How Much Is Enough?
Hospitals and health systems on the front lines of the COVID-19 crisis are in the midst of an intense battle to meet mounting, unprecedented demands on their resources and capacity. As addressed in other articles, Kaufman Hall’s point of view is that liquidity formation at every healthcare organization should track the following sequence:
- Reach out immediately to core relationship banks to determine how much is available through lines of credit from these organizations.
- Put in place a robust framework to methodically assess potential liquidity needs, using financial modeling and scenario analysis; use this to establish a revised perspective on liquidity needs and a process for adjusting this this on a rolling forward basis as you learn more about actual operating cash flow performance.
- Develop a catalogue of all available second tier liquidity resources. Move beyond lines of credit into the identification, assessment and implementation prioritization of other available resources.
- Put in place a framework to drive the accessing and allocation of liquidity resources over time.
Kaufman Hall’s recent articles provide our latest thinking on initial liquidity formation efforts as well as the range of financial planning tactics available to quantify the financial impacts of COVID-19. We recommend that this approach and analysis become the basis for sizing the system’s near- and intermediate-term liquidity needs. Equally important, this should emerge as a rolling process wherein liquidity needs are adjusted as the impact of federal stimulus is clarified and as experience is gained and operating cash-flow forecasting is improved.
Where Do We Get It?
Having secured initial levels of liquidity and established the size of the hospital system’s liquidity demands, finance leaders must begin to identify viable alternative second-level sources for liquidity needs. The list below primarily focuses on taxable alternatives to provide flexibility for how proceeds can be used. Importantly, this is not an exhaustive list and very few items on this list are uniformly recommended—our perspective in this moment is that no idea is a bad idea but that some ideas are preferable to others. Run every idea to ground in terms of feasibility and potential benefit but then move to develop a sense of implementation prioritization and process. Many of the ideas identified below will force matters such as the prioritization of rating versus liquidity procurement, which means that the prioritization framework will be complex and will vary from one organization to another.
Revolving lines of credit
Many clients have already begun to secure taxable working capital revolvers and lines of credit. These flexible bank facilities are relatively straightforward, but pricing and terms have tightened in recent weeks as hospitals (and the rest of the world) have begun to stock up on capacity. These facilities are excellent as a short-term alternative to fund liquidity needs, but they are not intended to be permanent committed capital. This is the only strategy that we would recommend universally: Every healthcare organization should be working with its core bank(s) to secure a baseline amount of external liquidity.
Investment portfolio liquidations
Clients should be working in close coordination with their investment advisors to understand the liquidity that can be realized from the investment portfolio and the consequences of securing that liquidity in the current environment. Frequently, in addition to operating cash/working capital, organizations carry significant amounts of cash/short-term investments within liquidity portfolios; this may represent a baseline amount of shadow working capital. Moving into longer duration and varied asset classes likely becomes more challenging, with concerns ranging from selling into a depressed market to the exposure to realized losses for covenant calculation. Again, elements of this initiative may wind up being last on your liquidity harvesting list, but the opportunity, consequences, and process need to be developed and put on the list.
Securities lending programs
Banks have historically been willing to provide clients with loans secured by a range of securities that the borrower already owns in its investment portfolio. These loans have had attractive pricing and terms because of the quality of assets pledged against them, but borrowers needed to exclude those securities in the calculation of unrestricted days cash on hand. The benefit today is that this approach would prevent borrowers from selling securities at deflated prices in the current market. However, current market conditions are such that many banks are unwilling to accept anything besides U.S. Treasuries. Once markets begin to find a footing, this approach may be worth evaluating.
Banks provide asset-based lending, which is loans secured by collateral. An asset-based loan or line of credit may be secured by inventory, accounts receivable, equipment, or other property owned by the borrower. Administering these facilities can be laborious because it requires constant monitoring and management of the collateral (receivables, for example), and borrowers need to consult existing Master Trust Indenture (MTI) and loan agreements to determine whether pledging assets is permitted and, if so, to what limits.
Banks can also fund privately-placed taxable term loans. These loans provide longer-term bank commitments (7-10 years or more), typically with fixed and floating rate alternatives. Implementation is fairly quick (30-45 days), but they come with bank covenants that are frequently more restrictive than the MTI.
Public floating rate issuance
Clients can issue taxable variable rate demand bonds (VRDBs), which trade daily or weekly based on a spread to LIBOR. These bonds are frequently wrapped by a bank letter of credit (LOC), which provides credit and liquidity support if the bonds are tendered to the borrower. Much has been written recently about tax-exempt VRDBs, but the taxable VRDB market has fared well during the recent liquidity crunch. This approach would be well suited for a hospital that wants a public market alternative with floating rate exposure and prepayment flexibility. Time to execute this approach (2-3 months) depends largely on preparing a public disclosure document, securing an LOC, and receiving a short-term rating.
Commercial paper programs
Taxable commercial paper (CP) programs provide clients with public market liquidity that does not rely on bank support, and clients can issue various amounts up to a pre-authorized limit under the program. This approach is for highly-rated borrowers that already maintain sufficient liquidity to support this program. Clients can repay tranches or roll them to future maturity dates, which must be less than 270 days. Time to market is relatively short given that initial disclosure requirements are limited.
Public fixed rate issuance
Clients with a desire to secure longer-term committed capital and have time to access the public market may elect to issue debt in the taxable market. This process can take 2-3 months or more, but clients gain access to institutional buyers and can issue substantial amounts of debt in the highly liquid treasury market. Frequently, these bonds are sold as 10- or 30-year bullet maturities. Terms are limited to MTI-only security and covenants. Borrowers need to evaluate municipal and corporate alternatives for taxable issuance; there are tradeoffs between the two, and both have merits.
Collateral posting relief strategies
Clients with interest rate hedges that have substantial negative mark-to-market valuations frequently have collateral posting requirements. This is particularly true in recent months as interest rates have fallen precipitously. These collateral requirements mean that clients post cash with swap counterparties on a daily or weekly basis. Several collateral relief strategies are available, which in essence finance the release of collateral back to the hospital. For example, relief can be negotiated on an interim basis for a small increase in the swap rate, and/or new swap counterparties can be introduced to provide additional capacity before the hospital passes the threshold with any one counterparty.
Hospitals spend significant capital on equipment and information technology (IT) needs. Banks and leasing companies can provide lease financing for a range of needs, and this approach can be attractive for equipment with obsolescence challenges. However, leasing equipment and IT needs may not make a material difference to a hospital’s liquidity position, especially in the near term. Nonetheless, it remains an alternative for consideration as hospitals evaluate how to procure new equipment and/or replenish old equipment in challenging times. Care should be taken in establishing equipment leasing programs to avoid the many pitfalls associated with this financing mechanism.
Pension funding strategies
Clients with unfunded pension liabilities face increasing funding pressures with the reduction of interest rates. This comes at a particularly difficult time for hospitals that face COVID-19 related challenges as well. It may make sense to finance near-term pension funding requirements with taxable debt in some format described here to alleviate liquidity pressures. Rating agencies are typically critical of financing pension liabilities because it monetizes the liability at a point in time, in this instance when interest rates have never been lower. The approach is therefore likely best employed on a partial basis within the context of various tradeoffs.
Other asset sales
Healthcare organizations may carry various illiquid assets on their balance sheets, ranging from investments in various enterprises to real estate to other elements. There may even be assets and revenue streams within the operating chassis that may be able to be monetized. Clients are undertaking a review of their options relative to retasking space across the system to care for the increase in medical patients. Even so, revisiting every asset holding class on the balance sheet to understand in a dislocated environment whether to hold or monetize is something that should be considered. Clearly, valuation levels and ability to sell or partner will be complicated by the moment, but many healthcare organizations carry “trapped” capital/liquidity on balance sheets and it is likely worth taking those assets out and examining them in light of COVD-19 pressures.
How Do We Decide What to Use?
The tactics you employ will depend on the size and timeframe for your needs and your risk and credit profile parameters. Bank agreements will be better suited to fund immediate liquidity needs because implementation timeframes are relatively short, and bank agreements provide relatively greater flexibility. Recapitalizing the system’s balance sheet to fund strategic objectives or major capital commitments in light of balance sheet deflation might better match with public market alternatives.
The size and strength of the hospital system’s credit will also dictate which alternatives are available to it. Higher-rated credits will have most or all of these alternatives at their disposal, while smaller or weaker credits will likely have a more limited set of choices, often at higher prices and with more restrictions.
The most important element is to put in place a resource allocation framework that can help measure one option versus another and otherwise guide the deployment of these options. This is a discipline that makes sense in any environment, but in an extended COVID-19 disruption, a disciplined decision-support framework will become a critical success factor.
Ultimately, hospitals will likely need to employ a combination of tactics to fund various liquidity needs over the next several years. Contact Eric Jordahl, Kaufman Hall’s Treasury & Capital Markets practice leader, at (224) 724-3214 or through email to find out more about how Kaufman Hall can help.