Here are two tales from the new world order of hospital credit rating:
A community hospital that has performed poorly in the past takes on new management and a new operating structure. Its debt is notched up to a respectable BB-.
Meanwhile, managers at another facility decline to furnish analysts with market-share information. The result is a lower rating.
While management has always made a difference in credit rating, analysts' assessments of executive character are taking on a new importance in the wake of changing market conditions and the financial collapse of Allegheny Health, Research and Education Foundation (AHERF). More than ever, management savvy, responsiveness and simple integrity can overshadow raw numbers in determining what credit rating a hospital gets and, ultimately, what premium it pays to borrow money.
"There is an element of wanting to look in the whites of the eyes of the folks who are making things happen for the system," says Duncan Gallagher, chief financial officer of Iowa Health System, Des Moines.
For example, in the case of the overhauled community hospital, which Craig Kornett, analyst at New York-based credit-rating agency Fitch, declines to name, "It's fairly likely that if we did not have a good feeling on management, (the rating) would be lower."
In the case of the managers who didn't provide market share numbers, "It cost them a notch (in their rating). It was a fair question, and they said, `Nah, we don't track that stuff.' I'm going, `Not the right answer,' " recalls Gordon Howie, a managing director at investment bank PaineWebber.
Tightening reimbursement, smaller profit margins, more regulations and stricter enforcement make it ever more important that the people behind the wheel of a healthcare organization really know what they are doing, credit-rating analysts say.
The 1998 bankruptcy of Pittsburgh-based AHERF also was a lesson in the importance of assessing the integrity of management and the quality of board oversight. Earlier this year, AHERF executives were arrested on charges of stealing endowment funds and sued for allegedly providing false financial information to buyers of the system's tax-exempt bonds.
Few would argue criminal activity by executives is endemic to the industry. But many point to the market decline in creditworthiness throughout the healthcare industry as evidence of tough times and the impact of bad management.
A July Moody's report projected that the amount of debt in the not-for-profit hospital industry downgraded this year could surpass the $13.4 billion downgraded in 1999. Driving the downgrades is the tight reimbursement environment, the report said. And in a growing number of cases, assessing management's ability to deal with that environment feeds directly into the decision whether to downgrade.
"It's more than the numbers. Otherwise, we don't need a team of 10 analysts (to do a rating)," says Lisa Goldstein, an analyst at Moody's Investors Service.
A case in point is Iowa Health, which in April issued $207 million in bonds rated A+ by Fitch and A1 by Moody's Investors Service.
Beyond cash flow and debt ratios, analysts look at "how the management team presents itself and interacts with the analysts while they are on-site," Iowa Health CFO Gallagher says.
In fact, he says, Iowa Health cash balances and operating margins aren't in line with the A1 rating category, and he attributes the bump-up to management's abilities.
Moody's A-rated credits post a median operating profit margin of 1.8%, while Iowa Health generated a 0.2% profit in 1999. And in its analysis for the new bond issue, Moody's called the system's 80% cash-to-debt ratio "somewhat weak for an A1-rated credit."
"We believed we had to do a good job with telling our story, and we made a lot of effort," Gallagher says.
Part of Iowa Health's success lies in its openness, he says. "We heard strongly from analysts and the credit community that they would like to see a more open relationship with the management and would like the ability to interact directly with management on a periodic basis to share our financial performance." (See related story, p. 44.)
So in what Iowa Health officials believe is a national first, the 10-hospital system has started posting its quarterly financials on its World Wide Web site.
"There was value in them feeling we were so open about it--it displays a confidence by management that we stand behind our numbers and that we are willing to explain on a quarter by quarter basis," Gallagher says.
Bill Bellenfant, CFO of Trinity Mother Frances Health System in Tyler, Texas, says that as profitability becomes harder to achieve, analysts look more to management for the answers.
"(Now) is the most significant credit tightening in my career, and the healthcare industry is beginning to have to pay a premium to get letters of credit, bond insurance is less available and (hospitals) have to pay a higher price than in the past. The future will determine whether this is an overreaction to AHERF, (the federal Balanced Budget Act of 1997), managed care and other (factors)," he says.
Trinity's $146 million debt is rated BBB by Fitch.
"All three ratings agencies seem to understand that subjective factors are as important, if not more important, than past historical financial ratios in trying to understand the future creditworthiness of the organization," Bellenfant says.
Subjective factors are also of concern to the side that ultimately matters most--investors who buy and sell bonds.
Andy Matteis, director of tax-exempt research at Putnam Investments, Boston, which has $17 billion invested in tax-exempt bonds, says that investors in not-for-profits have always focused on management and markets more than their brethren investing in corporate healthcare, who tend to look exclusively at cash flow.
"When you are looking at (performance) prospectively, you want to know how good is management at reading the industry, how sophisticated are their information systems, do they have the market leverage to be a price-maker instead of a price-taker," he says.
But Matteis says that the numbers tell a major part of the story, and says that leaving out the numbers does a disservice to investors.
"Management has always been one of the factors that we look at," says Moody's analyst Goldstein. "But ultimately, if the strategies are working, then we should see a financial profile that works."
Goldstein agrees that times have changed.
"Post AHERF, board members are taking their responsibilities much more seriously," she says.
She tells the story of a board member who called up the hospital CEO after reading in the Wall Street Journal that Columbia/HCA Healthcare Corp. (now HCA-The Healthcare Co.) intended to sell a hospital the trustee thought might make a smart acquisition.
"Now that's taking their strategic and fiduciary responsibilities to heart," she says.
Management matters more in some situations than in others.
"In a rural market with limited managed-care pressures, management doesn't have to be as good," says Fitch's Kornett. "In that environment we look at the numbers because they are more stable."
In May, a Fitch report on municipal bond ratings put it this way: "Fitch has come to the conclusion that management practices are even more important to predicting favorable credit performance than had been appreciated in the past. In its future rating assignments, Fitch will place greater and more specific weight on management practices, both good and bad, that are employed by issuers in running their financial operations."
Much the same can be said of healthcare credits, Fitch analyst Jordan Melick says.
Measuring management's abilities isn't rocket science, he says. It isn't a good sign, for instance, when the top managers take analysts for a tour of the facility and nobody recognizes the managers.
Analysts also try to see "how quickly will a management team or a board committee decide to terminate a service that is not profitable," Goldstein says.
"When we ask questions, if they can respond to us right away" that's a positive, says Standard & Poor's analyst Susan Hill. And it shouldn't always be the CFO who's responding. "We definitely want to see some depth of management (able and willing to respond to inquiries)," she says.
Boards should also know what's happening. When asked what the biggest challenge for the hospital will be, Hill says it makes a big difference "if they say, `Oh, we're getting an MRI,' or if they say, `Managed care is coming into our area.' "
"As healthcare becomes a more difficult industry I think that boards will look for senior management that has the ability and capacity and background to handle the continuing challenges coming in rapid fire," Goldstein says.
In some situations, even the best management team probably isn't going to make the desired impression. In the past two years, ratings analysts have become particularly concerned about mergers.
"There was this case of a merger situation that had been in trouble for a while, and they gave us a plan in which they were going to take huge amounts of savings out of the combined organization--more than $50 million--and we notched that rating down because we felt it was an aggressive plan and a huge reach," says Standard & Poor's Hill of a credit she recently rated.
"We felt (management was) a little of the old school. The board of trustees there was not as business-minded and profit-oriented as other boards."
But some say such skepticism might be overkill. "All the rating agencies assume the integration process is going to be a challenging one, and I think that's almost regardless of what management says. I think they've become big believers in Murphy's Law," says PaineWebber's Howie, who as an investment banker facilitates the bond-rating process for hospitals and healthcare systems.
Joan Payne, controller at Covenant Healthcare System in Saginaw, Mich., says she knew going into the rating process for her system that the Standard & Poor's analysts would want to assess management's ability to integrate St. Luke's Hospital and Saginaw General Hospital, which merged in 1998 to create Covenant.
She and management "talked about areas that they would ask questions on. We didn't do any scripting or preparing answers, (but we) wanted to have explanations ready."
Since Covenant had just issued bonds in 1999 and completed a full-scale visit then, this year's update took place over the phone, she says. Among other questions, the analysts asked "where we are heading and why do we think that we are able to survive," she says.
Apparently, management's answers were satisfactory: Covenant's $48 million June bond issue was rated A by Standard and Poor's.
PaineWebber's Howie says it's critical to stay in constant contact and be candid with analysts. "Nothing annoys ratings analysts more than to learn about one of their clients in MODERN HEALTHCARE."
Despite the obvious importance of margins and ratios, in the end, the human factor counts for a lot.
"In some way you could say it's 100% of the rating because in some way the management affects everything: demand, services, how you deal with the reimbursement issues, what your capital spending and operating plans are. So indirectly, it affects everything else," says S&P's Hill.