With hospital credit ratings tumbling across the country, it may be time to think about what a credit rating is worth to the average healthcare facility or hospital system. In other words, what can it do-or not do?
The question is newly germane because for one thing, Moody's Investors Service foresees continuing deterioration in the credit outlook for U.S. not-for-profit hospitals for the next two years. The New York-based rating agency says externally imposed limits on cash-flow growth will force health systems to rely more on debt to fund their future capital projects, which will dilute their credit quality.
But that doesn't necessarily mean hospitals should sacrifice strategy for their bond rating, some analysts say. It may be worthwhile to make a credit rating secondary to market strategy.
Take Internext Group of Burbank, Calif., for example. The newly formed operator of assisted-living and skilled-nursing facilities in Southern California wants to maintain its Standard & Poor's rating of BBB. Its debt-to-equity ratio is 85%.
The company, created in March 1999 through the merger of three smaller providers, needs to grow, says Internext Chief Financial Officer Bill Jennings.
The demographics are extremely favorable to the business, he notes. "The number of adults age 85-plus is going to double in the next 10 years," he says. "With the high debt level we have, it forces that question: With available cash, what do you do with it-keep it in the bank to improve the credit rating or spend it to grow?"
To Jennings' way of thinking, an AAA credit rating is not worth the sacrifice needed to attain and preserve it. "I'd like to be a BBB+ or maybe an A-, but I would forgo any better rating, because it would keep me from being able to grow the mission."
Susan Hill, an analyst with New York-based S&P, agrees with this approach.
"Our position is that a bond rating should not drive management's strategy," Hill explains. "The bond rating is important for access to capital. But there are other considerations that should be made when developing a strategic plan or business plan for a hospital system. A bond rating is part of that."
A bond rating indicates only a facility's ability to repay debt in a timely way, she says. "When you think about it, that's a very narrow thing."
"I think a lot of management teams and boards look to bond ratings as a measure of performance. It can be that," Hill says. "But there are other things that go into performance, not just what your bond rating is. A management team would have blinders on if they were looking only at the bond rating and not their overall position in the market."
One hospital system Hill recently rated and is following closely is making just those sorts of calculations. Winter Park, Fla.-based Adventist Health System, formerly called Adventist Health System Sunbelt Health Care Corp., wants to maintain a decent rating but also wants to take advantage of growth opportunities.
The system operates 19 hospitals in eight states and Puerto Rico. It has 3,929 beds, of which 1,382 are in its flagship Florida Hospital in Orlando. Aside from that, only three of its hospitals have more than 200 beds each.
In May 1998 Adventist acquired Hinsdale (Ill.) Hospital, just outside Chicago. Soon after, it bought nearby LaGrange (Ill.) Memorial Hospital, a strategic acquisition that made eminent sense to S&P. However, the money necessary to buy and improve LaGrange Memorial added debt but no liquidity, pressuring Adventist's rating.
In a new-issue review dated Sept. 15, 1998, S&P awarded a rating of A- to the system. Adventist had "good financial and geographic dispersion" and "forward-thinking strategies," but the rating was "tempered by aggressive use of debt," according to the report. But S&P assigned a negative outlook, observing that the system's operating losses were more consistent with a BBB rating. "The rating could be lowered in two to three years," the rating agency said.
"They had a softening in performance and also announced (plans) to purchase LaGrange Hospital," S&P's Hill recalls. "They accepted the negative outlook in order to pursue an aggressive acquisition. We have said (the acquisition) is OK with us at the rating level they are at now."
Adventist could pursue a further acquisition at its current rating of A- only if the acquisition didn't dilute the balance sheet or earnings streams, Hill says.
Other systems seem to be making the same trade-off, says Therese Wareham, a financial consultant with Kaufman Hall and Associates, a Northfield, Ill.-based financial adviser. "It is a more common strategy, and the big hospital systems that are doing it aren't necessarily making it public," she says.
As a not-for-profit, Internext, like Adventist, cannot access equity capital. "The only way to generate capital is to get it through bond markets, increased borrowings, money we earn ourselves, or gifts and contributions," Jennings says. Historically, such companies have not enjoyed high enough profit margins to generate the huge surpluses that would cover future capital needs.
Most long-term-care operators have turned to the debt markets to fund growth, he says. And when they do start earning money, is it wiser to put the money in the bank or invest it in more growth? Strictly from the credit standpoint, S&P likes to see high cash balances. But again, that alone won't fulfill the mission.
"There's no simple answer. It's one that each company has to manage," Jennings says. "Strategically, we have to balance the growth against improving the credit rating."