difficult the current economic environment is for health care providers — and how much effort is required to actually bankrupt a hospital.

The Sierra Kings Health Care District, a public hospital district near Fresno, filed for Chapter 9 municipal bankruptcy protection last week, and Downey Regional Medical Center, a nonprofit provider near Los Angeles, filed a Chapter 11 bankruptcy last month.

These cases represent extreme financial meltdowns, and they dramatize just how vulnerable stand-alone community hospitals are to reimbursement cuts and recession. But their roads to bankruptcy also show why the vast majority of their peers aren’t filing for bankruptcy: both bankrupt institutions blame a lot of their woes on bad management, not bad times.

“There are a broad set of financial pressures hitting all hospitals, including community hospitals,” said Martin Arrick, managing director of the health care group at Standard & Poor’s in New York. “If your liquidity and overall balance sheet is weak, then you’re really vulnerable.”

Arrick said California hospitals may face particularly large capital needs because state law requires them to retrofit their buildings to better survive earthquakes, but the main pressures face hospitals everywhere.

For instance, the Landmark Medical Center in Woonsocket, R.I., last year entered into special mastership proceedings, which is similar, under Rhode Island law, to a federal Chapter 11 bankruptcy reorganization.

Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings all have negative outlooks on the nonprofit health care sector.

Over the past year or so, hospitals have faced declines in investment portfolio values, difficulty accessing credit, and weakened operating performance, said Brad Spielman, a senior health care analyst at Moody’s. Operating margins have come under pressure because of increased demand for charity care, higher bad debt expenses, and decreased demand for profitable discretionary procedures.

That said, Spielman doesn’t think the recent bankruptcies presage a wave of failures in the universe of credits that Moody’s rates. He said he’s begun to see fewer downgrades and has seen stronger health care providers in California improve their performance, despite the hard times.

The two most recent California hospital bankruptcies are at relatively small, stand-alone hospitals that lack the support that comes from being part of a larger health system. Each blames management errors for a significant part of their woes.

The 181-bed Downey Regional Medical Center is the bigger of the bankrupt hospitals, but it doesn’t rank among the largest in the Los Angeles area.

“It’s a small facility in a lot more competitive market,” Arrick said. “It’s had management changes left and right.”

The nonprofit sought bankruptcy protection in September, saying it had faced a liquidity crunch and demands for more than $9 million in payments from physicians groups in a dispute with the hospital over the termination of money-losing capitation contracts.

The medical center blames many of its problems on poor financial systems, which led to improper cost accounting for managed-care contracts and the failure to fully bill customers for a decade. The Downey hospital says it has faced $25 million in one-time charges to fix the problems since hiring a new chief executive officer two years ago.

“With no cash reserves since March of 2008, and with the credit markets in free fall for the past year, DRMC has struggled with liquidity as it was making these monumental changes,” the hospital said in a press release announcing the bankruptcy.

The hospital said in a bankruptcy court filing that it has secured $15 million of debtor in possession financing from Healthcare Financial Group, which was formerly a unit of Daiwa Securities America.

In its bankruptcy filing, the Downey medical center said it has about $26 million of hospital revenue bonds sold through the California Health Facilities Financing Authority in 1993. Standard & Poor’s this week downgraded the long-term ratings on the debt to C with a negative outlook from CCC.

The agency said the medical center has been unable to provide financial statements for fiscal years 2007, 2008 and 2009, and it has run through four chief financial officers in the past 10 years.

Eric Rose, a spokesman for the hospital, said the bankruptcy filing has made it hard to get auditors to sign off on the financial reports, but the medical center expects to release the reports by the end of the year.

“We have paid and will pay the bondholders on schedule and in full,” he said in an e-mail. He said pledged revenues are more than adequate to cover debt service.

The much smaller, rural Sierra Kings Health Care District cited a combination of managerial incompetence and economic hard times when filing for Chapter 9 bankruptcy protection last week. The hospital district has posted operating losses since at least 2006, according to its financial statements. It is located in a region with unemployment rates approaching 15%.

But hospital management made matters worse by spending $1.7 million of bond funds on operating expenses, beginning in June 2008, the district said in a material event notice earlier this month.

It said it had fired or placed on leave the executives who misused bond proceeds. Interim chief executive officer Sanford Haskins did not return calls seeking comment by press time Thursday.

Sierra Kings sold investment-grade debt as recently as August, when it sold $4 million of general obligation bonds. Moody’s was the only agency that rated the deal and cut the district’s ratings to Baa3 from Baa1 ahead of the issue. It downgraded the debt to Ba2 from Baa3 last week and placed the credit on watch for further downgrade after the district’s board voted to declare bankruptcy.

Standard & Poor’s rated the hospital district’s earlier $16 million GO issue and had downgraded it to below investment grade before the August offering and the subsequent bankruptcy. The agency cut the rating to C from B after the bankruptcy. The rating is on credit watch with negative implications.

Sierra Kings, which has about $32.4 million of muni bonds outstanding, didn’t seek a rating from Standard & Poor’s for the August issue or disclose the junk rating in its official statement.

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