Last week, the healthcare real estate investment trust (REIT), HCP, the only REIT in the S&P 500 Dividend Aristocrats index, scared the hell out of investors, when it dropped by 17%. Its fourth quarter results included an $817 million noncash impairment that led to a negative FFO per share of 0.99. In isolation, for a noncash impairment that represents less than 3% of its total capitalization value, it goes without saying the financial markets have overreacted. Yes, the market has been very unstable, but, in this case, investors may be showing signs that they are tired of the developments behind the impairment.
The cause of the impairment can be traced back to HCR ManorCare, a top tenant focused on post-acute/skilled nursing facilities (SNF) for those not requiring the more intensive treatment, has seen its operational performance deteriorate. In light of this situation, HCP decided to project reduced future lease payments, which decreased the fair value of the related direct financing leases (based on the present value of the future lease payments).
The fact that HCR ManorCare’s rental rates are under direct financing leases (DFL), rather than operating leases, is an important accounting aspect. Unlike DFLs, the reduction of future operating leases wouldn’t lead to impairments. Consequently, if HCR ManorCare had been operating leases, the impairment and negative FFO wouldn’t have occurred and perhaps, the market wouldn’t have been scared as much. Regardless of the accounting aspect, the main takeaway is that HCP’s cash flow will be decreased.
This isn’t the first time HCP has been hit by an impairment charge. In the first quarter 2015, they recorded an impairment charge of $478 million because HCP and HCR ManorCare amended the original lease, reducing the rental payments by more than 10%. There were also minor impairments associated with HCR ManorCare in the fourth quarter of 2014 and the third quarter of 2015.
The US Department of Justice (DOJ) has been severely scrutinizing Medicare reimbursements to HCR ManorCare, which relies heavily on government reimbursement programs. In April of 2015, the DOJ filed a complaint reporting that HCR ManorCare had requested Medicare reimbursements they were not eligible for. The complaint also reported that the company consciously increased Ultra High billing, the highest daily rate for Medicare, from 39% in October 2006 to 81% in February 2010 (percent of all days that it billed for rehabilitation therapy). The complaint is still under investigation.
HCP is well aware of its dependency on top tenants. HCR ManorCare accounts for 23% of HCP’s total revenue. HCP has been working with HCR ManorCare to sell 50 non-strategic assets and have managed to sell 21 facilities so far. In addition to HCR ManorCare in SNFs, Brookdale is also a major tenant in senior living whose revenues represent 10% of the total.
The main thing to take away from this is that HCR ManorCare’s problems are far from over and new impairments could easily happen again, especially if the company has to make more adjustments to their billing. The worst outcome, of course, is bankruptcy. For HCP, the best thing to do now is focus on protecting itself even more.
Source: HCP, Inc.(NYSE:HCP), Yahoo!Finance, US Department of Justice (DOJ)
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