Brett Whysel

For health systems today, ample liquidity means "never having to say you're sorry" to your creditors, your board, or your community. Across the country, executives are asking, "When will things return to normal?" My answer: "Manage your liquidity as if this were the 'new normal.'"

In May 2009, Mohamed El-Erian, CEO/co-CIO of PIMCO, a global investment firm, wrote that the volatility of changes in the global markets is leading us to a "new normal," in which "business as usual" ceases to exist, global growth is subdued, unemployment remains high, and abrupt changes to financial markets, institutions, and government policies enacted in response to changing markets "are unlikely to be reversed in the next few years"(El-Erian, M., "A New Normal,"

In response to the new normal, today's health system managers are asking, How can we get enough bank credit? When can we issue fixed-rate bonds at reasonable rates? When will our swaps get back "in the money"? And when will we be able to stop worrying so much about investment losses and pension funding? These questions reflect both a renewed focus on liquidity and wishful thinking. We may never return to normal, if "normal" means the virtually free-money, high-growth, low-inflation, low-regulation environment we enjoyed from 1993 to 2007. So the better questions are, What is the new normal? And how do we respond?


The Emphasis on Liquidity

The past 18 months have been tumultuous for healthcare CFOs, treasurers, bankers, and advisers. The implosion of the auction rate market, the collapse of the bond insurance industry, bank retrenchment, the spike in credit spreads, and the ensuing recession of 2008 have devastated health system balance sheets, cut deeply into revenue from elective surgeries, impaired cash flow, and left us all wondering whether there's more bad news coming. We've become less trusting and confident, more risk-averse, and in need of a new game plan. It's gotten so bad that the market cheered the most recent announcement of 9.4 percent unemployment because the rate of job losses decreased from the previous month.

We want to believe that the slightly improved market outlook means the beginning of our return to normal. That's just not realistic due to fundamental changes in the economy. The global banking system is undercapitalized (perhaps even collectively insolvent) and unable to lend freely. The once-flush "shadow" banking system of aggressive hedge funds and off-balance sheet structured financing vehicles has evaporated-so, no liquidity there. Government stimulus funds can replace only a fraction of the lost liquidity. Although confidence will recover over time (it always does), banks almost certainly will take fewer risks and offer less liquidity due to greater regulation and market scrutiny. As a result, we can expect to see limited economic growth and inflated risk premiums. And steeper yield curves, wider credit spreads, and more expensive bank credit will likely be with us for a long time.

Welcome to the new normal.

Liquidity today is both a fundamental risk and a strategic business tool in the new normal environment of unexpected cash drains and impaired assets. Despite all the attention, liquidity remains an amorphous concept. For our purposes, liquidity represents a health system's ability to access funds, as needed, through borrowing, liquidating assets, or operating cash flow. 

Asset liquidity measures a system's ability to liquidate assets (or extinguish liabilities). In strong economic times, health systems can sell investments (or unwind swaps) at verifiable market prices. Alternative investments are well known for their limited asset liquidity. In worse times, some assets may not trade at any price (think post-bankruptcy Lehman swaps). Moody's Investors Service has indicated it will be looking more closely at asset liquidity, requiring systems to provide additional data, including categorizing funds by their ability to be liquidated within a day, a week, or a month ("Moody's Developing New Liquidity Ratios for U.S. Hospitals," Healthcare Finance News, April 23, 2009). Asset liquidity is important because it translates the system's wealth into the cash it can use to meet unexpected funding requirements.

Funding liquidity measures a system's access to credit from banks, investors, and vendors. It is important because it measures the system's ability to tap external sources to meet funding requirements. The level of a system's funding liquidity depends on factors such as:

  • Organizational cash balances and cash flow
  • Investment allocation and performance, as well as philanthropy
  • Availability of letters/lines of credit
  • Ability to remarket variable rate demand obligations (VRDOs) and put bonds
  • Collateral posting and termination payments for swaps
  • Pension funding status

The emphasis on liquidity in the new normal will lead analysts to weight days cash on hand, cushion, and debt-to-cash-flow ratios more heavily in assessing a system's credit strength. Newer liquidity measures, such as cash-to-VRDO par, will become standard components of credit assessment. Finally, enterprise risk modeling (and its limited cousin, asset liability management) will need to incorporate liquidity risk and its relationships to market, credit, and business risks.

In practical terms, systems should take steps to maximize and diversify liquidity sources, as well as limit potential drains. Steps to consider include:

  • Limiting use of variable rate debt instruments.
  • Staggering and lengthening put bond remarketing dates
  • Diversifying bank credit sources and swap counterparties
  • Actively managing swap market-to-market volatility
  • Reallocating investments to cash and other more liquid asset classes
  • Managing, measuring, and monitoring assets and liabilities programmatically
  • Delaying noncritical capital expenditures
  • Risk adjusting projected returns in capital budgeting
  • Minimizing endowment spending
  • Converting from defined-benefit to defined-contribution retirement plans
  • Selling noncore assets and receivables
  • Evaluating securitization and revenue cycle improvements


Time for Self-Analysis

Clearly, liquidity is now at the nexus of health system financial management. It links and influences business performance, borrowing, investing, hedging, and risk management. So it is critical that health systems evaluate sources of liquidity risk and test their ability to withstand stressful liquidity events.

We have seen that liquidity events rarely occur in a vacuum. Systems should assess the liquidity risks embedded in their debt, investments, hedges, and operations. Creating robust contingency plans for scenarios that, until 2008, seemed too remote to worry about should become a regular part of enterprise risk management.

Liquidity is now a strategic asset. Systems can use it to buttress their balance sheets and credit ratings, support operations, protect investments, and enhance bargaining power. In the new normal, stakeholders are demanding (to borrow shamelessly from Cuba Gooding, Jr.'s character in "Jerry Maguire"), "Show me the liquidity!"

Brett Whysel is managing director, Ziegler Healthcare Finance, New York (

Publication Date: Tuesday, December 01, 2009

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