Rating Agency Update: Covenants, Capital Spending, Consolidation, and Labor

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This year’s Therese L. Wareham Rating Agency Panel at the 2023 Kaufman Hall Healthcare Leadership Conference featured panelists Eva Bogaty, Associate Managing Director, Moody’s Investors Service; Suzie Desai, Senior Director, S&P Global Ratings; and Kevin Holloran, Senior Director, Fitch Ratings. A summary of our discussion with them follows.

Changes to rating distributions

While there have been signs that operations are stabilizing after what was a devastating year for many hospitals and health systems in 2022, performance in many markets has not returned to levels required for sustainability over the long term. Last year, our panelists were looking at 2023 as a “make or break” year for recovery; now, that “make or break” time span is extending into 2024. And, as the time span for recovery grows, the benefit of the doubt that may have been granted in 2022 has worn thin.

All three panelists emphasized that affirmations remain the dominant rating action; however, they also acknowledge that across rated credits, there has been a gradual shift downward in credit rating quality. There may, for example, be an uptick in A+ ratings this year, but it is coming at the cost of AA- ratings that have moved a notch down. One panelist noted that 20% of their rated credits are on a negative outlook, a level that has not been seen for a long time.

For credits that are holding their own or have received an upgrade, several factors may be in play. First, there is the simple benefit of being in a growth market. Beyond that are organizations that implemented partnerships or strategic plans right before or early on in the pandemic and had the discipline to stick to them. Lastly, organizations that have inculcated performance improvement into their culture are benefiting the most.


Increased labor costs continue to have a significant impact on financial performance, and the agencies will be interested in questions such as utilization of contract labor, the rate of wage increases, and negotiations with unions. There have been several high-profile labor strikes in 2023, and while short-term strikes rarely lead to a credit downgrade, they can have an impact if they begin stretching into weeks or months and start affecting revenues or expenses.

With nursing shortages expected to persist through at least 2030, the rating agencies are very interested in the strategies organizations are using to optimize workforce efficiency and enhance recruiting and retention efforts. Artificial intelligence (AI) holds significant promise for improved efficiencies, although it will take some time before the full potential of AI is realized.


Potential covenant breaches remain a concern for the rating agencies moving into 2024, given the slow course of recovery over 2023. The impact of a breach on a rating can vary, however, according to a number of factors, and a breach does not result in an automatic downgrade.

Factors that can mitigate the impact of a covenant breach include the likelihood that the breach was a one-time occurrence (tied, for example, to unrealized losses in the investment portfolio) and the ability of the organization to obtain a waiver from its creditors. On the other hand, if the breach is the result of more significant, structural revenue and cost challenges, it is more likely to affect the credit rating, especially if the rated organization does not have a clear plan for remedying the issues that have caused the breach.

Avoiding a covenant breach does not mean an organization also will avoid a rating downgrade. If an organization has more favorable covenants, the rating agencies will take that into account. The rating agencies’ focus is on an organization’s actual performance, not its performance in relation to its covenants. Headroom to covenants is a starting point.

If an organization is concerned about a potential breach (or any other event that could have an impact on the rating), the agencies strongly encourage early (and often) communication with them so they can be ready for calls from investors and determine whether they need to more closely monitor the organization or plan for a site visit. In general, the agencies have intensified surveillance of their credits. While they always look at their whole portfolio annually, they are now reviewing quarterlies or even doing monthly checks for a larger percentage of their credits.

Capital spending

As organizations continue to struggle with depressed operating performance, the question of how to pursue and fund strategic pursuits is becoming more urgent. The panelists agreed that organizations must focus on what is needed for their future sustainability and growth, regardless of the impact on the rating; an organization cannot grow by standing still. They are seeing organizations starting to move ahead again with strategic initiatives and are also seeing a return to longer-term projections.

There is not a clear trend on forecasts for capital spending going forward; some organizations are at pre-pandemic levels while others are still holding back. Certain types of spending can only be postponed so long, however, before metrics such as average age of plant or age of equipment start to grow and an organization moves toward a “break/fix” mode, which is typically a bad harbinger of things to come.

Some organizations have been pursuing private market alternatives to finance projects, which are typically not rated on the front end. Depending on the novelty of the instrument, the rating agencies may or may not have criteria to evaluate it. Ultimately, however, it has an impact on the balance sheet, and potentially on the credit rating, so the rating agencies will be asking about it.


Despite heightened regulatory scrutiny of merger and acquisition activity, consolidation within healthcare continues. One of the newest trends is cross-market mergers, which typically do not increase concentration within the merged organization’s local markets. From the rating agencies’ perspective, the verdict is still out on these mergers, but they are watching them with interest. Of particular interest is the relationship of these mergers with efforts to build a broader platform that has access to stronger data sets and enhanced intellectual capital, which could be beneficial in the long term for strategies around value-based care. More generally, the degree of financial stress that many organizations still face makes the prospect of additional mergers more likely.

When a merger is announced, the rating agencies will typically wait until a definitive agreement is signed before they begin evaluating the potential impact of the transaction on the merged organizations’ credit ratings. As the organizations grow closer—issuing debt together, for example, or sharing the same management team or board—the agencies will be more likely to merge the organizations’ ratings as well.

A thank you to our panelists

We are grateful for the time our panelists contribute to make the Therese L. Wareham Rating Agency Panel a highlight of our Healthcare Leadership Conference, and we look forward to continuing our conversation with them over the months and years to come.

Please join us on March 20, 2024, at 11:00 a.m. Central Time for our next conversation with the rating agencies. Look for an invitation to register for the webinar early in 2024.

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Lisa Goldstein is a nationally recognized analyst, speaker, writer, and expert on not-for-profit healthcare. At Kaufman Hall, she is a member of the Treasury and Capital Markets practice and Thought Leadership team.
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