Capital Finance

William F. Jarvis

Among healthcare organizations, debt has increased steadily in recent years. Now, most are deleveraging-perhaps in response to less favorable operating trends.

Debt continues to be a major issue on the global agenda. The European Union, Japan, and the United States all suffer from high levels of government debt-the legacy of borrowing over recent decades augmented by amounts issued during the 2008-09 economic crisis. In the United States, household debt has decreased in the aftermath of the crisis but remains at historically high levels. For U.S. healthcare organizations, debt has been increasing steadily for many years; the tide, however, may be turning.

The 2011 Commonfund Benchmarks Study® Healthcare Organizations Report analyzes data from 90 participating healthcare organizations representing financial assets of $144.9 billion as of Dec. 31, 2010, comprising $102.6 billion in investable assets and $42.3 billion in defined benefit (DB) plan assets.a Study data disclose that for the fifth consecutive year, participating healthcare organizations increased their debt load to an average of $1 billion in FY10 compared with $903 million in FY09. Viewed from FY05's average debt level of $395 million, the FY10 figure represents an increase of nearly 156 percent over the five-year period.

A closer examination confirms this overall trend. The study divides the group of 90 participating organizations into four size cohorts: organizations with investable assets over $1 billion, between $501 million and $1 billion, between $251 million and $500 million, and under $251 million. In each of these groups, the trend in recent years has been toward higher average levels of debt. For example, again going back to FY05, organizations with assets over $1 billion reported debt levels averaging $1.1 billion compared with $2.1 billion in FY10, while those with assets between $501 million and $1 billion reported average debt levels of $371 million compared with $447 million in FY10. Organizations with assets between $101 million and $500 million reported average debt of just $159 million in FY05. (The size cohorts were slightly different in earlier studies.)

Increased Debt Levels

But the move toward increased debt appears to have paused in FY10. The overall year-to-year increase in average debt from FY09 to FY10 was driven by a few large organizations, while within each of the cohort groups, average debt actually decreased from FY09 to FY10. For example, within the group of organizations with assets over $1 billion, average debt fell to $2.1 billion from $2.6 billion in FY09. Among organizations with assets between $501 million and $1 billion, debt declined moderately to an average of $447 million from $466 million the previous year. Those with assets between $251 million and $500 million reported average debt levels of $313 million, down modestly from $319 million the previous year. And the group with assets under $251 million reported average debt levels of $130 million, representing a substantial decline from $187 million the previous year.

This pattern is borne out by participants' responses to the question of whether their organization increased or decreased debt during FY10. Although slightly more than half of the large organizations with assets over $1 billion said that they increased their debt levels, in all of the other size groups, the proportion reporting a decrease in debt was larger-in some cases, substantially larger-than the proportion reporting an increase. In the two cohorts under $501 million, 53 percent and 62 percent, respectively, of responding institutions said that they had decreased their level of debt.

The Deleveraging Trend

Although lower debt levels may seem counterintuitive in the current environment of low interest rates and subdued inflation, the trend of deleveraging that has been remarked on at the household level may also be at work in the healthcare sector. It is true that the environment for borrowers in recent years has been favorable in historic terms, with low interest rates and low inflation. At this writing, the yield on 10-year U.S. Treasury bonds is a little over 2 percent and inflation is negligible.

Data on the interest-rate structure of participating organizations' debt, however, appear to reflect anxiety about the future. Respondents report that around 80 percent of their borrowings are at fixed interest rates (including swaps from floating to fixed rates), with the remaining 20 percent being at a floating rate (presumably, the latter are shorter-maturity borrowings). This prudence no doubt reflects concerns that, although excess productive capacity, high unemployment and slow growth in the broader economy may encourage regulators to keep interest rates low at the present time, large deficits, loose monetary policy and demand from developing markets pose the danger that inflation-and interest rates-could rise over time. Eventually, even fixed-rate debt may need refinancing-which, if it occurs in a rising rate environment, could be painful.

Operating Margins

Another factor behind the turn away from higher debt may be that healthcare organizations' operating margins continue to be under pressure. For organizations participating in the study, the median FY10 operating margin was 4.1 percent. This figure, however, obscures a substantial and ongoing divide between larger and smaller healthcare organizations. The operating margins of the two cohorts with assets above $501 million were, at 4.4 percent, nearly double those of the smallest organizations at 2.3 percent. This differential has been seen consistently over a number of years. In the FY04 report, the largest organizations reported average margins of 7.7 percent while the smallest reported average margins of just 3.6 percent.

This pattern of more robust margins at larger organizations shows no sign of abating. The competitive requirements of the modern healthcare industry mandate continuing acquisition and upgrading of expensive and technologically sophisticated capital equipment, and budgets must support the costs of skilled professional and operational staff. On the revenue side, reimbursement levels are expected to continue under pressure while, for endowed healthcare organizations, it is unclear whether investment returns will be as robust in the next quarter-century as they were in the 25 years from 1982 to 2007.

The main factor still under the control of healthcare organizations appears to be cost containment. Here, too, large organizations, with their ability to spread costs over a broader base and to obtain economies of scale in purchasing and operations, appear to be making the most progress. Smaller organizations, lacking these advantages of scale, face structural and systemic cost issues that may be difficult to remedy; for some, strategic alliances and mergers may be the best way to obtain control over costs and rising debt.

For healthcare organizations-like sovereign nations-steadily rising debt levels can be viewed as a symptom of more deep-seated financial challenges. Healthcare organizations' dynamic shifting away from historically heavy debt loads may be a harbinger of a further, and ongoing, rebalancing of resources within the sector.

William F. Jarvis is managing director, Commonfund Institute, Wilton, Conn. (


a. Investable assets include endowment/foundation funds, funded depreciation, working capital and other separately treated assets.


Publication Date: Monday, January 02, 2012

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