Financing maneuvers: two opportunities to boost a hospital's working capital - factoring and asset-backed securities - Special Report

Healthcare Financial Management, Oct, 1991 by Sandra Ferconio, Michael R. Lane

From a sale through payment collection on accounts receivable, funds are managed by an asset manager, who acts as a trustee to a securitization program. The organization selling its receivables, on the other hand, is responsible for collection and follow-up activities (other than cash management) of sold accounts. Actual cash collections, maintained by the asset manager, are used to retire commercial paper notes and pay administrative program costs.

When a hospital sells receivables, eligiblity of its accounts and quality of its collateral must be assessed. Because credit ratings are provided for commercial paper, the quality of underlying collateral becomes a concern of rating agencies. Consequently, the credit rating of individual payers is more important than the hospital's rating.

Securitization transactions are structured to capitalize on the favorable creditworthiness of a payment source, because payments on sold accounts ultimately will be recieved from third-party payers. The continued quality of sold receivables is assessed by evaluating the hospital's ability to effectively service accounts and the payment source of these accounts.

Net accounts receivable eligible for sale will be advance-funded at a level between 80 percent and 90 percent, depending on the quality of the collateral. Quality of collateral varies because of diverse credit risks of commercial insurance carriers and hospitals' abilities to service accounts. The unfunded portion, called over-collateralization, helps pay program expenses and provides protection to the program if estimates of net receivables require adjustment. Nonetheless, the unfunded portion remains an asset of the seller.

When a factoring program is terminated, excess over-collateralization amounts not used to pay program expenses are returned to the seller. Interest charged to the seller is based on funded (sold) accounts. Costs of capital vary between 50 and 100 basis points below the prime lending rate, including amortization of upfront fees.

Financing benefits

In an era of enhanced financing opportunities, the key asset targeted by commercial banks, investment bankers, and private investors will be accounts receivable. Financial officers may not be content to leave their accounts receivable undeveloped as a financing asset.

Factoring and securitization of receivables have several benefits in common.

Either program yields an initial cash flow boost and opportunity for providing steady cash flow over time. Funds provided from financing can be used for several purposes, including:

* Asset acquisition;

* Facilities acquisition. A parent hospital purchases a facility, including its accounts receivable. Accounts receivable of an acquired facility can be financed to provide working capital. On the

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other hand, a parent hospital can finance its own receivables to provide funds for an acquired facility;

* Constructiong financing;

* Arbitrage investments. Funds generated from financed receivables can be invested at a rate in excess of the cost of capital;