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.
The inflation question looms but our leverage accommodative world keeps spinning: Favorable taxable rates, very favorable tax-exempt rates, manageable supply, and supportive fund flows. The cost to de-risk remains low both in terms of absolute rates and the total curve spread, so the capital structure bias continues to support an overweight to long duration fixed-rate debt.
SIFMA reset this week at 0.03%, which is approximately 40% of 1-Month LIBOR and represents a 2 basis point decrease versus the May 26 reset.
Transitory Versus Systemic Risk
Late as usual to the contemporary culture party, I just started watching the HBO series “Game of Thrones.” A range of characters keep using the phrase “winter is coming” to hint at some looming existential threat, and it got me thinking about our situation and the idea of transitory versus systemic risk. Transitory risk follows the familiar dislocation to stabilization to normalization playbook, but stabilization is relatively shallow and short, and normalization looks a lot like the pre-disrupted environment. Things get unpleasant and maybe some things change, but not that much. Systemic risks, on the other hand, are deeper, with a much more complicated stabilization process leading to normalization that is different—sometimes profoundly different—from what existed before. In either scenario winter arrives, but the systemic version is long and hard and full of sub-events that ultimately lead to fundamental change.
As the U.S. economy and society reopen, it is tempting to imagine COVID winding up at the transitory end of the risk continuum. We moved into the initial shock stage and experienced a precipitous drop in volume and revenue and a limited ability to downshift expenses, resulting in severe margin dislocation; and then we moved into stabilization that includes volume recovery, although not uniformly to historical levels and with some modalities that may have different revenue characteristics. If this continues, perhaps a relatively familiar normalization is on the horizon, even if there is some lingering noise around margins as we rebalance revenue and expense.
But a very real concern is that policy responses to COVID—both monetary and fiscal—are laying the foundation for systemic tail risk. Consider the following three factors:
- Monetary Policy: In 2007 the Federal Reserve’s balance sheet included total assets of $0.87 trillion. By the end of 2019, the asset base stood at $4.1 trillion, the legacy of the Fed’s response to the 2008 credit crisis. At the end of May 2021, the asset base stood at $7.9 trillion.
- Funding Concentration: According to CMS, at the end of 1997 the federal government was the source of 21% of national health expenditures (and government collectively held a 38% share). At the end of 2019, the federal government percentage had reached 29% (with total government payers representing 45%).
- Leverage: According to the St. Louis Fed, at the end of 2007 U.S. Gross Federal Debt to GDP was 63% and by the first quarter of 2020 the percentage had reached 108%; if enacted, the proposed Biden administration budget—including new spending initiatives and increased taxes—is projected to push this level to as high as 117% over the next decade.
If the Monetary and Leverage factors prove unsustainable, then we may be on the cusp of a more ominous post-COVID stabilization process, with the primary threat being a great liquidity unwind that brings dislocation out over a long period of time. For health systems, this would expose both balance sheets and revenues:
- Healthcare balance sheets—the invested asset base that is so critical to credit positioning and institutional resiliency—are exposed to the unwinding of the Fed’s balance sheet. We have never lived through anything like this: What happens to financial markets when $7.9 trillion of single counterparty support is unwound? Can this be done in an incremental and tightly managed process or are there events or circumstances that might force a more accelerated and disruptive unwind?
- Healthcare revenue exposure has increased against a counterparty that is using deficit spending and leverage to introduce new or expand existing initiatives that ultimately compete with healthcare for funding. This works until it doesn’t, at which point things might get ugly. The Balanced Budget Act of 1997 (BBA) caused significant revenue and credit dislocation because at that point any effort to address federal budget deficits had to include material reductions in healthcare spending. In 1997, U.S. federal debt to GDP was around 64% and the federal government represented 21% of national health expenditures. Imagine what a 2021 version of BBA would look like and what it might mean to healthcare sector revenue.
I am not far enough along in my “Game of Thrones” journey to understand whether winter comes or what it will mean if it shows up; the same uncertainty surrounds the question of COVID as a systemic risk event. But no matter where COVID ultimately ranks on the transitory to systemic continuum, there is a best practice response:
- Understand enterprise risks, which means identification and quantification paired with an assessment of risk-specific offsets or management opportunities
- Understand enterprise resources (operational, credit, liquidity) and the sources and consequences of vulnerability
- Put in place an integrated resource management infrastructure that includes as part of its mandate deployment strategies to anticipate or respond to the realization of risk
We call our process Strategic Resource Allocation. Whatever system you use, the imperative is to put resiliency at the same level of importance as mission and margin, and then start the work of securing it.