Healthcare Portfolios Moving More Toward Fixed Risk As Interest Rates Rise

Changes in the economy are prompting healthcare CFOs to reconsider long-held financial strategies. Rising interest rates may require a different mix for capital portfolios.

Rising interest rates will dictate how healthcare organizations create efficient everyday capital structures, one analyst says.

CFOs must determine where they think interest rates are going, and then act to position their capital structures for the best performance in the near future, says Henry Grady III, healthcare industry specialist with the commercial and business banking division of SunTrust Bank. He worked to improve the financial standing of Atlanta's Grady Memorial Hospital, named for his great-grandfather, before joining SunTrust.

"I feel like we are emerging from one phase of the economy, where we've been in a declining to flat interest-rate environment literally for the last decade, to one now that feels like we're entering into flat to gradually rising interest rates," Grady says.

"We can discuss statistically how valid that is and how much we can count on that for the future, but as those conversations get validation with the CFO and the finance committee and boards, then we have to talk about how to position yourself organizationally from a cash flow, balance sheet, and access to capital perspective," he says.

For most hospitals and health systems, that will mean shifting from what has been a financial strategy based on a slow or stagnant economy to something more oriented to a dynamic economy and rising rates, he says.

"There are organizations that have been riding the declining interest rates for the past decade and have been absolutely right. They've made a lot of money and saved a lot of money for their organizations," Grady says. "Now that we feel like we're in more of a rising interest-rate environment there is a feeling that we need to be longer out on the curve and fixing our interest rate risk."

There is a growing desire in the healthcare industry to be less exposed to variable rate debt and more exposed to fixed rate debt, Grady says.

Portfolios for the past decade have been weighted to about 75% variable rate debt, but that split is moving now to about evenly divided at 50% variable and 50% fixed rate, he says.

In the near future portfolios will continue moving in that direction and become more heavily weighted to the fixed rate, Grady says. That will put CFOs in a better position to plan and strategize, he says.

"If you're a CFO and you're asked to put together a three- or five-year budget and make it as detailed and organic as possible, you have to start with where your money is coming from and what your debt service has to be," Grady says. "The more sure of that you can be with fixed rate exposure, the better off your organization will be. We're seeing people move out the curve, trying to find ways to have longer maturity to their debt, and they're trying to find more fixed rate exposure than variable rate exposure."

There are challenges and risks with switching gears like this, Grady notes. CFOs have to be confident that any new portfolio mix is supported by market trends, and missing the prediction there could leave an organization too exposed, particularly if it took an aggressive stance with the portfolio strategy.

But Grady says he is confident that the market is trending toward higher interest rates.

"As we see the stock market, commodities market, and the bond market all bouncing up and down, typically that gyration indicates a change and a trend. It feels like we're entering into a different environment where the interest rate cycle is going to be flattish to rising," he says. "You have to roll up your sleeves and look at how you're funded, where your cash is coming from, your receivables, your sources, your payers, and your obligations. We look at that item by item and try to find where we can take risk out of that picture based on the directional belief we have about the cost of capital."