Credit Crunch Spurs Innovation

June 1, 2009

With hard times depressing everyone from Wall Street to Main Street, the once routine act of buying and financing diagnostic imaging equipment suddenly looks like an extraordinary feat.Most planned purchases are still going through, but specific experiences drawn from facilities across the country indicate that successfully implementing new programs requires a motivated buyer, a willing financer, and more cash and creativity than were needed before last year's financial meltdown.Recent trends also show that if you want to buy a $2 million MR or other high-tech scanner, the odds of completing the deal are higher if you are associated with an acute care hospital.Interviews with officials of the captive financial companies representing GE, Philips, Siemens, and Toshiba reveal remarkable consensus about the events that led to the current credit crunch. Imaging equipment sales began to fall as soon as providers understood how the Deficit Reduction Act of 2005 would influence outpatient imaging. Medicare spending for outpatient imaging fell 13% in 2007, the first year the DRA was in effect.Many plans to establish services or to replace aging scanners were canceled, as independent outpatient imaging providers felt the full force of Congress's decision to pay the lower of the two rates set by the Hospital Outpatient Prospective Payment System and the Medicare Physician Fee Schedule for imaging procedures. Anxiety about more tinkering with Medicare payment formulas and the possibility of comprehensive healthcare reform also engendered caution, the vendors said.The historic balance of demand for equipment by freestanding clinics and hospitals then tipped toward the hospital sector, as outpatient facility operators decided against buying new equipment. Before 2008, diagnostic imaging centers accounted for 25% to 35% of equipment sales registered by Toshiba America Medical Systems. In 2008, they generated only 10%.Meanwhile, hospitals and healthcare systems had their own problems. Many nonprofit facilities were cut off from inexpensive sources of borrowed capital when the market for nonprofit tax-exempt bonds dried up in 2008. Hospital administrators, who were accustomed to bonds with interest rates as low as 1.5%, were forced to look for alternative funding sources, said Timothy Evenson, vice president of sales and marketing at Philips Medical Capital.Long troubled by low operating margins, hospitals were shaken even more by the long stock market decline through much of last year. The value of nonprofit institutions' charity endowments typically fell about 20%. Charitable giving decreased, and the value of securities held by both nonprofit and for-profit hospitals declined, meaning less cash was available for capital projects.

Many customers told Evenson that they were in the midst of a capital freeze that would not allow them to move forward with any project involving capital spending. Writing for the RSNA News, Dr. James Thrall, chair of the American College of Radiology board of chancellors, noted that nearly everyone he met at the 2008 RSNA meeting in December faced capital spending cutbacks. Many told Thrall that their hospitals simply would not have capital programs this year.As access to capital tightened, imaging center owners learned that they would be required to invest more of their own money to finance future growth. Before the crash, some facilities were financed entirely with nonrecourse loans that did not require the project owners to guarantee their repayment. With most of the financial risks shifted to other parties, owners were required to contribute only working capital, said Robert Maier, president of Regents Health Resources, a consulting firm in Brentwood, TN.“You can't get a deal done that way any more,” he said.To qualify for loans, owners now must contribute enough cash to cover at least four months of working capital and up to 40% of the value of the imaging equipment or real estate, he said. All this affected sales. Fourth quarter U.S. imaging device industry revenue totaled $1.27 billion, down 18% from the same period in 2007.WORST OF THE DOWNTURNGE Capital saw the worst of the downturn, partially because of misfortunes of its own making. The wholly owned subsidiary of GE made a fast transition in 2008 from its status as a major contributor of profits to its parent company to a source of monumental losses.GE required an emergency infusion of $15 billion in early October to counter a 38% drop in earnings from financial services in the third quarter. Many of the losses stemmed from GE Capital's investments in subprime mortgage loans and financial derivatives.Competitors claim that GE stopped adding new loans to its $8 billion portfolio of imaging equipment financing for several weeks in December, but James Ambrose, president of GE Healthcare Financial Systems, said in an interview that the company never faltered.“While the rest of GE Capital was really reluctant to put new money out, we in the healthcare services space did continue to lend,” he said. “We are strategically important to the company, and GE Healthcare's customers need us more than ever.”In early 2009, GE also recognized an opportunity to arrange private financial placements for hospital and health systems that no longer had access to low-cost bond financing.

“Hospitals are reaching out to us,” said Randy Waring, managing director for the hospital enterprise group at GE Healthcare Financial Services. “Even the biggest and strongest hospitals don't want to use their cash-and they have a lot less of it than six months ago.”Before the meltdown, many for-profit hospitals had no use for captive corporate financers. Now, they are accepting equipment loans and leasing offers from captive outlets associated with GE, Philips, Siemens, and Toshiba.As an alternative to tax-exempt funding, GE is offering nonprofit hospitals tax-exempt private placements for sums up to $25 million. In mid-April, GE closed a $6 million deal for imaging equipment with an A+-rated health system in the Northeast. The annual percentage rate for that tax-exempt loan was about 4%, Waring said.Those terms were unusually good. Hospitals with solid credit credentials now typically qualify for loans with interest in the 7% range, Evenson said.Hard times have stirred interest in refurbished equipment. GE's GoldSeal program specializes in pre-owned systems that are a generation or two removed from state-of-the-art. The purchase price is about 15% lower than new, said David Elcario, general manager of the program.In December, Philips closed $22 million in equipment loans for customers whose initial financing had fallen through.“We scrambled like madmen trying to pull together funding for those deals,” Evenson said.Philips Medical Capital draws a potential competitive advantage from an association with Rabobank in Amsterdam, the Netherlands. The AAA-rated bank was voted in Global Finance's 2008 survey as the safest privately owned bank in the world. Philips Medical Capital is a partnership between Philips Healthcare and De Lage Landen, a Dutch leasing firm. DLL is a subsidiary of Rabobank.As with the other captive financers, Siemens Financial Services is in business mainly to assure that attractive financing options are available to purchasers of Siemens imaging equipment. Beyond that, Siemens Financial extends credit to its parent company's energy or industrial customers in the healthcare market. Stronger relations with those institutions could eventually lead to imaging equipment sales, said John Sandstrom, senior general manager, healthcare finance.Organized in May 2008, Toshiba America Medical Credit arranges financing for about half of Toshiba medical imaging systems sold in the U.S. Well Fargo, Bank of America, and DLL are its main sources of capital.The need for alternative financing mechanisms or leasing options comes up in half the deals Toshiba arranges, according to Lawrence Dentice, senior vice president of Toshiba America Medical Systems. Some customers are looking for cash flow help, such as six-month deferred payment. Others can afford only rentals. An alternative to fair-market leases, capital leases appear as a leased asset on the balance sheet, but ownership passes to the lessee at the end of the lease term.

With the formation of a dedicated healthcare division in January, Wells Fargo Equipment Finance showed it is serious about financing the acquisition of imaging equipment. It named Peter Myhre as senior vice president to lead the new group, based in Minneapolis. Myhre was formerly CEO of MarCap Corporation, possibly the largest privately held equipment finance company in the U.S., before its owners, the Pritzker family of Chicago, dissolved the firm in June 2008. The new group's targeted customers include hospitals, cancer and kidney dialysis treatment facilities, surgery centers, and imaging services.“This is consistent with Wells Fargo's philosophy of identifying segments to pursue, so we really understand customers in those segments,” Myhre said.SIGNS OF LIFEDespite awful market conditions, imaging centers and hospitals are finding creative ways to fund new services. Some are relying on established banking relationships. Others are stretching out the estimated time needed to turn a profit on new equipment and using charity sources where they can to supplement unreimbursed imaging costs.Though some of Maier's clients have lost access to capital, other projects have moved forward after restructuring. Ground will be broken this year for a full-service imaging center in rural Mississippi developed by a partnership between physicians and a local businessman. They raised enough money themselves to cover 40% of the equipment costs. A loan from a local bank will pay for the rest. This approach was preferred over vendor financing involving an annual interest rate of more than 10%, Maier said.Local banking connections also helped DRA Imaging to finance a planned expansion from its base in Poughkeepsie, NY. Mark Newman, chief financial officer of the 20-member radiology group practice, received cold calls from area bankers who were interested in discussing loans for an imaging center planned for LaGrange, a community of about 16,000. DRA's success with two other imaging centers, contracts with four area hospitals, and its 38-year history in the region helped draw bank support.“Ultimately, we have been able to get good deals on equipment with good terms,” Newman said. “This is, in part, because of very low interest rates.”In Southern California, charitable donations from citizens of affluent Mission Viejo are among several mechanisms that helped a unique imaging and radiation therapy service at the 301-bed Mission Hospital move forward. State-of-the art medical imaging and radiation therapy services on the ground floor will anchor a four-story tower housing 64 patient rooms, a trauma center, and surgical intensive care and neurosciences departments. The facility will open in the fourth quarter of 2009.Joseph A. Gagliardo, executive director of imaging services and innovative technologies, designed new imaging services specifically for molecular imaging of cancer and neurological disorders. Emerging applications for the diagnosis and monitoring of cancer, stroke, and dementia led the hospital to purchase PET/CT, SPECT/CT, and 3T MR scanners and other imaging equipment.

Construction began in 2008, at about the same time the hospital negotiated a sole-source agreement with Siemens Healthcare for the equipment purchases. Financial planning had been completed two years earlier because of requirements of the California building code. When calculations for the hospital's imaging services were updated to reflect post-DRA conditions, Gagliardo found that PET/CT reimbursement had fallen more than $1300 per procedure. Instead of yielding a return on investment in 18 months, the scanner would have to operate 30 months before generating a positive return on investment.The hospital, which is part of the St. Joseph Health System, turned to the community for charitable giving. A portion of the $50 million pledged to the Mission Hospital Foundation for the entire project will support imaging services.Technologist cross-training is expected to cut some operational costs, and Siemens helped make the equipment more affordable, Gagliardo said. Because of the multi-unit purchase, Mission Hospital was well positioned to become a Southern California luminary site for the German manufacturer. That assured discounted equipment service, upgrades, and parts.“By selecting a single vendor, there is a commitment on the part of both parties to make it work,” Gagliardo said.IMAGING AT THE MALLLosing $600 million in endowment funds at Vanderbilt University Medical Center in Nashville may affect future capital expansion, but for now the impact has been mainly limited to a 5% cut to the operational budgets of radiology and other medical departments. Faculty recruitment continues, and no layoffs are affecting the imaging staff, said Dr. Jeremy J. Kaye, radiology chair.Except for the delayed start of a wellness center, the medical center's plans to establish 19 separate outpatient medical services in 440,000 square feet of commercial space in a Nashville shopping mall have also moved forward. The first stage of the $99 million Vanderbilt Health at 100 Oaks project was completed in February. An imaging center, women's health service, and breast imaging facility opened a month later.Responsibility for the $3.6 million investment in equipment at the imaging center was delegated to Vanderbilt Imaging Services, a self-funded for-profit company that operates five outpatient imaging centers in central Tennessee. The nonprofit medical center handled the acquisition and financing of $3.8 million of imaging systems for the women's health and breast imaging services.Vanderbilt Imaging Services drew from its own cash reserves to pay construction costs associated with the imaging center. After deciding to buy scanners exclusively from Philips Healthcare, the firm negotiated fair-market leases with Philips Medical Capital. The company has been using fair-market leases (also called operating leases) for 10 years, according Dr. Jeffrey A. Landman, CEO.“We believe that it is the best way to keep our equipment fresh. So at the end of a typical five-year term, we can either renew or opt for a lower lease rate for a year or two while we're looking at new technology,” he said. “A fair-market lease also keeps the debt associated with equipment purchases off the balance sheet.”Financing for the women's health and breast imaging services was secured before the bond market freeze hit Vanderbilt in September 2008. The sources of funding included cash from university accounts, debt financing, and philanthropy.Consolidating everything at a single site has simplified the logistics of diagnosis for patients and mammographers, according to Dr. John Huff, chief of breast imaging. They now move from room to room rather than from one building to another in the progression from initial diagnosis to biopsy.Huff appreciates the new arrangement for reasons other than the accoutrements and the high-quality imaging possible with the new scanners. As a radiologist, he likes it because the financing was in place before he joined the organization.