I am often asked how board members can play a helpful role in rating agency meetings if they are invited to attend. Below are three ways in which board members can add value to the rating presentation:
1) Acknowledge the organization’s challenges. Too many times the key issues that need to be addressed upfront are left to the end, when time is short. Examples may include a covenant violation, unfavorable variance to budget, downturn in liquidity, or an unexpected change in management. A rating should be able to endure the ups and downs of a business cycle but large swings in performance or covenant violations challenge the bandwidth of tolerance and need to be addressed early. Better meetings acknowledge these issues upfront before the analysts ask about them (said another way: the best defense is a good offense). If the analysts leave the meeting with the sense that management is on top of the issues, then that same confidence is brought forward to the rating committee.
Covenant violations have been on the rise since 2022 and board members should be well versed in the ramifications when there is a breach. In its simplest form, a bond is a promise to pay. To ensure full and timely repayment of that bond, hospitals agree to maintain certain financial covenants that serve as financial guardrails. Covenants are typically measured on an annual basis but may be measured more frequently per the terms of the agreements. The penalties for violating a covenant can range from a consultant call-in to an event of default with acceleration provisions. In any circumstance, covenant violations require an inordinate amount of time and resources to address and should be understood, even if at a basic level, by the board.
To that end, board members should maintain a basic understanding of hospital reimbursement and the ongoing challenges hospitals face, namely: inadequate reimbursement levels, labor shortages, perennial scrutiny over tax-exempt status, and the need to improve access and equity in healthcare. An informed trustee is a great trustee. One of the most impressive board members I met in my years as a ratings analyst was a business executive who was chair of a 25-bed critical access hospital and well-versed on the complexities of reimbursement. (You read that correctly: a 25-bed hospital, not a 500-bed hospital, academic medical center, regional or national system). Despite large-scale challenges as a small facility, that hospital continued to show good financial performance. Knowledgeable governance, working in tandem with management, had something to do with that.
2) Address how the organization will absorb additional debt if adding leverage. Ratings express the ability of a hospital to repay its debt; when debt increases, the ability to repay that debt can weaken. A board member or senior management should explain how they got comfortable adding leverage to the organization and what the benefits are of using debt to fund the projects, rather than, say, cash. Detailed, multi-year financial projections should show how the hospital will rebuild the balance sheet and absorb higher debt service. Projections are especially important when the size of the construction project or acquisition funded with the debt is material. This is also an opportunity for boards to demonstrate how the various skills and expertise they bring to the organization can be helpful. For example, individuals with real estate or construction experience can bring their experience to large projects. Individuals with experience in highly regulated or highly unionized industries can also bring their know-how to senior leadership.
3) Share the organization’s succession plan. Succession planning is one of the most important responsibilities of the board. Sam Altman’s wild ride (he’s in/he’s out/he’s in, again) as CEO of OpenAI and the mutiny his departure would have caused is a timely example of why succession planning is essential. From a ratings perspective, curating the very best leadership is viewed as a best practice of high-performing organizations. A good example of strong succession planning is Texas Children’s Hospital, the largest pediatric provider in the U.S. Earlier this year, the board and the CEO created the separate role of President (this title was previously combined with the CEO’s title) and launched a search that was completed in September. The new President will report to the CEO, who will continue in his role. The Chair of the Texas Children’s Board of Trustees notes that the new structure is intended to prepare the organization for its “next evolution in leadership.” The opportunity for the new President to work with Texas Children’s long-serving CEO should ultimately provide for a smooth leadership transition.
If we’ve learned anything from the past four years, it is the importance of strong governance and management. Undoubtedly, board members will be called upon for their guidance and expertise as turbulent times continue for the industry. Maintaining a basic understanding of the hospital’s financial challenges, supporting management, and building a succession playbook will be integral to the organization’s long-term success.