COVID-19 Brings Rapid Deterioration in Operating Cash Flow
The emergence of COVID-19 has generated pressures on health system liquidity that were unimaginable just a few weeks ago. Hospitals and health systems now face gale-force headwinds in the generation of operating cash flow from a combination of critical imbalances:
- Reduced revenue and margin due to the elimination of elective procedures and changes to payer mix, with a higher percentage of payments from government programs
- Sustained baseline expense load as providers keep staff intact to anticipate case surges; exposure to potentially higher expenses if case mix acuity increases during a surge
- Workforce disruptions and increases in contract labor
- Supply-chain disruptions and premium pricing related to securing scarce but necessary items
- Uncertain risk exposure associated with the unknown length of COVID-19 impacts
Rapidly deteriorating cash flow, combined with material lost value in investment portfolios, has been driving organizations to critically evaluate their liquidity positions. The immediate focus has been on the role that revolving lines of credit can play in addressing this issue. The recently passed federal stimulus will help, but there is uncertainty about how and when it will roll out and whether it will fully offset the revenue dislocation. The central liquidity problem will improve but will likely not be resolved, and mitigation planning will need to continue.
A Methodical Approach to Liquidity Formation
Even as hospitals and health systems seek additional capacity, access to bank credit products, specifically revolving lines of credit, has tightened up as a result of the systemic impact of COVID-19. All industries are facing liquidity issues as waterfall impacts cascade across both corporations and consumers. Banks are faced with the dilemma of how to allocate their available capital across the wave of new requests and best support high-impact regions.
The Federal Reserve has taken considerable action to shore up financial markets and provide liquidity as selling has occurred in every market in a rush to secure cash. However, regulatory and capital requirements continue to limit the amount of revolving credit that banks can make available to their clients. The rush for revolving credit and its limited supply also have created significant changes in parameters including capacity, tenor, pricing spreads, rate floors, covenants, and commitment timing.
In this resource-constrained environment, healthcare organizations should consider liquidity formation that tracks the following sequence:
- Reach out immediately to core relationship banks to determine how much is available through lines of credit from these organizations. Securing available capacity is the number one priority at the moment.
- Put in place a robust framework to methodically assess potential liquidity needs, using financial modeling and scenario analysis; use this framework to establish a revised perspective on liquidity needs and a process for adjusting 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. Thinking broadly in this effort is critically important, as is assessing whether historical constraints on various options still apply. The goal is to identify both the options available and the guidelines that can define whether the option will ever be utilized so you can establish an actual implementation road map.
Critical inputs for putting in place the necessary liquidity management infrastructure include, first, financial modeling and sensitivity analytics to estimate liquidity needs today and into the future, and second, a methodical resource allocation framework that can guide the utilization of the identified liquidity resources.
Securing Revolving Lines of Credit
A best practice is to reach out to banking partners and advisors to collect bids and determine whether pricing terms are “on market.” Our experience is that some banks are rationing credit for their better customers, so treasury departments should be very tactical with banks during this time as the importance of existing non-credit business (including treasury services, purchasing cards, merchant processing, and custody services) is significantly amplified as credit extensions are considered. The flip side of the coin is that you should be expecting your current bank providers for these services to accommodate your request for liquidity.
Your Master Trust Indenture and other credit documents likely limit your ability to issue short-term debt to some degree, so consult your documents and check with legal counsel to comply with relevant document provisions. Many bank bids are currently 364-day commitments, so be careful to check for relevant treatment of short-term debt, smoothing provisions for amortization of bullet indebtedness, and clean-down provisions, some or all of which may be included in your documentation.
Material Adverse Change (MAC) provisions, which are typical in interim credit facility documents, require that management attests to the fact that no material change to the financial condition or performance of the organization has or is expected to occur. Not only are these certifications required at closing, but also each time the borrower draws on the revolver for funds. Given the anticipated financial effects of COVID-19, consider carving out the effects of COVID-19 from relevant MAC clauses as you negotiate with your banks. Consult your counsel and advisors for assistance.
Interim lines of credit are excellent short-term funding sources, but it will also be necessary to consider more permanent liquidity sources in short order. Hospitals have a number of alternatives, but each takes some time to plan for and execute. Begin thinking about permanent alternatives in the very near-term to address expiration of new revolvers, access to additional liquidity, or both.
A Call to Action
Acting now to size and secure liquidity reserves based on the best available financial projections is a call to action for all financial professionals. Sizing liquidity needs will require a baseline analysis, financial planning to mitigate the negative impacts described above, and sensitivity analysis to estimate additional liquidity requirements.
In the short-term, tasks such as evaluating bank relationships for optimal credit partners; reviewing existing credit facility pricing, terms, and maturity dates; and soliciting indicative pricing and terms are within an organization’s control to best manage an uncertain market. Long-range planning should include budgeting for repayment of your revolver or securing more permanent liquidity.