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Honesty The Best Medicine In Hospitals' Capital Search
By Kerri Houston
September 5, 2002

Stop me if you've heard this one: a handful of high-flying executives line their pockets while expanding their corporation too fast, then mislead employees and investors as they scramble to cover up nose-diving finances with auditors asleep at the wheel or in on the fix. Enron? WorldCom? Adelphia?

Even more frightening - this could be your local hospital.

In 1998, before corporate reform became fashionable, Pittsburgh's Allegheny Health, Education and Research Foundation, a not-for-profit healthcare system, collapsed in a manner remarkably similar to today's corporate implosions.

In under a decade Allegheny's former CEO Sherif Abdelhak had built a 14-hospital empire boasting $2.2 billion in revenues. As his healthcare leviathan failed under the weight of $1.3 billion in debt and went belly up, Mr. Abdelhak allegedly pocketed millions in low-interest loans, salary and ostentatious perks.

On September 3, Pennsylvania's Attorney General will try Abdelhak on charges that he looted $30 million in medical endowments. The Securities and Exchange Commission claims that the former CEO improperly shifted $100 million in reserves to turn real losses into paper profits - with his auditors participating in the cover-up.

Unfortunately, Allegheny's train wreck is not an aberration as many other not-for-profit hospitals are in danger of financial meltdowns that could create healthcare risks for their patients.

Last month Slidell Memorial Hospital in New Orleans produced brochures for voters warning that the hospital would cease to exist if they rejected a $35 million bond issue authorization. The campaign didn't work, and the hospital is now seeking financial partners to bail it out.

New management at New York's Nyack Hospital has a daunting mess on its hands. Last February, after auditor KPMG abruptly terminated its relationship with the hospital, Nyack warned that its net assets had been overstated by millions of dollars. It has since released restated financials and filed a $50 million lawsuit against KPMG. During an investor conference call, CEO David Freed admitted that Nyack is hungry for capital.

Certainly not all not-for-profit hospitals are falling like dominos. Over the last two decades, competition and market forces have fueled a steady pace of hospital mergers, acquisitions and closures, but the trend for financial instability is likely to heat up - perhaps significantly - and certainly bears watching.

Even financially sound hospitals need abundant capital to finance the acquisition of equipment, expand services, and upgrade aging physical plants and information technology. However, a new report by the respected Healthcare Finance Forum warns that over the next two to seven years, "the amount of capital and revenue for not-for-profit hospitals is likely to diminish... not-for-profit hospitals have a short window of opportunity - perhaps 18 months - before revenue increases slowly and their financial performance begins to dwindle."

One unfortunate outcome of all this has been the length to which some hospitals have gone to put the best face on their financial condition when courting investors and the bond rating firms. It is so prevalent that Modern Healthcare, a leading trade publication, recently graced a cover with, "Happy Talk - When Hospitals Speak to Investors, as Opposed to Government, They Accentuate the Positive."

Some hospitals are not averse to slamming the competition in an attempt to improve their own position within the community. Norton Healthcare of Louisville, Kentucky is a not-for-profit that has landed itself in the news after creating a public feud with cross-town rival, Jewish Hospital. Perhaps Norton hopes that all the dust it kicks up will cloud and deflect scrutiny of its own financial challenges.

In 1998, Norton acquired four Kentucky hospitals from troubled Columbia/HCA, which was the subject of a sweeping fraud investigation. The purchase price was undisclosed, but it has been widely reported that Norton took on more than a half billion dollars in debt. Yet despite three straight years of running an aggregate operating loss of more than a $100 million, its CEO told the Louisville Courier in April he was "delighted with our operational improvements and our financial performance." He claimed that Norton would have broken even last year had the stock market not tanked. That Norton relied on a slumping market to finance crucial healthcare services will likely evoke little sympathy from the sick people of Louisville.

Fitch Ratings recently affirmed an "A-" bond rating for Norton but warned that a "failure to demonstrate ongoing financial improvement could cause downward pressure in the rating." Norton's debt service obligation increases significantly in 2006.

Most not-for-profit hospitals are holding up well considering the unforgiving medical, fiscal and demographic changes invading the entire healthcare sector. But the patients, communities and investors that rely on them deserve more fact and less spin. Given the recent epidemic of creative accounting in corporate America, hospitals should also adopt good governance reforms in the areas of CEO and Board accountability and financial reporting.

Now is not the time to slap happy face Band-Aids on financial statements bleeding red ink.