Bracing Yourself for the Coming Storm

There was no not-for-profit healthcare public issuance over the last two weeks, which says a lot. It is not yet clear whether this is just a pause following a relatively robust 2020-2021 financing cycle, or if this is a disruption brought about by some mix of higher rates, reduced liquidity, and credit concerns. We know that organizations are responding to weaker than budgeted operating performance by pulling back on capital, so issuance activity may remain muted until markets and/or the credit environment stabilize.

SIFMA reset this week at 0.68%, which is 33.94% of 1-Month LIBOR and represents a -14 basis point adjustment versus the May 18 reset.

The Coming Storm

The Chicago Fed National Conditions Index is one of several indices designed to assess whether conditions across money market, debt, and equity markets are “looser” or “tighter” than average. Zero is the norm, so positive values reflect tighter than average conditions and negative values reflect looser than average. The graph measures March 2020 to present and demonstrates that recent conditions have shown tightening. The interesting observation is that markets may be moving faster than the Fed (anticipating future actions rather than reacting to actual steps), which may have the effect of dampening economic activity and slowing inflationary pressures faster (doing the Fed’s work for it). Whether this ultimately changes the forward path of the Fed Funds Rate remains to be seen, but for those tracking general inflationary pressures, this suggests a favorable trend.

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Against this backdrop, the quote of the week comes from JPMorgan CEO Jamie Dimon: “Right now it’s kind of sunny, things are doing fine. Everyone thinks the Fed can handle this. That [economic] hurricane is right out there down the road coming our way. We just don’t know if it’s a minor one or Superstorm Sandy. You have to brace yourself.” The ”kind of sunny” comment seems a little tone deaf if you read it while thinking about everyone trying to buy gas and groceries; but Mr. Dimon was referencing the macro context the Fed is trying to navigate (the Financial Conditions Index), and here the logic holds. Yes, rates have moved to what feels like uncomfortable levels, but they are still below historical averages and well below historical highs. Relatively low-cost capital is still available and there is the possibility of materially worse funding outcomes, especially if it turns out the Fed can’t handle this.

Mr. Dimon’s broader point perfectly captures the not-for-profit healthcare environment. The storm is already here, damage is already being done, and the only question is whether this ends up as a tropical storm or strengthens to a category 5 hurricane. Kaufman Hall’s May National Hospital Flash Report was released earlier this week and, despite some improvements, there was nothing very encouraging in the data or accompanying observations:

• The emergency department is no longer the hospital’s front door.
• Patients are sicker and more expensive to treat.
• Expenses are still high from labor and specialty supplies.
• Extended negative margins are taking a toll.

The most important line in the report is that “even if margins return to pre-pandemic levels, many will still end up with substantially depressed margins at year’s end.” The damage from this will take two primary forms that have the potential to materially impact sector-wide capital access and cost:

• Rating Pressures. The three agencies have different sector outlooks (Moody’s is “Negative,” S&P is “Stable,” and Fitch is “Neutral”) and each has a relatively balanced scorecard in 2022 rating actions (Moody’s has 4 upgrades and 4 downgrades; S&P has 7 upgrades and 6 downgrades; and Fitch has 1 upgrade and 2 downgrades). But outlooks and upgrade-downgrade scorecards will adjust in response to the storm track. Sector credit performance will ultimately correlate to the duration, depth, and breadth of operating dislocation and the degree to which balance sheets are damaged by financial market volatility.
• Financial Covenant Pressures. The critical financial covenant for most healthcare borrowers is Debt Service Coverage, which tests the relationship between income available for debt service versus debt service. Depressed margins result in depressed income available, which elevates the covenant risk. My colleague Lisa Goldstein covered the covenant topic in her recent blog, but this is a critical area where even a potential breach merits a “hair on fire” level response.

Mr. Dimon is an exceptionally well-informed and credible voice and I appreciate his threat assessment. But I appreciate even more his call to action and reiterate some of our suggestions for healthcare:

• “Brace yourself” by developing financial and performance improvement plans that maximize your ability to understand and get ahead of credit rating and/or covenant concerns.
• “Brace yourself” by leaning into resource management and breaking down enterprise silos to drive the integrated management of operating, financing, and investing activities.
• “Brace yourself” by developing a point of view on whether the portfolio of resources that you control is properly positioned, or if you can manufacture a better or more resilient portfolio by converting some of them into a different form of resource (i.e., converting non-strategic real estate or operating assets into financial assets that meet different resiliency or return needs).

Until inflation is contained there is no more “Fed put,” meaning that liquidity will keep coming out of the system and the Red Bull and Cocoa Puffs playbook for U.S. fiscal and monetary policy is off the table, perhaps forever. What happens now is on us and action is the only response. If all this winds up being just a nasty tropical storm, then every one of these bracing actions will position your organization for stronger performance on the other side. But if things go downhill from here, then these actions will shape long-term viability.

Trending in Healthcare Treasury and Capital Markets is a biweekly blog providing updates on changes in the capital markets and insights on the implications of industry trends for Treasury operations, authored by Kaufman Hall Managing Director Eric Jordahl.