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.
Year-to-date total municipal market debt issuance is up 7.1% versus 2020 while municipal healthcare issuance is down over 50%. Some of the largest healthcare offerings this year have come in the taxable market, so are not captured in the municipal issuance measurement. But no matter how you look at it, 2021 has seen a materially lower level of healthcare issuance. Pair this with continued favorable fund flows and the result is continued strong pricing overall but especially for tax-exempt issuers.
SIFMA reset this week at 0.06%, which is approximately 53% of 1-Month LIBOR and represents a 1 basis point increase versus the March 24 reset.
The Idea of Return on Risk
My colleague Dave Ratliff recently shared that a common refrain from investment advisor forecasts is that volatility is increasing for most asset classes per unit of return. Put differently, the investment side of the healthcare house is experiencing reduced returns on risk. Unfortunately, this problem is not unique to the investment world. The same dynamic extends into debt portfolios where the return on floating rate risk relative to fixed rate options is also relatively low. Most importantly, this thread is rippling across operations and strategy as well; operating volatility and strategic uncertainties are significantly elevated and returns remain under pressure.
The discouraging likelihood is that this environment will remain in place for an extended period and may even get worse from here. Equity markets move higher, but are valuations justified considering forward earnings potential and the incredible access to cheap capital (and given private market appetites and Federal Reserve actions)? Is it all real or is it the mother of all market bubbles? Will the flood of liquidity from the Fed and Treasury trigger inflation and the escalation of fixed income market volatility that will impact investing and borrowing activity? And across operations there is the reality of dislocated service lines, volumes, and revenues and the resulting uncertainty about what post-COVID normalization will look like and how to get from here to there. No matter which direction you look in, healthcare leaders confront reduced returns per unit of risk.
From the perspective of the sellers of risk, this environment is helpful. As noted above, debt market yield curves remain relatively flat, which reduces the return on risk associated with floating rate exposure. But absolute rates are also low, which means that the cost to de-risk, and especially to do so by extending duration, is reduced. This dynamic has fueled the bias toward fixed-rate issuance over the past several years.
The problem is that there are limited options in healthcare to sell risk, because so many of the most compelling risks are embedded in mission or strategic imperatives. For the risks that remain in place, the questions include: Do you seek to defend returns and tolerate elevated risk? Or do you maintain a target risk position, knowing that return expectations will move lower (and perhaps significantly so)? Can you even choose a response? Navigating these realities is hard and two things are required if you have to buy or hold risk in a low return environment: you must get really good at risk management (figuring out how to reduce the unit of risk attached to an activity), and you have to put in place a resource deployment framework that allows you to identify and then pursue the right risk-return balance.
An interesting twist on healthcare financial management is the idea that every healthcare organization represents a portfolio of operating, strategic, and financial risk, and the systemic challenge for management and governance is how to optimize total return per unit of risk.
My colleague Steve Sohn developed a piece on LIBOR transition that can be accessed here. As Steve describes, the transition process is starting and there are some important differences between debt and swap instruments. While the topic is not “urgent,” it is important and depending on what you want to look at or test, it may take some time to develop your response. Steve’s article is a good start.