Capital markets continue to struggle, creating new pressure points for healthcare clients. The central theme of the moment is fear—and financial markets respond to fear quickly and frequently to excess. Market participants are generally moving to high-liquidity positions that are in “safe haven” assets, most notably U.S. Treasuries. Against this immediate increase in demand for U.S. Treasuries is a growing concern that the U.S. Federal Reserve will eventually need to issue significant treasury supply to finance the fiscal stimulus support that will be needed to help economies respond to the impact of COVID-19 mitigation efforts.
Provided below are observations across key areas.
Global Capital Markets
Both debt and equity markets remain extremely volatile, resulting in the following core challenges for not-for-profit healthcare providers:
Deflating Balance Sheets
Similar to the 2008 – 2009 Credit Crisis, sharp equity market moves are producing significant declines in the carrying value of invested asset portfolios. While losses may be unrealized, total cash positions are declining, which will adversely impact Days Cash on Hand positions and other credit ratios that measure total liquidity. In addition, as global resources have moved out of risk assets, they have moved into U.S. Treasuries, which have long been viewed as the safe haven. LIBOR, which is the yield curve that has been used to build most healthcare market swaps, generally follows Treasuries, resulting in sharp rate declines. For the subset of organizations that have LIBOR-based interest rate swaps, the rate declines have led to sharply lower swap valuations and increasing collateral posting requirements. Posted collateral is “restricted cash,” which is combining with investment portfolio reductions to put more pressure on total cash positions. By virtue of these negative effects on values, covenants such as Days Cash on Hand and Debt to Capitalization should be monitored for inadvertent breaches.
External Capital Challenges
Primary debt markets, both tax-exempt and taxable, remain inactive. There are a number of transactions that are in day-to-day mode, waiting for the demand side of the equation to stabilize enough to allow an orderly pricing process with the ability to secure reasonable pricing and terms. There are several sub-themes that will remain important to track:
- Funds Flows: For the first time in a very long time, municipal bond funds experienced outflows (redemptions) last week. This was occurring against an environment where huge amounts of dollars were moving into the U.S. Treasury market, which helped to drive the benchmark relative value disconnect discussed below. Funds flows have been the engine behind the exceptional performance of the municipal bond market over the past few years, and flow volatility or a reversal toward outflows can be expected to produce continued MMD volatility.
- Relative Value: The overall scale of market disruption is reflected in two key relative value indicators: the rate at which a high-grade tax-exempt bond prices versus its taxable equivalent (Tax-Exempt Ratio), and the rate at which one healthcare credit trades versus another (Credit Spreads). Disruption in either or both of these indicators complicates the ability of sellers and buyers to reach agreement on what is a “fair” clearing price and produces market dislocations. Over the past few weeks both of these relative value indicators have moved up sharply, to the point where it is difficult for market participants to establish baseline pricing levels. Both of these will need to find normalized levels before we can expect a return to a healthy market that can provide reliable funding to the broad healthcare sector. It is possible—perhaps likely—that the early stages of market re-opening will be led by higher grade credits. This access will be a very good sign, but it will need to be followed by broader participation before we can say we are on the road to recovery.
- Money Market Dislocations: Over the past week, short-term funding markets, including the municipal money markets, have experienced fund redemptions, resulting in significant increases in floating rate program resets. This is another form of relative value dislocation, as tax-exempt floating rate debt is trading at a significantly higher ratio to 1-Month LIBOR. This will result in significantly higher floating rate funding costs, as well as higher synthetic fixed rate costs in situations where LIBOR-based swaps are hedging SIFMA-based floating rate debt. Our understanding is that floating rate debt dealer inventories are increasing. The challenge in this market—similar to in the fixed rate markets—is a reduction in the demand side of the buy/sell equation that is pushing rate levels higher.
Liquidity positions among healthcare providers should be under scrutiny, given expected increases in costs of care and decreases in liquidity positions. Questions about payment/cash flow disruptions from an extended coronavirus experience are important and center on the three questions of:
- How much liquidity should the organization have?
- How much liquidity is available across various existing resources without triggering a need to liquidate investments at disadvantageous market levels?
- How can we supplement our liquidity position?
The obvious consideration is putting in place lines of credit with relationship banks. There is a lot of activity in this segment and availability and pricing may begin to become strained. Secondary considerations are around things like leasing or other alternate financing channels that do not directly require public market access and may help to preserve cash positions for a form of defensive working-capital positioning.
Next Steps for Treasury Teams During COVID-19
The market disruptions are likely to continue for an extended period of time. The extraordinary actions being undertaken in response to COVID-19 will have very, very material back-end economic consequences. For healthcare finance teams, it is absolutely critical to think about total balance sheet management and how the balance sheet connects back to total operations. We also think it is prudent to increase visibility internally on these topics with management teams and boards so that if or when action is required, your treasury team will have been educating relevant constituents. We will offer market commentary as often as possible and we will also be sharing a treasury tracking list that starts to identify near-term and longer-term issues that we all need to address as we move through this crisis together.
Please feel free to make this a dialogue—to share best practices around financial and treasury management that we can then offer out to the industry. Communication and collaboration will be critical to getting through this and we look forward to doing whatever we can to help.