iProtean—Bond Financing Part 2

iProtean—Bond Financing Part 2


Balance sheet strength remains an imperative for hospitals and health systems today, but is a significant challenge as organizations transition to a new business model.  A recent report from Moody’s Investors Service noted that nearly all of its rated hospitals cited the need to build balance sheet reserves as a key transition strategy.


“As the era of reform and tightened federal funding unfolds, not-for-profit hospitals face an imperative to deliver higher-quality service with lower reimbursement rates per unit of service. The strategic shift now taking place will challenge current business models and require forward-thinking strategies to manage through a transition period that will unfold over the foreseeable future. Hospitals that can manage well during this transition should be able to maintain if not improve their credit ratings. Conversely, hospitals that cannot navigate the payment reductions or reduce their expense structures quickly enough to mitigate the impact may see rating pressure.”

Moody’s Investors Service Special Comment: Doing More with less—Credit Implications of Hospital Transition Strategies in Era of Reform. May 2012


Managing this transition to a new business model remains a responsibility of management, with input from the board of directors.  Although trustees do not have to know the intricacies of balance sheet management, they should know the basic dynamics at play in the balance sheet in order to set sound debt and investment policies and thereby ensure a favorable credit rating.


In the iProtean course Bond Financing Part 2 our financial experts continue their discussion on the intricacies of capital financing for hospitals/health systems.  Marian Jennings (M. Jennings Consulting), Lisa Goldstein (Moody’s Investors Service), Michael Irwin (CitiGroup) and Eric Jordahl (Kaufman, Hall & Associates) cover bond risks and rewards, the relationship between credit rating and cash, investment capital and the board’s role in the credit rating process.


Eric Jordahl, Kaufman, Hall & Associates

Balance sheet strength remains probably the most important driver in a rating right now.  The strength and liquidity of the balance sheet is predominately measured by cash position, but also driven by the cash position relative to debt and the overall debt load.  That said, operations have become particularly important.  A strong balance sheet continues to cure a lot, but if there are hints of deteriorating operations or hints at operational challenges or strategic challenges, rating agencies are much, much faster to take action on the rating, to move the rating down, than was the case pre 2008.


That said, hospitals have struggled for a long time with how much cash to hold.  It is a challenge for boards and management to think about how much is too much cash, or how to find the right balance between cash on the balance sheet and debt on the balance sheet. We continue to believe that cash and liquidity, particularly as we head into healthcare reform, are extraordinarily important.  There is a great deal of uncertainty about how reimbursement models will look and what it will mean to the organization.  I think there is a good level of expectation that a lot of reform is going to be financed on the backs of not-for-profit hospitals.  Having cash resources certainly is going to give the organization a lot more cushion or a lot more ability to navigate through some of those changes . . .


Michael Irwin, CitiGroup

A key responsibility of the trustees is in evaluating the risk to which external financing will expose the organization.  One of the key decisions will be whether the organization can take on variable rate exposure, that is, an interest rate that is not fixed but periodically reset.  The advantage of doing a variable rate financing is typically a lower interest rate.  However, the interest rate could rise due to environmental factors outside the control of the organization, as well as anything unique about the organization and any financial challenges it might face in the future . . .


In a fixed rate financing, risks are typically transferred to the investors, whereas those risks are held by the organization when you do a variable rate transaction.  As a result, stronger organizations, those in the double A category, and the A category with strong cash flow, strong balance sheet metrics and ample liquidity are more readily able to take the risk associated with the lower cost variable rate debt, while organizations that have a more modest balance sheet and reliable cash flow can choose the safer more stable fixed rate alternative.


Eric Jordahl, Kaufman, Hall & Associates

The challenge for hospitals is balancing potential investments against the uncertainty of health reform.  Most organizations believe investments in technology—whether for electronic medical records or other tools that bind organizations or bind previously disparate parties closer together—will be valuable over the long term.  But the challenge really is what is healthcare reform going to look like?  How long will it take? . . . Is there actually going to be a business model where there is economic value attached to those investments?  It is a very large challenge because the magnitude of the investment in information technology that seems to be required is pretty big . . .


Marian Jennings, M. Jennings Consulting

What the rating agencies are looking for is a well informed board, a well informed finance committee—people who are not only committed to the hospital and thoughtful individuals, but also have the knowledge and skill that they need in order to perform their fiduciary responsibility . . .


The board as a whole plays a very important role in the credit rating process because the rating agencies see you as the policy makers and as the trustee of this asset.  They are looking for the commitment and rigorousness of the board in its fiduciary role to give them comfort that the organization 1) will maintain policies if they have been successful to this point, or 2) is able and willing to take corrective action if and when needed.


Lisa Goldstein:  As part of Moody’s review in accessing a hospital’s credit worthiness, we like to meet with a few board members at our initial meetings, either the chairman of the board or, equally as important, the chairperson of the finance committee.  We try to assess in a condensed period of time whether the board understands its responsibilities.  Is it able to articulate, without reading from a script, its responsibilities when it comes to repayment of debt, when it comes to setting financial goals for the hospital, when it comes to developing a vision and a mission for the hospital over the long term?  So we engage in a dialogue with questions and a conversation to assess pretty quickly whether the board understands the gravity of its responsibilities.


We understand that not-for-profit board members are indeed volunteers, not compensated for their time.  Nonetheless, we’re looking to see if the board members have an appreciation for the financial performance of the hospital and the responsibilities that issuing debt in the market entails . . .


Irwin:  The board plays a very important role in the credit rating process on the front end by developing a formal debt policy for the organization.  Working together with the management team, it is the board’s responsibility to establish aspirational goals from a credit rating side and then develop key target performance metrics and balance sheet metrics that the organization would have to adhere to in order to achieve and/or maintain those goals . . .   In that regard, the board is constantly, over time, going to be answering several key questions; for example, if a project arises, what portion of that project should be funded from cash flow of the organization?  What portion of the project could be funded from philanthropic sources, and what portion of the project could and should be funded with external debt?


The tension in the organization is typically going to be around the issue of using your own cash versus using borrowed money, or money raised in a bond issue.  Very often, organizations find that it is a combination of those three things that achieves the balance they are seeking . . .


The other question trustees should ask themselves is, “What is the responsibility the organization has to investors and to the investing public after the bond issue is concluded?”  Increasingly, the markets have high expectations for formal investor relations programs . . . So I encourage trustees to work with their senior management team to insure the kind of high quality secondary market disclosure that investors are looking for . . . they will benefit the next time they come to market with a bond issue because investors have been bolstered in their confidence that this organization has made a commitment to a high level of secondary market disclosure.


More from Moody’s Investors Service Special Comment: Doing More with less—Credit Implications of Hospital Transition Strategies in Era of Reform


“Many hospitals have restructured their debt portfolios since the credit crisis and most have been successful in extending their letters of credit or finding substitute liquidity sources for their variable rate debt.  Others have chosen to refinance variable rate debt with fixed rate bonds given the favorable rate environment and desire to remove bank risk from their structures.  However, some have chosen to leave “orphan” swaps outstanding in order to avoid large termination payments.  The result is that these organizations remain exposed to the possibility of needing to fund large swap collateral calls, which for certain organizations, exceeded $100 million at various times in the last three years. Certain organizations which have unwound their swap programs have done so at the cost of reducing cash, or taking on additional debt.”


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iProtean Symposium & Workshop

Mark the Date!! October 10 – 12, 2012 at The Lodge at Torrey Pines, La Jolla, CA. Faculty: Barry Bader, Dan Grauman, Marian Jennings and Brian Wong, M.D. For more information, click here.


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