The key advantages of a successful capital structure plan are increased capital access, flexibility, and lower overall cost of capital. To achieve the "right" capital structure for a healthcare organization is a complicated task. However, the following strategies can be employed to attain that elusive but important objective.
A combination of debt and equity that funds an organization's strategic plan is what capital structure is all about. Strategic management of capital structure guarantees access to the capital required to fund future growth and better financial performance.
Kenneth Kaufman, managing partner of Kaufman Hall says, "Organized properly in an organization of any size, a capital structure can be easily adjusted to meet changes in interest rates and the changing shape of interest rate yield curves. Capital structures by themselves can lower the overall cost of capital and can maximize the return of assets versus the cost of liabilities. Clearly, the creatively managed capital structure has become a competitive advantage. Perhaps most important, over a 10- to 20-year planning horizon, the quality of a hospital's capital structure can cost or save the organization millions of dollars."
Effective capital structure management can be achieved by efficiently employing the following strategies.
It is imperative to establish the team and define the company’s attitude toward risk.
Furthermore, education can guarantee that the board of trustees and other seniors are aware about the benefits of effective capital structure management to the organization's financial performance. Generally, both large and small hospitals and health systems set up a well-informed and experienced senior management team (led by the organization's CFO or vice president of finance). Professional investment banking, legal, and consulting advice is also usually imperative in this case.
ESTABLISH THE RIGHT LEVEL OF DEBT CAPACITY
Debt capacity determines the parameters of the debt portion of the capital structure. This figure must get bigger each year if the company desires to remain tactically and monetarily competitive.
Randy Fuller, hospital segment manager of GE Commercial Finance Healthcare Financial Services says, "The amount of debt organizations are willing to incur has to be balanced against their tremendous capital expenditure needs for information technology, new inpatient capacity, outpatient facilities, and a whole host of other spending opportunities. An organization's overall ability to support or sustain the level of debt is key"
KNOW HOW MUCH CAN BE BORROWED IN THE DEBT MARKETS
Once an organization knows its debt capacity, it can borrow accordingly in the debt markets and know how much capital will be required from other sources (traditional and nontraditional). Targets for the appropriate debt to equity ratio are dependent on debt capacity, rating agency benchmarks, and capacity to take risk.
Healthcare professionals used to rely completely on not-for-profit tax-exempt financing. At present, they have many more financing options to pick - off-balance-sheet option, real estate investment trust, participating bond transactions, receivables financing, and private placements among several others.
Healthcare professionals need to consider factors such as all-in borrowing rate, costs of issuance, use of proceeds, and credit position while taking into account which traditional or nontraditional financing vehicles are appropriate for an organization's circumstances and credit position.
FIXED-RATE DEBT AND VARIABLE-RATE DEBT
Achieving the "right mix" of fixed-rate to variable-rate debt requires planning, timing, and proper execution. This is dependent on the company’s bond ratings, accessibility of bond insurance, amount of free cash, investment policy and the board's attitude toward risk, and changing interest rates.
Peter L. DeAngelis, Jr., CHE's executive vice president and CFO explains, "We noted that many large systems had much more variable-rate exposure than we did, thereby lowering their overall debt service and favorably impacting relevant rating agency ratios. We also noted that rating agencies have not penalized large, diverse systems for increasing their variable-rate exposure. We found that CHE could increase its variable-rate debt to approximately 35 percent of its total debt within our acceptable risk tolerance limit."
PREVENT EXPOSURE TO ANY ONE FORM OF RISK
Variable-rate debt comes with certain dangers. This includes basis risk, put risk, bank risk, credit risk, and failed auction risk. With the help of a diversified variable-rate debt portfolio, one can lessen the hazards and lower the company’s overall cost of capital.
USE SWAPS AND OTHER DERIVATIVES
As an organization's capital structure increases in complexity so does the use of derivative strategies. Derivatives and swaps are devices to maintain a flexible capital structure. They help to make real time alterations to the capital structure as demanded by both the interest rate and competitive environments. In addition to this, they also allow suitable matching of assets to liabilities as interest rate and stock market conditions change.
MONITOR THE DEBT PORTFOLIO
To achieve a state of flexibility, keep interest costs low, and minimize risk levels, companies must actively adjust their portfolios as changes occur in the market and in the portfolios themselves.
"Capital structure is not something that you create and then become passive about, or that you forget about and deal with only when issues come up that may be affecting any portion of the debt portfolio," says Anthony Speranzo, senior vice president and CFO of Ascension.
Effective and efficient capital structure management is important to a company’s long-term financial performance. Making use of the strategies mentioned above can help organizations to gather crucial information and achieve a calculated monetary advantage.