Case Studies

  • Identifying and Mitigating External Risk in a Client’s Debt Portfolio for an Academic Medical Center based in the Mid-Atlantic Region

    Summary 

    Public Financial Management professionals assisted a health care client to identifying external risk in its debt portfolio and developed a strategy to reduce the level of risk without materially increasing the client’s cost of capital.

    Background 

    A health care client was concerned that its debt portfolio embodied excessive risk that was unrelated to the client’s own credit. The client was particularly concerned that the banking industry as a whole was subject to credit volatility, and that certain sectors of the tax-exempt money markets could experience significant volatility if a major bank experienced a credit event.

    PFM was retained to assist the client to quantify the level of such external risk and recommend a strategy which would reduce the level. The client wanted to mitigate the risks identified, but not in a manner which would materially increase its cost of capital.

    Strategy

    We analyzed the components outstanding debt portfolio and factored in future capital financing needs. 

    • The results of the analysis showed that approximately 52% of the existing debt was exposed to volatility in the banking industry. 
    • At the same time, the existing mix of fixed and floating rate debt provided the client with a desirable weighted average cost of capital, given the 30 year average life of its debt portfolio. 
    • The client was not exposed to market risk due to rising interest rates as it had successfully hedged itself against the risk of rising interest rates through interest rate swaps as well as a very conservative investment policy relating to its operating funds.  
    • We identified the following external risks the client was exposed to: 
      • An imbalance of committed capital and uncommitted capital at a time when the health care industry was subject to potential margin volatility due to efforts by both governmental and private payers to restrain increases in payments for services; 
      • Renewal risk of existing bank facilities; 
      • Liquidity risk due to facility renewals taking place either at a much higher cost, or in the extreme the inability to renew facilities with banks that the market was comfortable with (either due to credit issues or to market saturation issues); 
      • Market segment risk due to a credit event away from our client which led to disruption in the marketplace; 
      • Ongoing put risk due to the use of money market instruments which afforded the investor with a weekly or daily put option; 
      • Counterparty risk relating to the client’s banking relationships with respect to operating funds as well as derivatives; 
      • Basis risk due to the mismatch of the floating rate index on the client’s swaps and returns on its operating cash investments with the tax-exempt floating rates which are keyed to the SIFMA Index.
      • Recommendations 

    We recommended the following restructurings of certain outstanding issues which required bank facilities: 

    • Refinance certain outstanding debt which required a liquidity facility with a direct placement with a commercial bank that would eliminate the ongoing put risk while still retaining pricing based on money market levels;
    •  Restructure certain commercial paper issues to replace the liquidity support provided by a liquidity line with self-liquidity; 
    • Remarket expiring put bonds as Floating Rate Notes so as to tap money market investors other than the tax-exempt money market funds that served as investors for the client’s variable rate demand bond bonds and commercial paper programs; 
    • Reduce exposure to certain banks so as to diversify the client’s overall level of exposure to the banking industry; 
    • Take advantage of the current very low level of fixed interest rates to finance new capital projects with fixed rate bonds. 

     

    Results

    The recommendations were accepted by the client and implementation was commenced.

    The recommendations were accepted by the client and implementation was commenced.

     

    Requests for Proposals for a Direct Placement were issued, and after review of the proposals, a bank was selected to provide a five year facility keyed to 30 day LIBOR so as to eliminate basis risk;

    An investment banking team was selected to underwrite an issue of Floating Rate Notes with a final put period of five years, and which floated with 30 day LIBOR. The issue was successfully marketed to money market investors other than the traditional money market funds, thereby diversifying the client’s investor base while also eliminating bank risk.

    Upon completion of execution of the strategy, the client will have reduced its exposure to the banking industry from 52% of its debt to 32%, while retaining an average risk adjusted cost of capital of less than 5% for the 30 year average life of its debt portfolio. 

  •  

     

     

    These materials are based on factual information from actual projects that The PFM Group of companies has engaged in for a client. They are for general information purposes only and are not intended to provide specific advice or a specific recommendation. The results of individual projects will vary significantly depending upon the size and structure of each transaction, permitted investments, prevailing market conditions at the time of the transaction, and other events or circumstances beyond our control. Past performance does not necessarily reflect and is not a guaranty of future results. The information contained in these case studies is not an offer to purchase or sell any securities.