Sisters of Mercy Health System has pulled off a coup that should make it the envy of hospitals everywhere: It is the first not-for-profit healthcare organization to win an Aa1 bond rating from Moody's Investors Service.
Calling St. Louis-based Sisters of Mercy "the strongest credit in Moody's healthcare portfolio," the bond-rating agency raised the healthcare and hospital system's rating on July 16 to Aa1 from Aa2. The rating change affects $452 million of variable-rate debt.
Moody's said the upgrade derives from "strong financial performance with a strengthening financial position supported by good geographic diversification with several strong market positions."
"It's a wonderful kudo for them," says Kathy Costine, senior manager at Bear, Stearns & Co., which remarkets more than $300 million of Sisters of Mercy's variable-rate securities. The move should broaden the market for the system's securities.
Carrol Aulbaugh, Sisters of Mercy's senior vice president and chief financial officer, couldn't say exactly how much the new rating would reduce the system's annual financing costs. "It is going to fluctuate all over the board," he says. "This is the first Aa1 credit that has gone to the market. The market doesn't know right now how to price that. We would anticipate there would be a savings."
Sisters of Mercy operates 24 hospitals in Arkansas, Kansas, Missouri, Oklahoma and Texas. The system has other operations in Illinois, Louisiana and Mississippi.
Based on net patient revenues, Sisters of Mercy is the ninth-largest not-for-profit healthcare system in the country. It has 135 physician group practices, 80 outpatient-care facilities, and numerous nursing homes and managed-care plans.
Sister Mary Roch Rocklage, president and chief executive officer, says the bond upgrade was a result of the system's strategic plan to strengthen its presence within a defined service region. In fact, the system has sold off hospitals outside its core service area.
Kay Sifferman, a Moody's analyst in the public finance group, says geographic concentration was one of the system's credit strengths. "Those markets have not yet felt the pressures in markets such as California," she says, where managed care has put the screws to all providers. "St. Louis is the largest market they operate in and is the most competitive market in terms of the number of providers in the market." But even there, Sisters of Mercy's subsidiary Unity Health System, with 29% market share, is well positioned, even though BJC Health System is slightly larger. In several other markets Sisters of Mercy is the dominant provider.
Aulbaugh says the rating upgrade helped vindicate the system's decision to issue variable-rate debt, which is considered riskier than fixed-rate.
All things being equal, the upgrade should translate into a lower cost of capital for the entire system-at least 5 basis points on the long-term fixed straight market, says Costine of Bear, Stearns. That should lift the price of existing bonds.
"It's not that they're not easy to sell now, but it will create demand," she says. "There will be certain sectors of the market that don't buy hospital credit. They will look at Sisters of Mercy."
And what they'll see there will thaw their bankers' hearts. The system had 265 days' cash on hand on June 30, the end of fiscal 1997, while Aa-rated hospitals typically have 183 days' cash.
They'll see $100 million in operating income for each of the past two years. Current operating margin and operating cash flow margin are 5.5% and 13.3%, respectively, lending the system enormous flexibility.
They'll see a system where every hospital and care unit has to stand on its own financial feet and achieve a reasonable return. That means each unit must cover its own capital replacement needs.
"We do not want to incur a lot of debt. We believe that the organizations that will be most feasible in the future are the ones with the least debt," Aulbaugh says. "We don't enter into projects with the idea that we should have debt related to a current project."
That policy has kept debt levels at Sisters of Mercy far below industry norms. "I know $452 million sounds like a lot of money, but it's not for an organization of that size," Aulbaugh says. The system's cash-to-debt ratio is more than 2-to-1.
Further, Aulbaugh says, asset growth has been propelled by the rocketing stock market. Sisters of Mercy keeps 60% of its cash in equities, the rest in fixed-income instruments. Over the past three years the system has averaged 16% annual growth on combined equities and bonds.
Sisters of Mercy leaders stressed that the bond rating upgrade will enable them not just to save money, but to serve their mission better. Rocklage says that "by developing a broad, diverse network of services and providers, SMHS is securing the future of faith-based healthcare in our service area."
Ronald B. Ashworth, Sisters of Mercy's executive vice president and chief operating officer, says the upgrade gives the lie to the argument that the future belongs to for-profit systems because they have better access to needed capital.
"If you operate an efficient business to meet the needs of the community and provide for the mission you have, you don't have to be a for-profit entity," Ashworth says. "You're going to provide access to as many people as you can, and still provide charity care."
To keep true to its mission, the system budgets charity care on a one-to-one ratio with net income. In fiscal 1997, just ended, Sisters of Mercy budgeted $190 million for charity. That's a big dividend for fiscal prudence.