Risk and the Cost of Debt

Recently a great deal of public attention has focused on economic efficiency in the health care industry, but one rarely mentioned element of overall efficiency is the financing of hospitals. Although many hospitals are nonprofit, even these need operating capital, and an infusion of capital usually is accompanied by financial risk.  A recent article in Becker’s Hospital Review highlighted the importance of financial risk analysis in the process of choosing sources of credit, and its observations should ring true for any business, for-profit or not.   

In the article, Pierre Bogacz of HFA Partners, a firm specializing in risk management for nonprofits, examines a typical decision hospitals face regularly, whether to renew an existing letter of credit (LOC) or turn to variable rate financing.  He recommends that each financing vehicle be stress-tested using a financial risk simulation that takes into account the hospital’s entire balance sheet. Financial risk modeling–I assume using Monte Carlo software–is the way to calculate the risk-adjusted cost of debt, and the simulations that result can serve as a valid basis of comparison among various sources of credit. 

Bogacz makes the important point that it is easy to become comfortable with a current lender, and this in itself is a risk.  He believes that an expanded search for lenders is not only a sound risk avoidance practice, but it often yields information otherwise hard to come by–like how your current lender stands among its competitors.  He is not saying "Don’t trust your banker."  He’s saying "Do the math, run a financial risk analysis, and come up with what it really costs to borrow that money."   

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