Capital Markets Update and Implicationsfirstillinoishfma.org/wp-content/uploads/4-DEBT-MARKETS.pdf · 2016-10-13 · 6. Another bank industry collapse (e.g., commercial real estate,

Illinois HFMA Treasury Program

Copyright 2011 Kaufman, Hall & Associates, Inc. All rights reserved. 1

Capital Markets Update and Implications

Copyright 2011 Kaufman, Hall & Associates, Inc. All rights reserved.

4th Illinois HFMA Treasury Program Chicago, IL / December 15, 2011



• Big Picture Perspective

• Hospital Capital Markets Update

• Final Thoughts

Agenda

2



Big Picture Perspective

3



Capital Markets “Assumptions” Have Transformed • Capital access no longer a “given” for every credit and every project

– “New era” capital market expectations are evolving while the environment is subject to market-wide “on and off again” volatility

• Creditworthiness matter more than ever (unlike pre-2008) – Driver of capital access, product availability, costs and terms

– Key market indicator of long-term organizational capability and durability, especially during challenging times

– Attractiveness to potential partners (consolidator vs. consolidatee)

• Fixed-rate bonds are the sole form of fully committed capital, but access, costs and terms have fluctuated wildly since 2008

• LOC-backed variable-rate debt is largely uncommitted capital with considerable and unpredictable event risk

– Bank direct lending only mitigates some of the key risks

• When push comes to shove, you can’t expect the market to provide a reliable backstop to your capital structure under all circumstances

4



Unsettling Potential Capital Market Wild Cards in the New Economy 1. Deepening recession vs. pronounced inflation viewpoints 2. Short-term Fed policy leading into an election year 3. International economy melt downs 4. Saturation of long-term Treasury bond issuance pushing up rates 5. Another severe capital markets dislocation/ liquidity crisis 6. Another bank industry collapse (e.g., commercial real estate, credit

card debt, etc.) 7. Healthcare industry reform realities turning off investors 8. Healthcare industry sector saturation as more borrowers issue fixed-

rate debt and buyers get “full up” on healthcare allocation 9. Hospital bankruptcy announcements shaking investor confidence in

the industry (e.g., AHERF in the 90s) 10. More confidence in equities, real estate, or commodities shifting

money out of tax-exempt bonds

5



Given heightened risk awareness across the spectrum, capital management strategies and

tactics are transitioning…

Pre-2008: “Era of the Deal”

2008 to 2010: “Broken Deal Reactive Fixes”

2011 - ?: “Evolving enterprise risk management leading to more thoughtful decision making”



Identifying Risk Entry Points

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CAPITAL STRUCTURE

STRATEGY/ OPERATIONS

MACROECONOMIC/ HEALTCHARE INDUSTRY

Leases

Capital Allocation Governance/

Approval

Debt/ Swap Management

Capital Spending

Liability Portfolio

Inflation/ Deflation

Capital Markets

Commodity Prices

Interest Rates

Put/ Event Risk

Counterparty Exposure

State/ Federal Budget

Pressures

Patient Volumes

Asset Portfolio Credit/ Liquidity

Provider

Financial Covenants

ISTFP

Risk Capacity

Tax Exempt Ratio Exposure

Credit Rating

HC Reform

Changing Business Model

Clinical Integration/ Physician Alignment

Cost Structure Clinical

Transformation

Liquidity

Cost of Capital Allocation

Service Line Distribution

Facilities Planning

Business Strategy

IT Management

Brand

Energy Natural Disasters

Tax Exemption Status

Market Access

Investor Relations

Compensation Management

Insurance Shortfall

Risk Premiums



Optimizing Internal Risk Tolerance vs. Expected Risk Exposure

Internal Risk Tolerance/ Capacity

• How much capital capacity do we need to support the key strategic initiatives?

• What level of liquidity and balance sheet flexibility do we need to withstand potential shocks?

• How constrained will the organization be to react to new opportunities and challenges as capital is deployed to pre-existing initiatives?

Probability and Magnitude of Risks

• How likely is the change in competitive or operating environment?

• How quickly will the change occur?

• What will be the magnitude of the impact to the organization?

• What levers are available to manage necessary margin should such downside shocks occur?

• What confidence level exists in executing on the current projections?



Evolution to The Integrated Strategic, Treasury and Financial Plan Market Strategies • Service line initiatives • Geographic presence • Physician strategies • Site-specific volume and revenue

projections

Debt and Swap Strategy • Debt, swap, and lease risks • Market access

Facilities Management • Facility investments • Equipment investments • Information technology

Financial Planning

Treasury Strategy

Capital Allocation

Annual Budget

Mission-Based Strategy

Operational Strategy • Care delivery model • Process optimization • Throughput productivity • New technology impact

Financial Investments • Return expectations • Volatility, liquidity, and

counterparty risks • Infrequent events

Global Constraints Philosophy/ Policy Financial Targets Strategy Flexibility Credit Rating External Risks

Capital Market Strategy • Defined Benefit Pension Plan • Market reliance management



Integrated Planning: Do You Have Good Answers to These Questions? Strategic Planning What’s required to compete in the market and why? How does

your strategy relate to new era core competencies and changes to the business model? How much change is required and by when? How much will it cost? How will competitors react? Are you prepared to do what’s necessary? Can you do it alone?

Financial Planning Can you afford your strategic plan within an acceptable credit and execution risk context? What if you're wrong… then what? Is it too risky?

Capital Allocation How much should you spend? Is spending focused at the right strategies? What is the risk adjusted discounted cash flow return of the portfolio? Is actual vs. projected performance measured?

Capital Structure What is the right amount, mix, structure and cost of debt and equity? Do you know how much risk you’re really taking? What contingency plans are in place on uncommitted debt?

Budgeting/ Reporting Do you have the tools and process to deliver a credible budget tied to your strategic financial plan? Is it achievable? Is there accountability for results? What if you fall short? Then what?

Exit Rules/ Options Which strategies, services, facilities, or capital structure products? Under what conditions? How?

10



Hospital Capital Markets Update and Implications

11



Primary Capital Sources: No One Size Fits All and No Free Lunch 1. Variable-rate demand bonds supported by a commercial bank letter

of credit or own credit/ self liquidity 2. Public market fixed-rate bonds (own credit or insured by HUD/FHA

or USDA) 3. Private placements 4. Direct bank lending (bank or non-bank qualified, fixed or variable) 5. Capital/ operating leasing 6. Asset monetization/ developer-funded structures 7. Operations 8. Working capital management (A/R reduction and A/P extension) 9. Outside support: grants, philanthropy, new payor models, local

government tax support, etc. 10. Capital investment deferral, downsizing, and/or elimination 11. Outside capital partner (merger, joint venture, private equity, etc.) 12. Other

12



Fixed Rate Market: MMD Benchmark Index and Credit Spreads

• Municipal Market Data (“MMD”) decreased 97 bps since the start of 2011

• Credit spreads to MMD have stabilized, but remain well above average

Source: MMD Index, Thomas Reuters. As of 11/28/2011.

0%

0.5%

1%

1.5%

2%

2.5%

3%

3.5%

4%

4.5%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Cre

dit S

prea

d to

MM

D In

dex

Healthcare Credit Spreads'AA', 'A' and 'BBB' Healthcare Credit Spreads over MMD 'AAA' Benchmark

Index30Y AA Spread 30Y A Spread 30Y BBB Spread



• Price discovery less of a concern now with more supply • 30-year fixed rate access, costs and terms highly dependent on

overall muni fund flows, state tax advantages and intrinsic hospital creditworthiness

– “AA”: 5.15%+ – “A”: 5.60%+ – “BBB”: 6.25%+

• Underlying credit/ market fundamentals matter most, so expect to speak with buyers more diligently looking for highly rated, well-positioned, long-term market-winning borrowers

– Extended pre-marketing period (full one to two weeks) – Investor calls and possibly in-person investor meetings/ road shows,

depending on credit – Bank covenants (LOC and direct lending) surfacing in investor calls – Heightened review of bond docs, Appendix A and credit reports

Long-Term, Fixed-Rate Investors Remain Cautious

14



Variable Rate Market Remains Very Low Cost with Stabilized Commercial Bank Access… At Least for Now

• Public, tax-exempt, variable rate market remains at all time lows • Market access/ cost historically tied to commercial bank letter of credit

availability, cost and bank rating • Borrower takes responsibility for risks: interest rate, investor put, borrower

downgrade, bank downgrade, tax, hospital rating downgrade, etc. • Considerable market and credit support uncertainty exists

15



• Current relationship bank(s), if highly rated, will likely be your best partner

– One-off lenders to non-comprehensive clients are infrequent/unreliable • Pending regulations and other factors affect bank LOC appetite

– Increased bank reserve requirements affecting access, terms and costs – Push towards direct lending, but renewability a question

• Restrictive and highly negotiated covenants, security, and termination provisions

– Be mindful of borrower rating (e.g., “A-”) downgrade termination triggers – “Material Adverse Event” language creates an “easy out” for the banks – “Change in Regulation” language preserve a bank option to increase costs – Annual evergreen renewal provisions can prove helpful – Insist on “real” term-out provisions in the event of remarketing failure: 3-5 yrs

• Possible subjective consent provisions (e.g., issuing new debt, asset disposition, mergers, joint ventures, sale/ lease back, etc.)

• Significant tie-in with other commercial banking services a given

Access to Bank Letters of Credit Remains Okay for Now, but Expect…

16



• How do bank loans work? Direct bank loans have become increasing popular given the decreased number of LOC banks and increased number of borrowers that are converting VRDBs to fixed rate; these facilities are bonds that are directly bought and held by the bank

• What are the typical terms? Bonds are usually sold with a long-term maturity and have a renewal 3 to 7 years out; these facilities are priced at a spread to LIBOR, adjusted by applying a tax factor (i.e., 74% of LIBOR + credit spread); Spreads are dependant on the credit of borrower and the appetite of direct lending for each bank

Advantages + Generally no rating needed + Hospital public disclosure/Appendix

A not required + Competitive pricing (similar to LOC) + Eliminates the daily/ weekly put risk

associated with VRDBs + No debt service reserve fund + Better hedge with % LIBOR swaps

Disadvantages and risk factors – Put feature is essentially the term

of the loan – Bank establishes its own covenants – Banks require tie-ins to other

commercial business (could be significant)

– Retain variable rate and bank renewal risk

– Change in regulation circuit breaker

Direct Bank Lending Rising, But it is Not Committed Capital

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Key Financing Product Cost and Risk Summary AA

Fixed Rate A

Fixed Rate

BBB Fixed Rate

LOC-Backed Variable Rate

Bonds

“AA” Own Credit/ Liquidity Variable Notes

Direct Bank Lending

30-Year Bond Yield 5.15% 5.60% 6.25%+ SIFMA, wkly SIFMA, wkly n.a.

Letter of Credit n.a. n.a. n.a. 0.90%, 3 years n.a. n.a.

Bank Lending Rate n.a. n.a. n.a. n.a. n.a. 74% 1M Libor +90 bps)

Annual Remarketing n.a. n.a. n.a. 0.10% 0.10% n.a.

Cost of Capital 5.15% 5.60% 6.25%+ SIFMA + 1.00% SIFMA + 0.10% 74% 1M Libor + 90 bps

Risks Put Risk No No No Yes Yes (self funded) No Bank Renewal Risk No No No Yes No Yes Rollover Risk No No No Yes Yes Yes Credit Enhancer Risk No No No Yes Own rating No Interest Rate Risk No No No Yes Yes Usually Tax Risk No No No Yes Yes Depends Borrower Downgrade Reserve Fund Mortgage

No

No

No

No

Maybe

Maybe

No

Yes

Yes

Yes

No

No

Yes

No

No

Yes

No

No

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Final Thoughts



• Protect credit ratings

• Manage organization-wide risk

• Balance global capital strategy

• Diversify (products, providers, risks, etc.)

• Anticipate municipal capital market volatility

• Consider banking market volatility

• Incorporate leasing as a balance sheet borrowing strategy

• Integrate strategic, financial and treasury management planning

Consistent Themes Across Hospital Capital Management Strategies

20

Rush University Medical Center Obligated Group

Debt Management in the Best & Worst of Times

December 2011

Patricia S. O’Neil Treasurer & Chief Investment Officer

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Members of the Rush Obligated Group

Rush University Medical Center has been part of the Chicago landscape for more than 170 years. RUMC includes: 664 staffed bed academic medical center serving adults and children Health sciences university with over 1,900 students and $126 million in

annual research expenditures Rush University Medical Group with 405 employed physicians across

multiple specialties Over 660 medical residents

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Rush Copley Medical Center (located in Aurora, IL) 193 staffed bed community hospital Employed medical group with

42 physicians Expansion to Yorkville, IL: $48 million

second campus with new urgent care and outpatient center (opened July 2008) and freestanding emergency center (to open in 2012)

Rush Oak Park Hospital (located in Oak Park, IL) 128 staffed bed community hospital Employed medical group with

40 physicians

Members of the Rush Obligated Group

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2009 2010 2011 2012 2013

Major Inpatient Electronic Medical Record Milestones

Complete

New Hospital Tower Opening

Orthopedic Building Opening

Outpatient Cancer Center Opening

HIMSS EMR Adoption Model:

Stage 6 Recognition

Ambulatory Rollout of Electronic Medical Record

to Employed & Private Faculty Complete

‘Clicks’

‘Bricks’

Additional Major

Renovations Complete

Transformation Timeline

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Transformation of Facilities

Embracing Advancements in Care Model Delivery

New Hospital: Expected January 2012

Acute & Critical

Care Floors

Women’s Services & NICU

Interventional Platform and

Imaging Floors Center for Advanced Emergency Response

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

$45,000

$50,000

$55,000

$60,000

Leases

2009C/D

2009A/B

2008A

2006B

1998A

1989A

1985

2015 Peak Debt Service = $55,124

Tota

l Deb

t Ser

vice

(Dol

lars

in Th

ousa

nds)

Fiscal Year

Debt Profile – Obligated Group

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Interest Rate Swaps – Obligated Group

27

EstimatedObligated Group Hedged Notional Mark-to Termination

Member Item Amount Market(12) Value(13)

RUMC 2008A Bonds 50,000$ (6,984)$ (7,474)$ RUMC Unhedged 17,050 (2,382) (2,549) Total RUMC 67,050$ (9,366)$ (10,023)$

RCMC Unhedged 29,700$ (5,139)$ (5,707)$

Total Outstanding Swaps 96,750$ (14,505)$ (15,730)$

Swap agreements are entered into at the Obligated Group level and expire 11/1/2035.

Interest Rate Swap AgreementsPay 3.945% / Receive 68% of 1-Month Libor

Amounts in $000's

The Obligated Group holds $48,375 in notional with Citigroup and $48,375 in notional with Morgan Stanley as the swap counterparties.

Capital Structure Evolution

• Issued $200M variable rate with fixed-rate swaps (1/2 ARS and ½ VRDBs) • Amended and Restated MTI • Received standalone rating of A-; first since early 1990’s • Approved 50%-50% fixed/variable rate mix

• Converted ARS to fixed rate • Terminated $100M swaps (loss) • Secured lines of credit and MLA • Issued fixed rate new money •De-risked unrestricted investment portfolio

• Primarily fixed rate debt • Still dealing with unhedged swap (set trigger) • Reporting liquidity via Moody’s template • Refinanced bonds with bank private placement •Set capital structure based on overall risk at RUMC

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2006 2008 – 2010 2011 and Beyond

New Structures mean different concerns

Tax-Exempt Private Placement

1. Market Risks • Market risk? • Put risk? • Refinancing risk? • Tax/capital charges?

2. Material Adverse Change (Do NOT have your lawyers negotiate business terms!)

• Objective test, if possible • Stress test the condition (back-test and what would have to happen for a breach)

3. Rating Agency & Bondholder assessment

• Share documents with rating agencies • What are bondholders’ expectations? • Type of disclosure in MD&A

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Measuring DCOH to Cover Debt

% Unrestricted Endowment

% Short term Fixed Income

% Cash and MMF

30

% Illiquids

% Equities

% Corporate Debt

% ABS, MBS

% Government

Assessment

? Cost of debt versus investment yield ? Manager exposure on investment managers and credit providers ? Concentration

? Average quality ? Lock Ups ? Commingled or separately managed

Number of Days In Each

Category

Proactive Debt Management Initiatives

1. Investor Relations • Not only rating agencies • Talk to the bondholders • Quarterly or fiscal year investor call • Annual bank meetings with access to non-finance management

2. Superior Disclosure to Investor Community • Best practice quarterly and fiscal year (approved by Audit Committee) • Post on EMMA and website • Ask for feedback

3. Superior Disclosure to Board Governance • Standard reporting package on financial metrics (including quantitative benefits if higher rating) • Linkage with DCOH • Spread between investments and risk-adjusted cost of debt • Swap MTM, collateral posting • Annual Board approval of debt, lease and derivative policies

4. Contingency Planning • Back stop lines of credit • Master Lease Agreements • Call on cash

5. What’s left? • Full Enterprise Risk Assessment

31

Rush University Medical Center Obligated Group Investor Relations Plan – FY2012

Q1 Q2 Q3 Q4

Fitch review (outlook upgraded to Positive) GE Master Lease Agreement increased to $75M Finance Committee approval of Debt, Derivative, Capital Lease policies Assess refunding opportunities for Series 1998A

S&P review (outlook upgraded to Positive) Review of A1/A+ metrics with Finance Committee Peer analysis completed Series 1998A refinancing approved (12/16 closing) Dec. 1st Investor Tour Renewal of $50M Northern Trust Letter of Credit and $100M JP Morgan line of credit

• Moody’s review • Renewal of $50M Bank of Montreal line of credit

• AHA/Citigroup/ HFMA Annual Bondholder Conference

32

Documents

Capital Markets Update and Implicationsfirstillinoishfma.org/wp-content/uploads/4-DEBT-MARKETS.pdf · 2016-10-13 · 6. Another bank industry collapse (e.g., commercial real estate,