Over the years, I have had many things that I have wanted to tell the executives at not-for-profit hospitals. As a ratings analyst, however, I couldn’t.
Now I can.
This is the first of several blogs in which I’ll share some of the observations I have stored up from the thousands of hospital ratings I have participated in. Let’s start with one reflection that is especially important in times of rapid change.
Metrics matter, but so does the story behind them.
Metrics provide the basis for assessing credit. Rating analysts compute hundreds of metrics that measure your organization’s ability to make full and timely debt payments, which is the cornerstone of credit. Metrics are analyzed over multiple years to determine if future financial results will be consistent or variable. Other data such as volume statistics and payer mix composition also inform analyses, as do qualitative factors that measure demand, like market share and acuity. In general, rating downgrades reflect a trend of weaker financial performance and narrowing of debt service coverage while upgrades reflect an expectation of performance that will create greater headroom to covenants.
Ratings are meant to be durable as credit agencies seek to “rate through the cycle.” However, strategies that will alter the complexion of a healthcare system, such as mergers, acquisitions, or other bespoke goals, can immediately impact the risk profile. Some of these bold and transformational strategies include acquiring senior living companies, construction of a greenfield hospital or the creation of a new health insurance plan. Despite longer-term synergies and expectations of favorable cash flow, near-term risk and the impact of additional debt or use of cash can lead to downgrades.
Risk also includes external factors that may be outside of management’s control. A perfect example is the liquidity crisis of 2008. Many hospitals experienced escalating interest rates on variable rate debt and negative carries on derivatives, requiring large collateral postings to counterparties. While some downgrades occurred, many ratings were affirmed as management teams moved quickly to address debt structure risk. More influential to performance than the market dislocation was the Great Recession that followed. Volume and revenue reductions led to thinner debt service coverage. Downgrades followed.
That said, numbers and metrics only tell part of the story. It’s up to management to tell “the rest of the story,” as radio commentator Paul Harvey used to say. Not-for-profit hospitals are complex organizations, and the clear articulation behind a major strategic initiative is a critical component when evaluating credit. The same can be said for discussing financial results. Diving into the weeds of audited and projected statements to explain non-recurring adjustments will allow rating agencies to distinguish between the signal and the noise.
In my years as a ratings analyst, great meetings with management teams were those that not only celebrated accomplishments, but also discussed lessons learned from past strategies and acknowledged future challenges. The look-me-in-the eye discussion made a difference. Humility, not hubris, built credibility.
The recent upgrade of 300-bed Silver Cross Hospital in New Lenox, Illinois provides a good example of how the story behind the metrics matters. In 2015, the hospital issued a sizable amount of debt to further its campus expansion project. While financial performance and liquidity were projected to stay in line with “A” medians, pro forma leverage indicators were very high. Moody’s and Fitch assigned Baa1 and BBB+ ratings, respectively.
Silver Cross completed the construction project on time and on budget. Financial performance and liquidity remained at strong historical levels, but the debt metrics, while improved, remained high compared to peers. Management provided a conservative forecast and articulation of ongoing strategies that would enable Silver Cross to lower leverage. The ability of Silver Cross to demonstrate consistent performance through a transformational construction project not only built new towers, but also credibility. Even in the midst of COVID given an excellent discussion of their tactics during that period, Silver Cross earned an upgrade from Moody’s in 2020 and Fitch in 2021 to A3 and A-, respectively.
Some of us are more comfortable with the quantitative than the qualitative. For us, the lesson is to nurture a capability to couple metric-based assessment with an equally tangible depiction of environmental conditions and strategic rationale.
Others of us are born story-tellers. In many cases, our professional experience has shown that rewards come from our ability to play up the positive and play down the negative in our stories. For us, the lessons are two-fold: first, to ensure that our stories are thoughtfully supported by metrics, and second, that our stories highlight not only the pride of our successes, but also the learnings borne of hard experience. A “look-me-in-the-eye” discussion should always be part of telling the story.