The Importance of

Balance Sheet Strength

Bradley C. Bond CPA, CFA, MBA

May 23, 2018

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Today’s Discussion

1. The need for external capital funding

2. Forms of external capital, financial covenants, Bond Rating

3. Access to capital markets

4. Risk management

5. Working capital management

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The Need for External Capital Sources

• Sophisticated equipment

• Skilled medical professionals

• Opening new treatment facilities

• IT infrastructure

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Fund Working Capital

Growth in Patient Accounts Receivable

• Hospital with $4.0 billion in annual revenue= $11million per day

• Growth in days of Patient A/R of 9 days requires $99 million of cash

Faster payment of Accounts Payable – reduction in A/P

• Hospital with $4.0 billion in annual cash expenses = $11 million per day

• Reducing A/P by 9 days consumes $99 million of cash

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Pension Funding

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M&A Trends

Valuation at 60-70% Revenue

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June 11, 2017 12:00 PM

Cleveland Clinic continues its march south

LYDIA COUTRÉ –CRAIN’S

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Summa Health looking for health system partner

Posted Sep 27, 2018

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Contingent Cash Requirements

• Retirement plan funding (ERISA funding requirements)

• Accelerated debt service (certain variable rate debt structures)

• Unexpected capital spending

• Posting margin on interest rate swaps

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Forms of External Capital,

Covenants,

Bond Rating

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Sources of Capital

1. Traditional bond financing – public finance

2. Private bank financing – direct purchases

3. Revolving credit facilities (banks)

4. Public-Private-Partnerships (P3’s)

5. Eb5 Immigration financing

6. New markets tax credits

7. Property leasing

8. Equipment leasing

9. Joint ventures / M&A

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Different Types of Public Debt

1. Fixed rate bonds

2. Variable rate demand bonds (often require bank letter of credit)

3. Self-liquidity variable rate bonds

4. Floating rate notes

5. Variable rate – “auction style”

Credit enhancement

• Bank letters of credit

• Bond insurance

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Traditional Bond Financing – Public Offering

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Traditional Bond Financing – Public Offering

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UH Debt Profile $1.3 Billion

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Financial Covenants

1. Payment of debt service

2. No bankruptcy

3. ERISA compliance

4. Transfers of assets

5. Financial reporting

6. Financial ratio covenants

• Debt service coverage test

• Days of cash on hand

• Leverage: debt-to-unrestricted capitalization

Moody’s Bond Rating Scale

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Finance 201

Balance Sheet Ratios

Key Metrics – Days of Cash on Hand “DCOH”

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DCOH = Cash & unrestricted investments *365

Annual Operating Expense

Liquidity Position - Consolidated System

Dollars in Thousands

Actual Actual Actual

31-Dec-17 31-Dec-16 31-Dec-15

Cash and cash equivalents 201,782 264,527 201,457

Unrestricted investments 1,475,567 1,290,173 1,262,873

Total cash and unrestricted investments 1,677,349 1,554,700 1,464,330

Operating expenses 3,752,433 3,660,972 3,161,324

Less: Depreciation and amortization 151,722 140,616 121,460

Cash expenses (a) 3,600,711 3,520,356 3,039,864

Days of cash on hand 170 161 176

Increase in cash expenses – reduces cash, reduces DCOH

(both numerator and denominator)

Key Metrics – Leverage Ratio

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Leverage = Total Debt

Total Debt + Unrestricted Net Assets

+Net Income +Unrestricted Net Assets = Reduced Leverage

Leverage Position - Consolidated System

Dollars in Thousands

Actual Actual Actual

31-Dec-17 31-Dec-16 31-Dec-15

Current installments of long-term debt 23,736 23,190 24,827

Revolving credit borrowing 40,000 40,000 -

Long-term debt, less current installments 1,252,444 1,272,085 1,283,215

Total debt 1,316,180 1,335,275 1,308,042

Unrestricted net assets 1,738,444 1,508,451 1,372,564

Total unrestricted capitalization 3,054,624 2,843,726 2,680,606

Debt-to-unrestricted capitalization 43.1% 47.0% 48.8%

+ Cash Flow Less need to borrow = Reduced Debt / Leverage

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261.6

220.6

184.7

146.1

0

50

100

150

200

250

300

Cash on Hand (days)

Aa A Baa Speculative Grade

758.3

454.2

213.9

0.00

100

200

300

400

500

600

700

800

Cash-to-Demand Debt (%)

Aa A Baa Speculative Grade

248.9

176.4

124.9

80.4

0

50

100

150

200

250

300

Unrestricted Cash and Investments -to- Total Debt (%)

Aa A Baa Speculative Grade

24.329.4

36.5

52.0

0

10

20

30

40

50

60

Total Debt-to-Capitalization (%)

Aa A Baa Speculative Grade

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AA Credits

Operating Margin UH

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UH

AA Credits

Days of Cash on Hand

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UH

AA Credits

Debt-to-Capitalization

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Rating Agencies – Healthcare Industry Outlook

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Healthcare Industry Outlook – Moody’s

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35

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Access to Capital

Capital Sources

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Banks &

BondholdersRating Agencies

• Risk of capital loss

• Credit assessment more rigorous

• Often a leading indicator

• Influenced by regulatory/market trends

• Can deny future credit

• Risk of reputation loss

• Credit assessment less rigorous

• Often a lagging indicator

• Not influenced by market trends

• Rating impacts cost of debt

Moody’s – UH Report

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Moody’s – UH Report

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Risk Tolerance &

Risk Management

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Balance Sheet

Strength

Access to Capital

Markets

INTER-RELATED GOALS:

Need for Liquidity

Asset Allocation

(Investment Risk)

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• Investments

• Operating leverage

• Debt (leverage)

• Maturity mismatch

• Retirement plans – defined benefit pension plans

• Swaps

• Changes to operating cash flows

• Unexpected capital requirements

Sources of Balance Sheet Risk

Who has the higher risk tolerance?

Risk Tolerance

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“Markets can remain irrational longer than you can remain solvent”

John Maynard Keynes

Tolerance for Investment Risk:

• Even if an organization defines itself as a "long-term investor," short term

volatility may bring a quick end

• At 300+ days of cash on hand, it is easy to take the view of "long-term"

• At 100 days of cash on hand, a "long-term" view may not be appropriate

Financial covenants

Ratings implications (access to capital)

Conservative vs Risky Investment

$253 M

$40 M

$90 M

$140 M

$190 M

$240 MD

ec-0

7

Jun

-08

Dec

-08

Jun

-09

Dec

-09

Jun

-10

Dec

-10

Jun

-11

Dec

-11

Jun

-12

Dec

-12

Jun

-13

Dec

-13

Jun

-14

Dec

-14

Jun

-15

Dec

-15

Jun

-16

Dec

-16

Jun

-17

Dec

-17

Jun

-18

Dec

-18

Growth of $100 Million

S&P 500 10% Risk Budget Cash

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Conservative vs Risky Investment

$60 M

$65 M

$70 M

$75 M

$80 M

$85 M

$90 M

$95 M

$100 M

$105 M

$110 M

Sep-08 Oct-08 Nov-08

2008

$80 M

$85 M

$90 M

$95 M

$100 M

$105 M

Sep-18 Oct-18 Nov-18 Dec-18

2018

S&P 500

10% Risk Budget

Cash

Projected

Cash $1.0B

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Required

Cash

$400m

Operations

Risk

$300m

Capital Structure

Risk $150m

Allowed

Investment Risk

$150m

Allowed investment risk $150

Projected investments $1,000

Investment risk budget = 15%

Investment Risk Budgeting at UH

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Working Capital Management

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Tools for Working Capital Management

Patient Accounts Receivable

1. Electronic charge entry systems

2. Denial management systems

3. Outsourced specialist collection advisors

4. Optimized managed care agreements

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Tools for Working Capital Management

Accounts Payable

1. Slow down payment at quarters (external financial reporting)

2. Key vendor contract negotiations (Group Purchasing Organization)

3. Bank credit card programs with rebates

4. Bank ACH programs with or without rebates

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Questions?