One is Catholic, the other is secular, and they used to be head-to-head competitors in a town of 25,000. After years of distrust, their boards decided to call a truce.
Rather than merge, the only two hospitals in Hazleton, Pa., proposed a corporate alliance that requires them to share the risks and rewards of their partnership on a cash basis.
Over the past 18 months, the hospitals' executives conceived and fleshed out a financial covenant. Now they await the blessing of Pennsylvania's attorney general.
The goal of the pending alliance of Hazleton General Hospital and Hazleton-St. Joseph Medical Center is to eliminate duplicative services. The hospitals' efficiency plan targets $11 million in cumulative savings over five years, to be achieved through capital avoidance and some operational savings.
In January 1994 the hospitals created a management company called Greater Hazleton Health Partners to oversee the plan.
To prevent one hospital or the other from being squeezed out of business, executives agreed to a plan that links their cash flows. Cash flow is a measure of net income plus depreciation and other noncash charges.
So, for example, if Hazleton General ends the year with $750,000 in cash flow and Hazleton-St. Joseph has $1 million in cash flow, the total is redistributed so that each hospital has control of $875,000.
Before moving forward with its plan, Hazleton-St. Joseph faced a legal barrier. A 1992 bond document spelling out the terms and conditions of the hospital's $10 million private placement with Eaton Vance Management prevented cash transfers "out of the ordinary course of business."
Since the deal wasn't rated, Eaton Vance had negotiated some fairly strict covenants, explained Marvin Loh, a vice president and municipal credit analyst at the Boston-based institutional investment firm. That particular covenant discouraged cash transfers from the hospital, he said.
To proceed with the corporate alliance, Hazleton-St. Joseph would have to renegotiate the bond document. Eaton Vance wanted to ensure that its security interests were still being protected, Loh said.
Daniel C. Confolone, Hazleton-St. Joseph's vice president of finance and chief financial officer, was in charge of presenting a proposal that would ensure the corporate alliance's financial success and protect Eaton Vance's interests. He devised three "service guidelines" that test the financial equality of the partnership and force action if tests are failed (See chart).
Under the "asset test" ratio, neither hospital may post a gain or loss of 0.5% in its ratio of net revenues to net assets in any budget year.
So, if all urology services, for example, were transferred to Hazleton General, it would gain assets and net revenues while Hazleton-St. Joseph would lose assets and net revenues. If the cumulative impact of such service changes were too great in a year's time, a red flag would go up. Without such a warning, one member of the corporate alliance could be at risk of whittling away its service base, Confolone explained.
The other two tests ensure equality of net patient revenues and capital investment.
In negotiations with Eaton Vance, Hazleton-St. Joseph agreed to take remedial action if in any budget year red flags were tripped on the asset ratio or net patient revenues tests, or if the capital budget test was failed in two consecutive years.
"It really does guarantee that we don't end up with one very profitable plant and one parking lot," Loh said.
Under terms of the amended budget document, which is close to being finalized, Greater Hazleton Health Partners would have 25 months to correct problems that contributed to any financial imbalance. The bond document allows five months to retain a consultant, eight months to develop a business plan and 12 months to implement the plan.
The 25-month plan is a compromise, reflective of the "give and take" that went on during negotiations with Eaton Vance, Confolone said. "We were hoping for 42 (months), and they wanted 12."
By allowing the transfer of cash within negotiated parameters, "we've given them more flexibility," Loh said.
If all goes well with the state attorney general's office, it's hoped that the corporate alliance will take effect Jan. 1, 1996.
Hazleton-St. Joseph's red-flag tests (INFOGRAPHIC)
To assure its sole bondholder that its proposed corporate alliance with Hazleton General Hospital won't harm its creditworthiness, Hazleton-St. Joseph negotiated financial tests that force action if failed.
1. Asset test ratio. A red flag goes up if the ratio of either hospital's net revenues to net assets moves up or down 0.5% in any budget year.
2. Percentage of net patient revenues test. Total net patient revenues generated by the two hospitals are added together. A flag is raised if either hospital's percentage of that total falls below 35%.
3. Capital budget test ratio. A combined capital spending figure is calculated. A warning flag is triggered if either hospital's portion of the total drops below 35%.