Inside the numbers: Ballad Health
Photo above: Alan Levine, photo by Scott Robertson
Better bond rating, merger mechanics and timing save Ballad $20 million a year
By Jeff Keeling
Ballad Health CEO Alan Levine is talking cash flow, and he’s happy.
It’s a Wednesday morning and Ballad’s fiscal year-to-date operating numbers look relatively grim. The newly formed health system faces an unprecedented challenge: leading regional population health improvements and quantifying those results for two states. Leadership must integrate two former rival hospital systems, overcome egos and short-term pain to “right size,” find synergies and improve quality. That “right-sizing” will occur against the backdrop of the continued shift to value-based payments, declining inpatient volumes and the compounding factor of operating in a region with slow to no population growth, low incomes and lots of people who are old, sick or both. Ballad must generate sufficient cash flow to pour hundreds of millions of dollars into population health, mental health, research and other worthy endeavors as part of fulfilling the Certificate of Public Advantage (COPA) in Tennessee and Cooperative Agreement in Virginia. Those strict oversight instruments represent the framework of the “state action immunity” required to justify the competition-diminishing merger that produced great angst at the Federal Trade Commission.
If those challenges send Levine into an emotional downturn he’s not revealing it. He lists accomplishments since Ballad took control of Mountain States Health Alliance and Wellmont Health System Feb. 1. “We’ve merged two corporate structures,” Levine says. “We’ve done a complete plan of finance and gone to market. We’ve redone all of our benefits. We’ve created a senior management team and integrated the management team throughout the system – and we’re trying to get our arms around some of these external factors that affect us, the loss of “340B”(reduced prices on pharmaceuticals) in some of the hospitals and things like that that have affected our current year performance. And on top of it we’ve hired 350 new nurses and eliminated 150 duplicative positions.”
The leadership that engineered that quick work helped earn Ballad a ratings upgrade (from BBB-plus to A-minus) from Standard & Poors and Fitch, two bond ratings agencies. S&P noted among positive factors in its late April upgrade report Ballad’s “management team with proven turnaround and integration skills.” The combined system’s “excellent business position, with an overwhelming market share” didn’t hurt either. And so Levine and Ballad CFO Lynn Krutak, architect of much that influences the rating agencies’ decisions, are happy – $20 million a year in free cash flow happy. Armed with that A-minus rating and having structured the merger advantageously, the system will soon refinance (it occurred in early June) $1 billion of its $1.3 billion in long-term debt that decreases annual debt payments from $105 million to less than $85 million.
This is Ballad’s bond rating story – The Business Journal is listening.
Fortuitous and timely
Ballad’s interest savings come just when it needs cash flow the most: at the outset of a nationally scrutinized attempt to transform the health of a region, remain financially viable and meet the states’ stringent requirements. (Requirements, it bears noting, that are designed to protect consumers and help facilitate better overall health and higher healthcare quality in the region.)
S&P, which listed “ability to comply with terms of the COPA and (Cooperative Agreement) and the high number of performance metrics” among partially offsetting rating factors, put it this way later in its report: “While every merger has its own set of challenges, the creation of Ballad Health is unique, given the regulatory oversight, and it could be more difficult for the system to implement certain strategies due to onerous guidelines and approval process set forth in the COPA.”
Even Levine, who knew what the systems were getting into when they sought state action immunity, seems to suggest that the final product’s bite appears capable of being as bad as its bark. “The COPA, state action immunity, is a very strict regulatory instrument that we did not anticipate, and so we had to do a lot of work with the rating agencies to explain how we would operate within the COPA, how we would be successful even given the constraints of the COPA. And the reality is the rating agencies, and I think more importantly … the actual bond investors – they believe us. I think they believe us because of what Standard & Poors put in their report. We have a strong organization, we have good management, we have good governance and I think those factors play to our advantage.”
The wind in Ballad’s sails from the refinancing certainly plays to the system’s advantage. “Not having to make $20 million in debt payments, over 10 years that’s two-thirds of our commitment,” Levine says, referencing the COPA requirements for community investment. “And that’s without even one dollar of (merger) synergies. We believe we can achieve the synergies in addition to that, which we need to do.”
How Ballad restructured the long-term debt that Wellmont ($411 million at March 31, 2018) and Mountain States ($892 million) brought to the marriage is an interesting story in itself. How Ballad’s leadership utilizes that windfall will have critical implications for the success of the whole merger endeavor and the COPA. And the role debt load has played and will play in the fortunes of the region’s hospital systems can’t be overstated.
The one that didn’t get away – how a merger became an acquisition
Late last fall, as Mountain States and Wellmont’s merger drew close, the subject of tax-exempt bonds and “advance refunding” of high-interest bond debt entered the tax reform debate. The House version eliminated tax-exempt bond financing for non-profits. If bond purchasers’ interest payments from borrowers were taxed, the cost to those borrowers – including Ballad – would increase.
“There was a brief moment of panic,” Levine recalls. Leaders called on former Tennessee Lieutenant Governor Ron Ramsey, who talked with Congresswoman Diane Black, a Tennessean who chairs the budget committee. “She’ll tell you she was very involved in changing the language during conference to permit refinancing,” Levine says.
In the end, the method the systems used to structure the merger trumped even the results of that debate in terms of impact. Leadership created Ballad as a holding corporation that would own both systems, post-merger, allowing their brief continued existence. Due to the systems’ complexity, Levine says, leadership didn’t want to immediately fold both into a new legal structure. “We figured it would be better to create a new holding corporation that would acquire Wellmont and Mountain States and leave all those legal structures in place, and over time we’ll consolidate.”
Debt-wise, that move gave Ballad six months to seek what’s called “acquisition financing.” Had the two systems merged and then formed Ballad, their only refinancing option would have been advance refunding – taking advantage of lower interest rates prior to bonds’ call date – an option tax reform had eliminated.
It got even better. Borrowers who qualified for tax exempt refinancing flooded the market during the early winter to beat the law change. Spring debt issues were rarer, and thus more attractive to investors. Ballad received $5.6 billion in offers as it sought $540 million in fixed-rate financing, Levine said. The new system is restructuring the remainder of the $1 billion using variable rates, with the added advantage of a better rating.
Why it matters so much
Levine says Ballad has a solid plan for long-term success, including meeting the COPA and Cooperative Agreement requirements. “I don’t want to make it sound easy,” Levine says. “It’s not easy. It’s never been done. And so we will certainly stumble and make mistakes along the way.”
Even without the mistakes that inevitably occur in any organization, Ballad faces a heavy lift. While the merged system’s 77 percent market share and historically strong financial performance and operating margins are other positives noted by S&P the report also lists several “offsetting factors.” In addition to the earlier-mentioned COPA compliance challenges, they include poor operating results through seven months of the fiscal year that ends June 30, and challenges with the legacy systems’ integration and the ability to recognize benefits and cost savings initiatives over time.
For Ballad to thrive and meet the states’ expectations, it needs every bit of spare cash flow it can get. Additionally, the system must continue chipping away at debt levels S&P described as “moderately elevated, with debt as a percent of capitalization and debt burden above median levels.” At 3.96 percent through March, Ballad’s debt burden was well above the 2.40 percent median for comparable A-rated healthcare systems. That’s one reason, Levine says, Ballad plans “voluntary debt reduction” – funded through cash flow – of $385 million between fiscal 2021 and 2023. Combined with regular payments that would notch Ballad’s debt down 44 percent over five years according to the S&P report and put its debt ratios much more in line with peers.
Debt was a double-edged sword for Mountain States for years. The system long used it as a tool, starting with its formation in the late 1990s when it purchased five hospitals from for-profit competitor Columbia/HCA. The debt load continued increasing through former CEO Dennis Vonderfecht’s creation of a “hub and spoke” system as MSHA grew and gained regional market share. The results generally included strong financial performance and market share, but the ratings agencies typically mentioned the system’s maximum annual debt service (MADS) ratio as a primary reason for keeping its rating at BBB+. Nonetheless, “it was effective,” Levine says of the strategy. Krutak agrees.
“You compare where we were in operating ratios, liquidity ratios, everything was well above what we needed to be A-rated except for the leverage ratios,” Krutak recalls of past days at Mountain States. “We knew we had higher debt ratios than what everyone liked, but all of that debt was the result of a planned borrowing from a strategic standpoint as we grew the system and acquired these facilities. It wasn’t just debt issues for routine equipment. Each of those issues was in our plan.”
When Levine arrived in 2014, plans changed. The system was forecasting about $126 million in EBIDA midway through its fiscal year, but with long-term debt pushing $1.2 billion its MADS was $70 million. That would have resulted in a 1.80 MADS ratio, a situation Levine refers to as “brutal. We had to take some swift action.” Mountain States laid off more than 150 people and began to focus on debt reduction. “Those are very relevant ratios for a system like ours,” Levine says of MADS ratios, adding that ratios skewed to high long-term debt “leave us very little in the way of capital and slows our net asset value. It’s a death spiral.”
At the end of June 2014, the system’s long-term debt totaled $1.075 billion and had budged very little for several years. Levine says leadership foresaw macro changes in health care that would make such a debt load riskier than it had been. “We saw this coming – you go back to the reporting four years ago, we projected a decrease in inpatient utilization, there was no population growth. We knew we … needed some flexibility on the balance sheet.”
A bit about the challenges
Ballad is navigating the early challenges of merging during a tough fiscal year for the legacy systems. Through March 31 (nine months), Mountain States had operating income of $2.3 million compared to $28.0 million at the same period of fiscal 2017. Net patient service revenue was down more than 7 percent to $775 million. Conversely, expenses increased with salaries/wages, contract labor and benefits up nearly 15 percent. Wellmont endured an operating loss of $6 million through March 31 and also saw salaries and benefits jump. Levine says the total labor cost increase of about $40 million included almost $20 million in wage increases – part of a strategy to attract and retain talent and to move away from more expensive contract labor.
Heading into the final quarter with a combined operating loss of $3.7 million, compared to $40 million in operating gains at the same point last year, may not seem like a great position. Levine’s not fretful, and the S&P report shows that the systems’ EBIDA margin – even given the difficult year through seven months – was just a touch below the median for a comparable A-minus system. He says the wage increases, the impact of contract labor and the loss of some “340B” reduced-price drug supplies account for much of the difference. “There’s not been any real operational issues that are a result of poor operational oversight per se. These are factors that hit us that we couldn’t control.”
Looking ahead, Levine says the long merger process allowed the systems to recognize their “cultural differences” and work through them. This has helped pave the way for significant progress in the things that matter most in the long run both from the COPA’s perspective and in the current value-based reimbursement climate – quality of care, innovation, and cost to consumers.
“There’s very little if any, ‘well, this is how Wellmont does it,’ or “this is how Mountain States does it,’” he says. “We have an integration team that’s collaborative, that’s working extremely well together.
“We’re making decisions based on data and evidence… I ask the same question every meeting we’re in – ‘how does what we’re talking about get us to top decile performance.”
Already, he says, moving to a common supply item in one specialty has saved nearly $1 million. And Ballad’s “clinical council” has set out to reduce “c diff” (one of the most dangerous hospital-acquired infections) by 40 percent. “The implications of that are, number one it improves quality. It helps us achieve the results of the COPA, and it reduces our cost.”
Adds Krutak, “We are very focused on what the synergies are and the operational improvement opportunities that we have, and we have timelines and dollar amounts assigned to each of those.” Those efforts complement quality improvements, she says. “Quality and financial go hand in hand, and so our team is very focused on both of those.”
S&P reports Ballad is forecasting “integration expense savings” of $41 million annually, “compounding to about $158 million by 2023.” With $308 million in required spending over 10 years to meet COPA requirements and another $385 million in planned debt reduction, $20 million a year represents a significant boost indeed. S&P’s report offers several cautionary notes, but allows that the merger, even with the COPA’s complexities and demands present, provides “many benefits, such as the ability to expand the scope of services by providing more efficient and quality care and meaningful cost savings, among other things.”
Seeing those potential benefits materialize is top of mind for Levine. “Us being successful is reducing the overall cost of health care, it’s investing in clinical services that are needed, it’s improving the health of our population,” he says.
That will mean efforts to integrate the health care delivery system. “If we identify for instance the people in the region that are diabetic, and we can invest in technology that identifies the people who are diabetic and allows them to have connectivity to our care managers, then when they’re having an acute issue with their blood sugar spiking, our care managers are made aware of it and they can then reach out to them and get them into the delivery system before they have an acute problem. To us, that’s an example of how population health can work.”
An extra 20 million bucks a year will pay for a lot of care managers and a lot of technology to connect them to chronically ill patients.