"Strategies for Responding to Changing Credit Markets"

Strategies for Responding to Changing Credit Markets

1Copyright 2009 Kaufman, Hall & Associates, Inc. All rights reserved.


September 11, 2009

Copyright 2009 Kaufman, Hall & Associates, Inc. All rights reserved.



Our Basic Capital Market Assumptions Are No Longer Valid

1. Cheap/ dependable capital access would be facilitated

– A fully functioning marketplace

– Investment banks as a backstop

2. Credit enhancement to improve market access and lower cost

– Expanded buyer universe even for mediocre and unsophisticated credits

– Access to alternative products and structures with ostensibly lower cost and full commitment

3. Cash retention/ creation would generate net investment returns

– Cash as protection during volatile times

– Dependence on net positive returns to bolster operating “bumps in the road” and support higher credit ratings

4. Ready availability of funding for large strategic and facility plans

– Assumed access to investor dollars

– Only uncertainty related to cost, covenants, and security



How Bad Was 2008?20072005199419931992198719841978197019601956 20061948 20041947 19881923 19861916 19791912 19721911 19711906 1968

2000 1902 19651990 1899 19641981 1896 19591977 1895 19521969 1894 19491962 1891 1944 20031953 1889 1926 19991946 1888 1921 19981940 1887 1919 19961939 1881 1918 19831934 1877 1905 1982

2001 1932 1875 1904 19761973 1929 1874 1898 19671966 1914 1872 1897 1963 19971957 1913 1871 1892 1961 19951941 1903 1875 1886 1951 19911920 1890 1869 1878 1943 19891917 1883 1868 1864 1942 19851910 1882 1867 1858 1925 19801893 1876 1866 1855 1924 19751884 1861 1865 1850 1922 19551873 1860 1859 1849 1915 1950

2002 1854 1853 1856 1848 1909 19451974 1841 1851 1844 1847 1901 1938 1958 19541930 1837 1845 1842 1838 1900 1936 1935 19331907 1831 1835 1840 1834 1880 1927 1928 1885

2008 1857 1828 1833 1836 1832 1852 1908 1863 18791931 1937 1839 1825 1827 1826 1829 1846 1830 1843 1862

-50% to -40% -40% to -30% -30% to -20% -20% to -10% -10% - 0% 0% to 10% 10% to 20% 20% to 30% 30% to 40% 40% to 50% 50% to 60%

US Equities Return by Year Since 1825

2008: -38%

Source: Investment Strategy Group, Yale University; Goldman Sachs.



Capital Access: The New Economy

• Banks raising own equity for survival

• Investment banks not willing to provide back stop

• Access to capital for many organizations is restricted

• Credit spreads have widened, and cost of capital has increased for all organizations

• Confidence in bond insurance has been severely shaken

• Bank letters of credit are a much scarcer commodity

• Fixed-rate bonds are the sole form of fully committed capital



Investment Earnings: The New Economy

• Net negative returns from borrowing in tax-exempt market and investing retained cash

• Huge asset-side losses related to market’s decline

• Loss of income from diminished cash reserves and pension and endowment portfolios

• Significant hit to hospital liquidity



Investment R

iskBusiness Operations Risk

Fina

ncia

l/ C

apita

l Ris

k

These three risks equal an organization’s affordable “risk budget” and need to be balanced and offsetting

The stronger the credit, the larger the affordable “risk budget”, given the implied greater “room for error”

Hospitals must determine the degree of its business and investment risk, which will drive funding decisions

• Business operations risk– Industry– Service area– Institution-specific operations

• Investment risk– Institutional decisions– Global capital markets– Domestic capital markets

• Financial/ capital risk– Debt structure decisions– Absolute borrowing rates– Fixed versus floating rates

Sound Capital Management Embraces Three Sources of Risk



As an Example, an Organization’s Significant Business and Investment Risk Requires Low-Risk Financing Strategies

If business risk is high and investment risk is high to moderate, this must be offset by a lower risk profile for

financing strategies and the capital structure.

Investment R

isk

Business Operations Risk

Fina

ncia

l / C

apita

l Ris

k

Pursuing a low-risk financing will offset…

…a current high-to-moderate risk

investing strategy…

…and high business and operations risk



Seven Strategic Management Requirements



• Don’t allow your credit rating to be downgraded if you can possibly help it

• We are in a “domino environment” – don’t knock over the first domino

Strategic and Management Requirements1. Credit Ratings Matter



• Are hospitals operating non-core businesses that no longer make sense?

• Are hospitals operating clinical services or parts of clinical services that are not justified by cost or quality?

Strategic and Management Requirements2. Reduce Fixed Costs – Nibbling at Variable Costs Will Not

Bring Real Change



Strategic and Management Requirements3. Aggressively and Proactively Reassess Your Strategic and Financial Position—Extremely Thoughtful and Conservative Financial Planning Is Required

• Planning and governance based on just “healthcare issues” is no longer enough

– Focus is plural: healthcare issues as well as economic issues



Strategic and Management Requirements3. Aggressively and Proactively Reassess Your Strategic and Financial Position—Extremely Thoughtful and Conservative Financial Planning Is Required (continued)

• Key questions to be addressed:

– Utilization. How has utilization of inpatient and outpatient care changed? How has your payor mix changed? What do you expect utilization to be in 2009 and beyond?

– Competition. How have your competitors been affected? What strategies are they likely to pursue and how will that impact your organization?

– Physicians. How have your physicians been affected? Do you expect physicians to increasingly seek the security of employment models in uncertain times? Will physician joint venture partners look to unwind their positions and “cash out”?

– Financial Damage. How much damage has occurred to your credit profile and balance sheet? What level of performance do you expect for 2009 and beyond?

– External and Uncontrollable Factors. How much cushion do we have to respond to negative economic changes outside our control? Are we braced for healthcare reform?



• Is the organization making as much cashflow as it can?

• Is the allocation of funds to the right capital expenditures and strategies?

• Are there noncore assets and/or real estate that can be divested?

• Is there debt capacity (and access thereto) that can be tapped?

Strategic and Management Requirements4. Reassess and Maximize Capital Capacity



• Many weaker providers have been pushed over the edge by the financial crisis and now are turning to divestiture as a survival strategy

• Strong, independent providers are now re-evaluating their ability to stand-alone – particularly those in need of significant capital

• Larger, stronger, systems are looking at the downturn as a time to re-evaluate their portfolio of operations – pursuing possible opportunities to consolidate the market

Strategic and Management Requirements5. Consider Consolidation Trends in Your Market



• Understand total enterprise risk, which includes operating, interest rate, financing, project, and event risk

• Understand how the risk equation changes, with:

– Strategy selection

– Change in cost of capital

– Marketplace events beyond organization’s control

• Total risk taken must equal financial ability to accept such risk

• Understand de-leverage vs. de-risk; reducing debt does not necessarily reduce risk

– “Tail risk” (the risk of planning in the shadow of a once in a lifetime event) is a clear concern as we emerge from the deepest recession in a generation, plus healthcare reform is on the horizon

Strategic and Management Requirements6. Consider Risk



Financing and Capital Structure Risk

• Interest rate risk

• Credit enhancement risk (bond insurers and/ or banks)

• Credit risk

• Put risk

• Mark-to-market exposure

• Tax risk

Strategic and Management Requirements6. Consider Risk (continued)



• How will healthcare reform work?

• What is the healthcare reform/ financial crisis dynamic?

• What priorities will reform drive?

Assess organizational readiness to meet the requirements of healthcare reform

1. Where is my organization on the readiness continuum?

2. Where does my organization need to be?

3. What resources will we need to get there?

4. Do we have the size, scale, and capital (both human and financial) to move along the continuum on our own?

Strategic and Management Requirements7. Consider Effects of Healthcare Reform



Reform Readiness Assessment

Extensive use of protocols/ EBM

Limited or no protocols/ EBM

Care Management Infrastructure

Strong historical care management orientation

Limited historical care management orientation

Care Management Culture

Employed physicians with incentive contracts

Independent/ unaligned staff

Physician Integration

EMR, IT distributed throughout system, sophisticated care management and monitoring software

No EMR, limited connectivity

Information System Sophistication

Highly accessible primary care, rationalized upper-level care

Poor primary care access, extensive unnecessary service duplication

Balanced Service Distribution System

SufficientInsufficient

Capital Capacity

StrongWeak

Composite Position

Weak Strong



One: IT systems that allow you to succeed and prosper under healthcare reform (EMR/ quality control)

Two: Physician strategy/ primary care/ integrated physician-hospital organizations of some workable model

The Reform/ Financial Crisis Drives Two Hospital Priorities



• Consolidation strategies

• Multispecialty group formation and management

• Exploring alternative delivery models

• Care and disease management as a core competency

• IT infrastructure development

• Restructure of both organizations and markets

Thinking the Big Think

"Strategies for Responding to Changing Credit Markets"

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