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Seeking Commercial Paper

By Dr. David E. Marcinko; MBA, CMP™

Hospitals and healthcare organizations have significant short-term financing needs and are constantly rolling over large sums of commercial paper to finance accounts receivable [ARs] to pay their bills, vendors, debts, payroll and investors in the form of dividend payouts or retained earnings and disbursements, etc. But, because of the dismal economy and current credit-crunch, physician executives, healthcare administrators, hospital CEOs and all CXOs seem to be asking the same questions these days:

• If short-term financing suddenly becomes difficult to obtain, how will hospitals cope? 
• What precautions can healthcare organizations take to prevent trouble down the road? 
• Can the health industry turn to the Federal Reserve or US government for assistance? 
• What else can we do as medical practitioners, CFOs and/or physician executives?

Cause and Effect

To first understand root cause-and-effect of the credit squeeze, consider that at the beginning of 2008 there were five major investment banks in the US. By October only two remained in hybrid form, and credit was stifled.  What caused this major change was the so-called sub-prime mortgage security debt problem? Its’ prime catalysts was a financial derivative called a credit default swap (CDS) – which caused both the remaining investment and most commercial banks – to virtually stop their lending practices.

Credit Default Swaps [What they are – How they work]

According to the Dictionary of Health Economics and Finance www.HealthDictionarySeries.com, a derivative is a financial instrument that derives its value from another instrument. Derivatives can range from financial securities as simple as a stripped bond, or pooled mortgage, to extremely complex securities customized for a particular risk management need. And, some doctors know that perhaps the simplest form of derivative is a short-sale, where a bet is placed that some owned asset will go down, so that you are covered whichever way the asset moves.  

Example:

In an institutional example, a party would enter into a credit default swap contract with an insurance company, investment or retail bank; largely mortgage backed-securities.  Payment of premiums insured the default. In the event of obligation default, the bank would satisfy the contract. But, it is significant that in these transactions there was no federal or state regulatory body supervising them. Why?  Because these contracts were not securities per-se and no oversight was necessary. The instrument does not even need to be associated with the buyer or the seller of the contract.

Wall Street Gurus [nyuck! nyuck! nyuck!]

And so, it seems that the smart financial folks on Wall Street that designed derivatives and credit default swaps, forgot to ask one thing; what if the parties on the other side of the bet didn’t have the [mortgage] money to pay up? As a result of this “amorphous toxicity default”, the short term commercial paper markets reached a three-year low of $1.6 trillion, in September 2008, as money-market fund managers – typically huge buyers of commercial paper – became extremely risk averse.

Some Possible Cash Crunch Solutions for Hospitals

Possible solutions to the cash-crunch involve passive external, and more active internal, strategies.

The EESA

Externally, for example, President Bush signed into law the Emergency Economic Stabilization Act (EESA) [Pub. L. 110-343, Div. A] On October 3, 2008. Commonly referred to as a bailout of the US financial system, it authorized the US Treasury to spend up to $700 billion to purchase distressed assets like CDSs and mortgage backed securities from the nation’s banks to free up the commercial paper market. Nine of the nation’s biggest banks have already received $125 billion of the Treasury’s $250 billion banking earmark, with $35 billion more going to various regional banks to increase liquidity. Traditionally, hospitals find commercial paper a less expensive liquid alternative to traditional asset-based borrowing. Commercial paper is a short-term promissory note issued by a hospital or other entity to raise short-term cash; either asset-backed or unsecured. The issuer of the note agrees to repay borrowed money within a range of one to 270 days, with 30 to 180 days being the most popular maturities.

The Fed’s Next Financing Gambit

Another program offered by the US Federal Reserve was to buy commercial paper as a means to increase access to funding and free up frozen credit markets. Clients, like hospitals and healthcare systems, with huge short-term funding needs are eager to take up the offer amid the difficulty in accessing credit. The new Commercial Paper Funding Facility (CPFF) provides a backstop to the commercial paper market that has been brought to a standstill, even for those industries – like healthcare – that are seemingly far removed from the financial sector. The CPFF will remain in place until Apr. 30, 2009, at which point the Fed Board of Governors would need to vote to extend it if necessary.

Interest Rates and the FOMC

Finally, the Federal Reserve cut interest rates at the Federal Open Market Committee [FOMC] meeting of October 29th; the second time that month. Overnight lending rates were lowered from 1.5% to 1.0%.

Other Intrinsic Financing Strategies

Other, more organizationally intrinsic, sort-term financial strategies may be used by some hospitals, and medical clinics, to accelerate their own cash conversions cycles [CCCs]. This is not an easy task however, but may be accomplished by streamlining and efficiently accelerating three key areas:

1. Patient access made up of all the pre-registration, registration, scheduling, pre-admitting, and admitting functions.
2. Health information technology management consisting of chart processing, coding, transcription, correspondence, and chart completion.
3. Patient financial services which includes all business office functions of billing, collecting, and follow-up post-patient care. These functions are optimized with automated biller queues to improve and track the productivity of each biller; claims scrubbing software to ensure that necessary data is included on the claim prior to submission; and electronic claims and reimbursement processing to expedite the payment cycle.

Moving to Cash

Under current pressure from the troubled economy, hospitals and clinics can also turn to their investment cash flow as a source of short term capital financing by focusing attention on managing and rebalancing investment portfolios. Although investment income typically is viewed in a capital budget, it may be used as supplemental cash generated from operating activities in an emergency. This is accomplished by:

• allocating a greater proportion of invested assets to cash and short-term investments,
• seeking marginally higher returns from other investment classes like mutual funds and real estate investments.

Non-Profit Fund Raising

Of course, not-for-profit hospitals and clinics can accelerate fundraising to generate cash donations. Donations are a good source of quick capital in certain markets. However, one must be aware of expended fundraising costs and it is important to ensure that all the costs incurred in fundraising activities are properly attributed.

Assessment

Related info: www.HealthcareFinancials.com

Conclusion

Your comments on this topic are appreciated. Is this one reason why the financial markets dropped more than 900 points in the last two days; or since election day?

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com  or Bio: www.stpub.com/pubs/authors/MARCINKO.htm

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Filed under: Health Economics, Healthcare Finance, Op-Editorials, Practice Management | Tagged: credit squeeze, financial derivatives | Leave a comment »