Soon, hospitals will likely need to update their ratings, either because rating agencies continue to maintain their surveillance requirements, or because clients will need to access the capital markets for one of several reasons. Rating conversations have always been a combination of historical review and discussion of forward-looking plans, and this time will not be different. However, the current set of challenges related to COVID-19 portend significant operational and financial stresses for the not-for-profit hospital sector. Consequently, the nature of your next rating conversations will be very different from the past.
Moody’s, Standard & Poor’s, and Fitch have all published sector outlook changes to negative, and there are themes which run across all three reports. Near term, all three agencies expect potentially severe revenue declines, unexpected expenses, supply disruptions, and workforce challenges. Uncertainty related to the severity and duration of the COVID-19 outbreak remains difficult to assess. Weaker credits that faced headwinds leading into the COVID-19 outbreak are likely to face additional challenges. Balance sheet strength, in particular liquidity, is a focus for all three agencies. Longer term, recovery from a widely anticipated worldwide recession is difficult to assess, but the topic looms on the horizon.
Rating Conversations: What Presentations Should Cover
In the current environment, rating conversations should take a different format, with the primary topics centered on operational resource deployment, project financial/cash flow performance, and liquidity. Every rating conversation should focus on these three areas. As noted below, there are other key elements that should not be forgotten—such as strategic initiatives—but as noted below, strategic tilt is likely a byproduct of forecasted performance and liquidity needs.
Rating agencies appreciate that each management team is being pulled in many different directions, and conditions are changing rapidly. Rating conversations are likely to be less lengthy, perhaps less formal, and with less time to prepare. What may have previously been a two- to three-hour conversation may take half that time, with presenters coming and going during the presentations. The Chief Operating Officer and Chief Financial Officer, in particular, will have essential roles in the conversation.
Operations: What Is Happening Now
Rating conversations will need to cover an operational assessment of the impact of COVID-19. The Chief Operating Officer can cover this set of topics, or if not, the Chief Financial Officer should be prepared to do so. Each market is different, and so too will be the impact of the coronavirus on hospitals in that market at any given time. Management should share any updates to regional or statewide coordination of efforts. Management will need to provide a status update about current COVID-19 volumes and projected surge demand in their market and at their system. Discussion about the need for ICU beds, ventilators, and other key resources is important. Rating analysts are interested in an update on deferral of elective surgeries and procedures across other major service lines in the system and reduced ambulatory volumes, and any related strategies to mitigate the loss of volumes. Supply chain challenges and tactics are important to discuss in terms of operational and financial impacts. Additionally, organizations need to be prepared to discuss workforce and staffing plans, both outlining how to secure adequate inpatient coverage as well as strategies to deal with reduced staffing needs on the ambulatory and elective surgery/procedure platform. Similarly, organizations will want to discuss physician compensation and revenue considerations.
Historical Financial Results Are Still Relevant
Rating conversations need to cover your financial condition leading into COVID-19. While it may seem like ages ago, analysts are interested to discuss year-to-date performance through February or mid-March relative to budgeted expectations. Analysts are interested in understanding what was working well, where issues were already present, and whether those issues remain challenges. Systems that entered the COVID-19 crisis on relatively solid footing are likely to fare better during the crisis, so it will be important to stress financial and operational strengths leading into the COVID-19 outbreak.
Financial Projections—Different This Time
Much of the discussion will cover the analysis clients have conducted to anticipate the financial impact of COVID-19. Because a great deal of uncertainty still exists, modeling exercises remain very focused on the near term: What does the organization look like during the “pre-surge” period? When will the surge of COVID-19 patients come, how big will it be, and how long will it last? What will the recovery period look like?
Rating analysts will want to see that the organization has conducted in-depth scenario planning, as uncertain as it may be. The analysts want to know how you are thinking about this and the potential implications. Many clients have begun monthly or even weekly projections that focus on the next three to six months, but they will necessarily need to pivot to the upcoming budget-year cycle and longer-term financial planning implications. Enhanced performance improvement planning will be more sharply in focus as hospitals and health systems look to address the current set of challenges. Be prepared to discuss planning for labor and non-labor expense challenges. While many variables come into play, the main focus of the exercise is to project the cash needs required to weather the current storm and carry the organization into the future. Be prepared to discuss the quantification and benefits of the CMS and CARES Act packages.
Balance Sheet Strength and Liquidity Are in Focus
Rating agencies want to understand the organization’s ability to weather the current storm until operations can establish a new normal. Fitch has already published an article discussing the changes to and characteristics of the portfolios of its credits. Current liquidity levels and access to additional liquidity sources, including any advanced payments from CMS, are important to address. Equity market losses may have impacted your investment portfolio, so a discussion about asset allocation (previous, current, expected) will be critical. The potential for realized losses may affect covenant calculations, so be prepared to discuss. Loss of investment returns may exacerbate pressures on already challenged cash flows, all of which will tie into your determination of projected liquidity levels and potential liquidity needs.
On the debt side, management should be prepared to discuss potential balance sheet challenges related to liquidity levels—lengthening collections, loss of philanthropy, capital structure risks, swap collateral posting requirements, potential pension funding needs, and others. Rating analysts will want to understand your exposure to potential covenant breaches which may have surfaced as you conduct the scenario planning discussed above. In particular, watch for potential MTI or bank covenant debt service coverage violations. Many boards have asked for an analysis of potential covenant breaches; it would be helpful to share the results of such an analysis. Bank lines and revolvers are to be expected, but the rating analysts will want to discuss covenants for bank lines and management’s expectations for how long liquidity facilities will remain in place and drawn upon.
Strategy Is Still Important
Updates to previous strategic initiatives remain relevant, but this component of the conversation is likely to take less time than usual, mostly because previous strategies are either on hold or because pursuit is not currently viable. Be prepared to discuss any negative implications of suspending strategic intiatives. Consumerism is in focus as hospitals seek to balance unprecedented demands for care from COVID-19 patients with consumers’ other care needs, limited staff and resources, and heightened safety concerns for patients and employees. The pandemic is driving changes in care delivery models, including propelling use of virtual visits for COVID-19 screening and efficiently extending routine care services to consumers from afar. Clients are sharing success stories about the ability to effectively transition to telemedicine alternatives, so be prepared to update your rating analyst about developments in this area.
Hospitals are on the front lines in the fight against the COVID-19 pandemic, and your organization is providing healthcare to your community in very challenging circumstances. The essentiality of your organization has never been more evident. Hospitals have put forth immense efforts to enact strategies and tactics to battle the effects of COVID-19. This is your chance to share what your hospital has learned as you care for your community.
If Kaufman Hall can be of any assistance as you prepare for upcoming rating conversations, please reach out to Eric Jordahl, our Treasury & Capital Markets Practice Leader, through email or at (224) 724-3134, or Robert Turner through email or at (214) 295-3200 to discuss.