StewartBrown Discussion Paper - Financial And Prudential Standards
Following a considerable number of discussions with providers and peak bodies seeking our opinion in relation to the Quality Commission's recently released "Public consultation summary report (the new financial and prudential standards" which included the amended Financial and Prudential Standards, and in particular the Liquidity Standard, we have prepared a Discussion paper for public comment.
Below are some of our overarching comments in relation to the Discussion Paper analysis:-
Commission's Liquidity Risk Assessment
The Commission has overstated the liquidity risk as there has been no material increase in provider failure, and the draw on the Accommodation Payment Guarantee Scheme has been well within acceptable tolerance levels
Concerns with the Commission's Modelling
Concerns in relation to the modelling used by the Commission. The modelling was performed on the FY18 - FY22 period and should be updated to consider the latest financial performance. The direct care funding model was changed (ACFI to AN-ACC) in that period, occupancy levels have dramatically risen and the funding reforms as contained in the new Aged Care Act 2024 are specifically designed to improve revenue flows and sector profitability. In this sense, the funding reforms are revenue driven with no additional impact on recurrent costs
The modelling risk assessment provided to date by the Commission makes no reference to the fact that the residential aged care sector is unique in that over 70% of revenue is provided by government subsidy. This reduces the ongoing risk matrix and concerns significantly
The modelling has been released at a high level with no detailed analysis provided to support the modelling and assumptions adopted (other than the impact of a 7.7% reduction in occupancy and 1.3% CPI increase). We note that IHACPA release a very granular report on the modelling used to support the AN-ACC subsidy pricing adjustments, which allows for independent review by the sector and appropriate feedback. This transparent process should be adopted by the Commission, and particularly for such an important change to the Liquidity Standard and minimum levels of liquidity to be held by providers
Transparency and Governance
The submissions made to the Commission, and the considerations and response to each submission by the Commission should be made public for proper governance and transparency. It would be also beneficial if the Commission acknowledged each submission individually and provide some explanation as to the Commission's response
Commission Statements on Liquidity
The Commission statement "We will not make more changes to the formula. We do not want to increase the liquidity risk across the sector." (page 8 of the Public Consultation Summary Report) is misleading in our opinion. The new Liquidity Standard effectively doubles the required amount of mandated liquidity (from 24% as per the average of the current audited Liquidity Management Strategy to 48% average under the new liquidity calculation being adopted by the Commission). Increasing liquidity risk would only occur of the new Commission calculation formula moved the mandated liquidity to below the current 24% threshold, not dropping it from the proposed higher 48% threshold
The Commission statement "Providers who cannot meet the minimum liquidity amount or give us other assurances, are unlikely to have enough funds to meet their expenses over the next quarter." (page 8 of the Public Consultation Summary Report) is exaggerated in our opinion. It is highly unlikely that even if a provider did not meet the new amended mandated liquidity then the provider would not meet the next quarter's expenses. A provider failure like this would previously have had a number of red flags, not least being going concern (emphasis of matter) from the independent auditors, QFR submissions, the financial indicators and subsequent reviews from the Commission's Financial Monitoring program, and direct contact from the provider to the Department and the Commission seeking support
The Commission statement "just under 84% of all residential aged care providers already hold a liquidity amount equal to or above the amount they would need to comply by using the original formula" (page 8 of the Public Consultation Summary Report) is not relevant when considering the new mandated liquidity amount. Having sufficient liquidity under the Standard and then having to maintain this (artificial) liquidity amount, whether or not it is actually required for the normal operating environment, is restrictive. One of the single biggest concerns for the residential aged care sector (possibly the major concern) is the growing supply constraints, as the sector requires new builds and major rebuilds to support the increasing demand and market expectations. Occupancy has risen to over 98% in many locations, primarily driven by supply not keeping pace with demand. The sector must be encouraged to invest in new builds/rebuilds as a priority and increasing the mandated liquidity threshold will be counter-productive as it will reduce access to available liquid funds for this purpose and increase costs of capital though having to use alternative sources
Alternative Liquidity Assurance
The Commission has stated that they will provide the basis for alternate liquidity assurance. There are concerns as to whether this will be a subjective assessment and consistent for providers submitting alternative assurances. As an example, if a provider requires 65% mandated liquid assets, however their business model is to use lines of credit and withdraw excess liquidity until required for capital development, and the provider's alternate assurance is for 15% liquidity. Will the Commission accept that level or make a determination that (say) 45% is required, which is still a much higher liquidity level than the provider feels is actually required. This may lead to a prolonged disagreement. If then, another provider seeks such a significant lower liquidity level and provides assurance, will there be a precedent and therefore ease of approval, or will the Commission still seek further assurances? Any alternate assurance must be clearly stated as to what the criteria is and reduce subjectivity by the Commission in their determination
General Comment on Residential Aged Care Financial Liquidity
A general comment regarding the residential aged care financial liquidity. The StewartBrown Survey has noted that for the last 6 years that around 50% of homes were running at an operating loss, and around 30% were running at an EBITA loss (effectively a cash loss). Clearly, this has had the effect of reducing the equity and cash reserves within the sector, and importantly, has reduced the appetite for investment and capital growth. The Survey has its focus on individual home performance rather than provider aggregate for the analysis of the residential aged care sector, and whilst many homes are running at a loss, the providers at organisation level still, by majority, remain financially stable even after absorbing the recent losses over the last 6 years. This needs to be recognised when considering any changes to the liquidity levels as placing further constraints on liquidity will affect the ability to increase the building supply.
Next Steps
Given the important reform and financial juncture that the sector is currently in, we feel that having a further workshop with a representative attendance from providers, financial institutions, accounting firms, analysts, the Department and the Commission would be beneficial to further consider the implication of the new Liquidity Standard.
As always, we are available to discuss our analysis or provide further clarification.
