Forget licensed beds and gross patient revenues. Neither number tells healthcare bond buyers what they really want to know: Will they get their money back -- with interest?
Credit-rating agencies are filling the data gap with new gauges of not-for-profit healthcare providers' ability to generate cash and repay debt. A number of ratios are plucked directly from the pages of corporate bond-rating intelligence.
Standard & Poor's formally introduced a dozen-and-a-half new ratios last month. Agency analysts discussed the measures during a nationwide teleconference Oct. 22.
"We started internally by looking at our own corporate finance and insurance group to see what they were doing," Cynthia Keller, a director with Standard & Poor's, told listeners. Then the agency consulted just about every constituency involved in healthcare analysis, from issuers of debt to obligors and from consultants and certified public accountants to healthcare data companies, she says. "As you can imagine, we had hundreds and hundreds of ratios that we reviewed, and they were all calculated differently."
The chosen few included a number of measures of cash flow and debt repayment capacity.
"We wanted to get away from strictly looking at bottom-line and profitability analyses and look at what cash an organization was able to throw off on a yearly basis," says Susan Hill, an associate director at New York-based Standard & Poor's.
The agency's repository of financial yardsticks now includes a measure of "earnings before interest, depreciation and amortization," or EBIDA for short. A similar measure -- EBITDA, which backs out taxes as well as interest, depreciation and amortization -- is commonly used in assessing corporate issuers' ability to generate cash.
The agency also will begin calculating what it calls "free operating cash flow," which accounts for changes in working capital, such as decreases in receivables.
Standard & Poor's is updating its capital-structure ratios, too. It will use "free operating cash flow to total debt" to keep tabs on creditors' ability to repay total long-term debt from operating cash flow. "This is a big figure that we borrowed from corporate finance," Paul Rizzo, an associate director in the agency's healthcare group, told teleconference listeners.
Every major healthcare bond-rating agency now uses cash flow and debt repayment ratios of some sort.
"We actually added a number of ratios within the past two years, and a number of them are related to cash-flow measures," says Bruce Gordon, vice president and senior analyst with Moody's Investors Service, New York.
One is debt to cash flow. Moody's adjusted the ratio last year to exclude interest expense from the denominator. The revised measure assesses a provider's ability to repay principal using ongoing cash flow from operations. It differs from cash on hand, which measures available cash at the end of an accounting period.
"We think the debt-to-cash-flow ratio captures the ability to repay debt on a forward-looking basis," Gordon says.
Based on a sample of 300 freestanding hospitals and single-state healthcare systems rated by Moody's, median debt-to-cash flow was 3.41 for all healthcare credits last year. The median for junk-bond credits rated B and below reached 11.15. The higher the number, the higher the leverage.
Fitch Investors Service, New York, incorporates two cash-flow measures into its ratings. One is EBITDA. The other is cash flow from operations before interest. Fred Martucci, Fitch's senior vice president of health and higher education, says the firm would like to add even more cash-flow measures to its ratings process.
"I love the cash-flow stuff," he says. "We've been using that for five years."
Generally, Standard & Poor's attempt to better assess the industry's financial and operational strengths and weaknesses drew positive reaction from bond-issuing authorities and healthcare organizations.
"Certainly they make sense in terms of looking at the areas that are going to be important in terms of credit analysis," says Steve Fillebrown, director of research and investor relations at the New Jersey Health Care Financing Authority.
Sometimes a system looks good on the income statement, but its cash position isn't very solid, says Fillebrown, who also chairs the National Council of Health Facilities Finance Authorities' rating agency and credit enhancement committee. Revenues might be tied up in property or accounts receivable, for example. But measuring free operating cash flow helps demystify its cash position.
"To the extent that it's getting at cash as opposed to accrued income, I think that's a good measure," he says.
Several of Standard & Poor's new ratios focus on outpatient activity. The agency will begin gathering more detailed data on net revenues from the outpatient side and publishing a measure of admissions adjusted for outpatient revenues.
"I think what they're really doing is fine-tuning the system a bit," says William Cleverley, president of the Center for Healthcare Industry Performance Studies, Columbus, Ohio, which collects and publishes hospital financial and operating indicators. "We've always used adjusted admissions and adjusted discharges."
However, borrowers and issuers remain wary about the new ratios.
"I'm always concerned when rating agencies, without a lot of input from the entities that they're rating, want to change their ratings and their calculations," says Neil Moss, executive director of the Idaho Health Facilities Authority in Boise.
Standard & Poor's executives say the new ratios are not written in stone and will probably be refined over time.