H2C PERSPECTIVE

Strategic Capital Planning

Does Your Strategic Capital Plan Need a Refresh? What Healthcare Leaders Should Consider

January 2022

Capital Planning Image

An adaptive strategic capital planning process can help sharpen organizational focus toward achieving 

transformational goals. 

Strategic capital planning never becomes less critical, but it does need to change with the times. And never has this become more obvious than today, after almost two years of unprecedented challenges for healthcare providers.

In the 1990s, the introduction of “integrated strategic and capital planning” shifted the focus of healthcare finance leaders from how best to finance a project to how best to finance the corporation—i.e., to ensure access to capital to fund the organization’s mission over a longer term. This “corporate finance” approach sought to minimize capital costs by positioning the organization to access markets when they were favorable and, as a result, maintain the strongest credit rating and an acceptable level of risk. However, for many organizations, the objective of the plan was to fund a mission that included providing care across the full continuum, primarily through internally generated funds and external debt capital.

 

Today, as leaders assess the ongoing impact of an ever-more-disruptive healthcare environment on their organization’s financial and operational outlook, they must consider not just the types of capital initiatives their organization should undertake and how to fund them, but also, “Can we fulfill our strategy and mission, can we do it well—and can we or should we do it alone?” An adaptive strategic capital planning process can help healthcare leaders answer these questions as well as sharpen organizational focus toward achieving the transformational goals of reducing per capita costs and improving population health as well as the patient experience.

A more holistic capital planning approach is particularly well-suited to a COVID-19 environment, where some organizations are finding they may not be optimally positioned or able to own and operate all the care they want to provide. As a result, many healthcare leaders have begun to emphasize resource allocation and capital investment in their core (and not easily replicable) hospital inpatient service mission over enhancing ancillary capabilities and diversifying service lines.

Adapting Your Capital Decision-Making Strategy

For many organizations, federal relief funds and advance payment dollars helped protect financial viability while providing the funds for innovation. But even with federal help, some organizations deferred needed capital expenditures that they must deal with in the near future. Some will find that they are in a weakened position after special funds run out.

 

As the prolonged nature of the pandemic continues to drive unbudgeted operational and capital spending, healthcare leaders must reassess whether their organization has ongoing access to sufficient capital to meet the needs of the communities it serves. Further, they must do so within a level of risk tolerance that is acceptable to both the board and key stakeholders.

 

Leaders are realizing the need to become more creative in exploring how to access capital or ensure their organizations have enough capital to weather changing circumstances. Some are looking for ways to raise capital from different sources. Others are exploring opportunities to mitigate the amount of capital investment required to meet their community’s needs and protect long-term sustainability. A refreshed capital planning process and updated strategic capital plan supports this effort, empowering leaders to make decisions that support an appropriate and achievable mission during the pandemic and beyond.

The operating forecast drives balance sheets and cash flow statements and considers:

  • Strategic vs replacement capital needs

  • Debt capacity, based on credit rating objectives and risk profile

  • Funding sources, including cash philanthropy, and debt

  • Capital allocation policies

When it comes to strategic capital planning, speed to insight is critical. H2C develops comprehensive strategic capital plans in less than 90 days. This includes the critical step of reviewing our initial assessment with the organization’s leadership—including the board of trustees—to build a consensus around capital philosophy and policies to drive capital decisions in the future.

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Strengthening Agility in an Uncertain Environment

To establish the optimal strategic capital plan for a dynamic environment, leaders must establish a capital philosophy, or the financial tenets that guide the organization’s capital decisions and tolerance for risk. Whether or not it is formally stated, every organization has a capital philosophy that drives financingdecisions. However, the philosophy is not always known and may not represent a consensus of board and management. A particular focus of H2C’s strategic capital planning process is to ensure that the organization’s leadership understands, among other factors, the advantages of debt, the importance of liquidity, the perspectives of investors, the implications of credit ratings, and the risk implied in certain capital strategies.

A capital philosophy both guides the analysis of capital structure options and supports the selection of the ultimate plan. A multi-year financial forecast—one that brings together the outlook for operations and cash flow, capital requirements to support the mission, credit ratio targets, and debt policies—enables the evaluation of strategic initiatives and funding scenarios. Most important, it enables leaders to run sensitivity analyses to estimate the level of risk associated with a given strategy.

Leaders should evaluate a broad range of assumptions to identify new areas of risk, uncover areas of opportunity in their market, and shape their organization’s response. For organizations whose financial position has weakened during the pandemic or that were already struggling prior to arrival of COVID-19, this may mean evaluating alternative sources of capital—such as by divesting non-core assets—or exploring ways to strengthen operations, such as through partnerships with specialty operators. For financially strong organizations that are emerging from the pandemic with their balance sheets intact, performing sensitivity analyses around their financial forecast not only ensures they are prepared for another surge in COVID cases or other unexpected developments, but also enables them to be opportunistic with regard to growth opportunities.

 

The right strategic capital plan gives organizations a degree of flexibility and the ability to react more quickly during periods of uncertainty. The selected plan serves as a dynamic tool that measures actual results versus the plan. Especially in an uncertain environment, a robust, real-time tool for measuring results against forecasts empowers leaders to make mid-course corrections to achieve long-term objectives.

 

When hospital leaders possess a deep understanding of their organization’s financial forecast as well as its capital needs, with the aid of their strategic capital plan and tools, they are better positioned to objectively evaluate options for mitigating operational and financial risk. They also can more easily uncover new ways to optimize their performance and their long-term financial outlook.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Giving Your Strategic Capital Planning Process a Refresh

Take a new look at your capitalization philosophy. How has the recent crisis affected leaders’ views around risk and liquidity? Should the organization’s debt mix be adjusted? Does the organization have sufficient liquidity to withstand future negative events? In a volatile or margin-compressed environment, diversifying funding sources and strengthening relationships with banks, investors, and community donors is important. So is stress testing for “black-swan events” to determine the impact on investment income, interest expense, access to capital, and headroom for financial covenants.

 

Consider new ways to meet the organization’s mission. For example, while the need for behavioral health services ramped up during the pandemic, not every organization had the expertise or the bandwidth to meet these needs on their own. It’s one reason why one Midwest health system entered into a joint venture with a national behavioral health services provider to build a 184-bed behavioral health facility earlier this year. This transaction demonstrates the value health systems can gain when they strike the right connection to meet their community’s behavioral health needs.

Reevaluate capital projects to determine whether they are still consistent with the organizations's go-forward strategy. In some instances, a project may still be relevant, but the scale and timing of the project should be adjusted. For example, 76 percent of hospitals and health systems delayed one or more construction projects during COVID-19, and 29 percent canceled at least one project altogether, a recent survey found. In addition to reconsidering and redesigning projects, hospitals have also placed greater emphasis on modular designs that provide more future flexibility and adaptability. The pandemic caused hospitals to shift capital expenditures toward renovating existing space or creating temporary structures to accommodate the infectious nature of the disease.

Evaluate the impact of the pandemic on your care delivery model and associated revenues. This includes taking a hard look at how consumer preferences have changed throughout the pandemic, with an emphasis on on-demand, virtual care, and emphasizing virtual over physical investments. Further, hospitals contemplating more robust non-hospital-based outpatient services strategy must determine whether the organization can still count on a high percentage of commercially insured patients for these services, especially if new competitors have entered the market or other organizations have adjusted their offerings.

Reassess your real estate strategy. Strong investor demand and limited supply of assets created a window of opportunity for health systems to monetize their medical office buildings during the pandemic, with the largest buyer pool for single-tenant medical office buildings that the market has ever seen (1). For example, in December 2020, Yuma Regional Medical Center monetized an 11-property healthcare real estate and administrative office portfolio located throughout greater Yuma, Ariz. The portfolio monetization enabled Yuma to extract cash tied up in real estate and reinvest dollars in the system’s core areas of business. However, another real estate trend is also emerging among health systems: the move toward buying back the facilities they currently lease. In many instances, these are buildings that the organization chose to monetize 10, 15, or even 20 years ago. Now, some organizations may find economic advantages in owning versus renting, such as property tax advantages and the ability to avoid bottom-line implications of lease accounting standards. Developing a cogent real estate strategy will help your organization fully understand its options in light of its goals and objectives. It will also enable leaders to carefully assess the ramifications of a particular transaction before proceeding.

Times of Crisis Can Be Strategic Litmus Tests

 

As leaders continue to assess the ongoing impact of COVID-19 on their organization’s financial and operational outlook and access to capital, adopting a more comprehensive approach to strategic capital planning can help organizations prepare for healthcare’s future state. It can also bolster organizations’ ability to weather the next crisis by empowering leaders to draw upon their capital playbook when circumstances change. H2C’s strategic capital planning process is consistent with our industry-leading approach to develop tailored, custom solutions for the unique challenges and needs of our respective health system clients. With H2C’s expert strategic capital planning advice, health system leaders can optimize access to capital at favorable terms and timing, identify new sources of capital to achieve long-range strategic goals, and enhance their organizational adaptability to disruptive forces. 

 

For more information, contact the authors.

Footnote:

 

  1. H2C Q4 2020 MOB Report, March 2021, https://www.h2c.com/mar-20-2021-4q20-mob-report.

Financial Forecast Modeling: Bringing It All Together

Financial forecast modeling starts with an assessment of the organizations market demographics along with key considerations related to reimbursement, utilization rate, and the organization's operating expense structure.

From There, Leaders Evaluate the Implications

 

Sensitivity analysis, including assumptions related to strategic initiatives and service lines, helps identify the optimal strategic capital plan.

About H2C Securities Inc. ("H2C")

 

H2C is a strategic advisory and investment banking firm committed to providing superior advice to public and private healthcare and higher education institutions and related organizations throughout the United States. H2C’s professionals have a long track record of success in mergers and acquisitions, capital markets, and real estate transactions, acting as lead advisors on hundreds of transactions representing billions of dollars in value.

Securities and services offered through H2C Securities Inc., member FINRA/SIPC, a registered broker-dealer and an indirect subsidiary of Fifth Third Bank, National Association. All rights reserved. Securities and services offered through H2C Securities Inc.: Are Not FDIC Insured; Offer No Bank Guarantee; May Lose Value; Are Not Insured by any Federal Government Agency; Are Not a Deposit. 

For more information, visit h2c.com

 

About The Authors

Victoria Poindexter Headshot

Victoria Poindexter is a managing director at H2C. Contact Victoria at vpoindexter@h2c.com.

George Huang Headshot

George Huang is an executive director at H2C. Contact George at ghuang@h2c.com.

To establish the

optimal strategic capital plan for a dynamic environment, leaders must establish a capital philosophy.

The right strategic capital plan gives organizations a degree of flexibility and the ability to react more quickly during periods of uncertainty.

For healthcare leaders, key action steps that should guide the strategic capital planning process include the following:

  • Take a new look at your capitalization philosophy 

  • Consider new ways to meet the organization's mission

  • Reevaluate capital projects to determine whether they are still consistent with the organization's go-forward strategy

  • Evaluate the impact of the pandemic on your care delivery model and associated revenues

  • Reassess your real estate strategy