Securitizing receivables offers low-cost financing option

Healthcare Financial Management, May, 1995 by Sunasiir Sen, James P. Lawler

PATIENT ACCOUNTS MANAGEMENT

Securitization began in the 1980s with mortgage payments, auto loans, and credit card debt being pooled and used as collateral for securities offerings. More recently, healthcare providers have securitized accounts receivables to obtain low-cost, off-balance-sheet financing. As the need of both raise capital and contain costs grows in health care, providers likely will make increased use of this financing method.

Securitization involves pooling and structuring predictable cash flows, derived from the transfer and sale of assets, to an entity that is "bankruptcy remote." Among other benefits, securitization is an efficient source of off-balance-sheet financing.

History of securitization

Securitization was introduced to capital markets in the early 1980s, as mortgage payments were pooled and used as collateral for securities issues. The United States government played an active role by creating agencies that guaranteed the securities' principal and interest. Securitization became a cost-effective financing alternative to traditional bank sources for a large number of thrifts and other mortgage originators. In 1985,securitization was extended to include automobile loans and, shortly thereafter, other consumer assets, such as credit-card receivables, second mortgages, and home-equity loans.

By the late 1980s, companies such as Citibank, General Motors Acceptance Corporation, Marine Midland Bank, Chrysler Corporation, and Ford Motor Company accessed the securitization market to raise billions of dollars of off-balance-sheet financing. Over the next several years, new issuance of consumer asset-backed securities averaged about $50 billion annually.

Following the initial focus on consumer assets, securitization of commercial receivables was the next frontier to be developed, asset by asset. Investment bankers positioned lease-rental payments as analogous to the cash flow from a pool of automobile loans, while trade receivables were likened to credit-card debt. By the end of the 1980s, securitization of trade receivables had become an accepted financing option for companies in a variety of industries. Securities backed by trade receivables used newly issued credit-card securities as a pricing benchmark.

In 1992, healthcare-provider receivables were introduced into the AAA-rated securities market. These receivables represented those due from insurers (Medicare, Medicaid, and Blue Cross/Blue Shield and other commercial carriers) for medical services rendered. The $40 million, three-year securities were underwritten by Prudential Securities and dubbed NPFIII Health Care Receivables Program Notes. The transaction involved securitizing a pool of receivables sold by approximately 14 healthcare providers.

In January 1994, Jersey City Medical Center securitized its receivables in a stand-alone program, issuing five-year, A-rated, medium-term notes underwritten by Prudential Securities. Although three healthcare providers had previously securitized their receivables in stand-alone programs, these transactions had used commercial paper. The Jersey City transaction was the first to use medium-term notes, a more efficient financing option than commercial paper.

Introduction to securitization

The key to securitization is transfer of a pool of assets - in this case, receivables - to a bankruptcy-remote structure. The bankruptcy-remote structure insulates the investor from any "corporate" risk of the entity selling the cash flow stream. Once the cash-flow or asset is transferred, under no circumstances can it become the property of the transferrer, not even if the transferrer files for bankruptcy.

Certain conditions need to be satisfied to achieve a bankruptcy-remote sale of assets, also called a "true" sale. A critical condition is the transference of the assets to a special-purpose corporation created for the sole purpose of buying assets and issuing debt. The receivables must be sold, not financed. The seller records the transfer of assets as a Financial Accounting Standards (FAS) 77 sale for generally accepted accounting principals accounting purposes. The seller is permitted limited recourse for purposes of providing a credit enhancement for the receivables.

The security also must be structured in a manner that provides ample protection for anticipated losses. The tenet "past is prologue" iS implicit in rating and structuring the security. Therefore, extensive historical analysis of the bad-debt experience for the asset is performed. Based on this analysis, the rating agencies size the protection at two to three times expected losses for a high investment-grade rating of the securities. Because direct recourse to the seller for losses only can be very limited (to ensure a bankruptcy-remote transfer), the protection for losses usually takes the form of credit support from a highly rated entity, such as a bank, an insurer, or a subordinated security held by the seller. This third option has become increasingly popular. The subordinated security represents the residual cash flow of the transferred assets after the debt service of the senior securities, taking into account any losses. The subordinated securities are accounted for by the seller as a capital investment in the special-purpose corporation.