by James C. Sherlock

A brutal pattern is observed repeatedly.

Some chains offering the worst nursing homes in America have established a singular process for profit maximization. It is seen in a combination of the Center for Medicare and Medicaid Services (CMS) data on their operating subsidiaries and city/county property records on their real estate subsidiaries.

CMS and state agencies, failing systematically to access property records, do not fully understand those structures.

The scheme makes frail and injured people suffer horribly and die too soon from a lack of both medical treatment and assistance with the activities of daily living. Stomach-turning stories of the outcomes and citations for neglect and abuse are regularly recorded in state inspection reports. Small fines sometimes follow. They constitute rounding errors in the profits.

The managers and owners of the chains do not care. Administrators and Directors of Nursing in their operating facilities go along or are fired. Medical Directors work for the chains, not the operating subsidiaries, and seldom, if ever, visit residents.

The process used is stunningly profitable. Seldom is anyone held accountable.

The whole scheme is based upon government-insured loans. This article will recommend a permanent solution to that problem.

The scheme

Step 1. Target properties for acquisition and obtain inflated Federal Housing Act Section 232 nursing home and assisted living facility mortgage, improvement, and refinancing loans.

The lenders chosen by the worst chains are among those authorized to write Section 232 loans. The process is managed by HUD, and the loans are guaranteed by the FHA. That program was designed 66 years ago specifically to create a market for the construction, purchase, and refinancing of nursing homes and assisted living facilities. Those loans by law:

• are written at fixed rates lowered by the FHA guarantee, and have non-recourse provisions, so only the LLC itself is liable for repayment. Members of the LLC are not, and
• require separate operating and property LLCs, with the property company being the borrower.

The lenders apparently choose the Debt Service Limit option (b) available in § 232.903 Maximum mortgage limitations to scale the loan amount.

The insured mortgage shall involve a principal obligation not in excess of the amount that could be amortized by eighty-five percent (85%) for a profit-motivated borrower (ninety percent (90%) for a private nonprofit borrower) of the net projected project income available for payment of debt service. (emphasis added)

In a decade of research, I have seen a hundred instances in which a relatively small set of lenders write loans, not for 85% of the property value, but rather for as much as three times more than was paid for the properties. We must presume the bankers justify the loans when presented with signed lease agreements from the operating subsidiaries that will cover the mortgage payments.

But HUD provides a Handbook for Section 232 lenders. It is full of reasons not to write loans to those particular borrowers. See Chapter 8 – Owner and Management Agent Analysis.

It is the Lender’s responsibility to review whether the proposed Operator and/or Management Agent demonstrates the capability and track record to ensure that the project will be operated in a prudent, efficient, and cost-effective manner, while providing excellent care to the residents. (emphasis added)

The loan brokers are small private bank subsidiaries of larger banks. Some of the loans bundle an entire group of nursing homes being bought at once, and can be very large loan amounts. Some approach a billion dollars. A big slice of the entire businesses of some of these boutique banks is made up of Section 232 loans and the 3 1/2% fees they get for originating them.  They may have no idea how to comply with Section 8 owner analysis requirements. But they certify them.

The loans likely would be audited by HUD only if they turned non-performing, which is never allowed to happen. Thus, HUD program managers would have no reason to challenge the inflated estimates.

But CMS would have ample reason to challenge the Section 8 eligibility of the worst chains.

Step 2. Increase operating company cash flows to fund the high lease payments to the property companies, which are used to pay the inflated mortgages.

These existing properties, upon acquisition, are already functioning. Higher cash flows are then created in the operating subsidiaries to pay the very high lease payments to the real estate subsidiaries, who pass them on as payments and escrow funds to the mortgage lender.

The method for creating higher cash flows:

• Slash staff to cut costs. Staffing reports are auditable because CMS requires specific payroll standards. Some regularly show mass staff departures soon after a change in ownership and after state inspections. Understaffing becomes a self-fulfilling prophecy. They advertise for help, but too few want to work in the new environment. Nurse turnover rates approach 100% annually. They don’t have enough nurse assistants, but also fail to train any. They then blame the problem on the labor market without explaining how other facilities in the same markets are well-staffed.
• Maximize occupancy. Jumps in occupancy rates are inevitably seen very soon after acquisition. That represents a combination of willingness to accept new residents when understaffed and new contractual relationships with local hospitals. Hospitals often look the other way in transferring patients to bad nursing facilities in markets with very high occupancy rates. They would say that they have to put their patients somewhere. In Virginia, COPN helps drive that problem.
• Raise the average Nursing Case Mix Index substantially by maximizing assessment judgments upon resident admission. CMI is a metric that measures the complexity and severity of care required by patients in healthcare facilities. A higher CMI results in higher Medicare and Medicaid reimbursements. Some of the worst chains’ average nursing home CMIs match those of some entire states’ hospitals when half of the nursing home resident population needs only long-term care, not skilled nursing.  

Regardless, the worst nursing homes in the worst chains do not have anywhere near sufficient staff to deliver the required care for which they certify resident needs and for which they accept those payments. If charged and proven, that constitutes Medicare and Medicaid fraud.

Step 3. Keep the LLCs poor

• Register all of the LLCs in Delaware to take advantage of business-friendly laws and chancery courts.
• Create layers of virtual management entities and wholly owned consulting companies to bleed fees from subsidiaries;
• Use the excessive lease and mortgage payments to drain reportable cash flows from the subsidiaries;
• Distribute excess mortgage loan payouts to investor trusts and LLCs acting as pass-through entities. Such a transfer of funds can be accomplished, importantly, without having to affect the reportable cash flows of any of the LLC subsidiaries or the chain LLC.

All of that may prove legal.

The reasons for keeping all of those LLC entities poor on the books?

• First, the fees create profits for investors.
• As importantly, the chains and subsidiaries are regularly sued in tort cases. They plead poverty.  It works.  That is why they are required by federal law to maintain malpractice insurance.

Step 4. Pocket un-obligated mortgage proceeds.

The properties are bought for a fraction of the loan proceeds. The subsidiaries pay off the inflated loans. The excess mortgage proceeds available after facility purchases are passed through to investors. The investors who owe the taxes are nearly all LLCs and trusts. Many of the mailing addresses of those investors are residences of the chain leadership.

But neither CMS nor the state licensing and inspection organizations has visibility of any of that. They just see bad nursing homes.

HUD just sees performing loans.

Step 5. Use regional operations and nursing teams to enforce policies related to increased operating company cash flows. Chain owners have to terminate facility administrators and Directors of Nursing who will not go along with the unethical corporate rules. They have to do that or the scheme will not work.

That may be the biggest flaw in the scheme. They create a lot of angry insiders. But it has worked so far.

Recommendations

1. CMS and state regulators struggle to understand the structures of chains. HUD has, or is supposed to have, everything those regulators need.

Any borrower accessing Section 232 loans, which includes every nursing home chain, is required to submit to the HUD Office of Residential Care Facilities (ORCF) a Full Corporate Credit Review (CCR) checklist, a Modified CCR checklist, or both. Take a look.

•  CMS does not have much of that data reported to HUD and is seeking it without noticeable success.
• But CMS already has some of it with which to cross-check the HUD submissions.  If CMS finds it is not correct, the borrowers face a significant problem with HUD.

I recommend that CMS set up a program with HUD:

• to provide CMS access to CCR documents in the appropriate HUD database,
• to allow CMS to control access for state regulators, and
• to notify HUD of errors in lender submissions.

There will be no more need for CMS and the states to try to gather all of that information independently.  They do not have the staff to do so.

2. I recommend that CMS, with state participation, provide to HUD lists of potential borrowers that are unsuitable under HUD Handbook Chapter 8 criteria.

HUD will then be enabled to:

• call in such existing loans as it can absorb, and
• cease future loans to the worst-performing chains and their owners.

That will pull the legs out from under this deadly scheme permanently.