Health systems increasingly comfortable dropping bond ratings

A month after Fitch Ratings downgraded Lexington Medical Center by six notches, the agency agreed to the hospital’s request to withdraw the rating.

Fitch had recently changed its methodology for evaluating pension risk, and cited the South Carolina hospital’s high pension liability in its July 2018 downgrade to BB+. Lexington Medical Center’s finance chief disagreed with Fitch’s rationale, and said his team no longer believed the agency could accurately rate the hospital.

“Consequently, we requested that Fitch withdraw its rating,” Chief Financial Officer Jeff Brillhart said in a statement. “Standard & Poor’s did not use that same methodology.”

In going from being triple rated to double rated, Lexington Medical Center took a calculated risk in a municipal market that’s become increasingly hospitable to borrowers with fewer ratings. Consequently, more and more issuers—both inside and outside the healthcare space—are taking bonds to market with fewer ratings and asking Fitch, S&P Global Ratings or Moody’s Investors Service to drop existing ratings.

The numbers paint a dramatic shift. In 2012, 43% of issuances came to market with three ratings, according to an analysis by Municipal Market Analytics. By 2021, that had fallen below 25%. During the same period, issuances with zero, one and two ratings increased.

All three rating agencies declined to discuss the subject on the record.

It’s not always because the companies don’t like the rating, either. Maintaining a bond rating is expensive and time consuming, and some finance experts say it’s worth running the numbers on whether the borrowing savings offset those expenses.

“Health systems are thinking more about the value of each rating and the cost and effort of each rating,” said Liz Sweeney, president of public finance consultancy Nutshell Associates. “I think the market has become more accepting of fewer ratings.”

‘You don’t need three’

Sweeney, a former S&P analyst, faced such a decision firsthand in her capacity as a board member at the University of Maryland Medical System.

The Baltimore academic health system had three ratings at the time in 2020, but was weighing whether two would be enough. Sweeney explained before an audience at the Healthcare Financial Management Association conference in November that every rating has a financial cost. They require lots of care and feeding of those relationships.

“Would investors care? Would it raise our cost of capital?” she said. “In talking with financial advisers, we determined two ratings was sufficient for us, so we did drop one.”

The most benefit comes from the first rating, with each additional rating providing less incremental benefit, Sweeney said in an interview. She declined to elaborate on UMMS’ request that Fitch withdraw its rating—which the agency did in 2021—and UMMS declined to comment.

Finance experts recommend health systems assess the value of their ratings and how the cost of the rating compares with the improvement it brings to their cost of capital.

Getting and maintaining a bond rated takes time and money. There are presentations, responding to information requests, building trust with the ratings analyst and maintaining an ongoing dialogue. Each agency has a different approach to ratings, so there’s a need to learn their unique styles.

It’s not work that can be passed to interns, either. CFOs, treasurers and other high-level finance executives are expected to head up the correspondence with agencies.

On top of the staff costs, the rating itself has a cost. The price corresponds with the size of a debt issuance. The bigger the issuance, the more cost effective the rating becomes, said Vasanta Pundarika, co-head of healthcare investment banking at Matrix Capital Markets Group.

“$40,000 on a $20 million deal seems expensive, but when it’s $100 million, the relative rating cost goes down,” she said.

Ultimately, it’s a very different thing to go from three to two ratings than from two to one, Pundarika said. The “vast majority” of bond deals have two ratings, and she said it’s rare for even large health systems to have three ratings.

“Once you have two rating agencies telling investors what they think, you don’t need three,” she said.

That’s not to say hospitals can’t go down to one rating, but they should be prepared to explain to investors why they decided to stray from the norm.

Sometimes, the reasons for dropping a rating are more intangible. Perhaps you’re an academic medical center, and one agency doesn’t weigh your specific circumstances, Pundarika said.

“No matter how much trust you’ve built over time, it just doesn’t feel like they’re understanding you,” she said. “That might be a reason to drop one.”

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investors doing their own research

As with so many economic trends, this one took root during the Great Recession.

Before the global financial crisis that spanned 2007 to 2009, investors relied heavily on—and some exclusively on—bond ratings when making investment decisions.

But credit rating agencies lost some of their clout after it was discovered that they gave high ratings to the mortgage-backed securities at the heart of the crisis. A 2011 congressional inquiry concluded that the Big Three agencies were “key enablers of the financial meltdown,” leading to expanded oversight by the U.S. Securities and Exchange Commission.

As a result, investors have taken to doing more of their own research into credits before making investments, rather than relying so heavily on ratings. Many now have dedicated healthcare analysts who study financial statements and talk with management teams.

“There used to be a big push to have a number of ratings,” said Jeffrey Sahrbeck, a managing director with advisory firm Ponder & Co. “I think right now with where the market is and people doing their own credit work, there are fewer and fewer deals being done with three ratings.”

The Great Recession also led to reinforced firewalls between the agencies’ analysts and sales teams. These days, if you even mention price to an analyst, they have to inform their compliance department, Pundarika said.

Despite all this, experts said analysts aren’t thinking about the amount of time their information requests require or how an issuer will react to their ratings. Above all, they’re just trying to be accurate.

“They’ll do everything to make it a positive customer experience, but I do think they’re going to ask for what they need,” said Lisa Washburn, managing director with Municipal Market Analytics and a former Moody’s analyst.

Another factor pushing issuers to fewer ratings: the insatiable demand for tax-exempt municipal bonds bumping up against a dearth of supply, Washburn said. Over the years, mutual funds have amassed more and more money that they’re expected to put to work. That’s increased demand for bonds even as the total supply of municipal debt has stayed flat.

“Investors give up yield all the time; they’ve given up covenants over time,” Washburn said. “But giving up a rating is just one more way to give up a transaction in a way that benefits the issuer because they don’t have to pay for it.”

Timing is everything

When it comes to dropping a rating, timing is important. Hospitals want to keep investors from getting spooked and questioning the rationale for the change, which could lead to higher interest costs.

“The last thing you want when you’re going to market is questions,” Pundarika said. “You want the story that investors are hearing to be very clear.”

If a health system plans to drop a rating, experts say it’s best to do so between bond issuances and simply come to market with fewer ratings on the next issuance. That’s going to look better and cost less than getting the rating and asking to have it withdrawn after the fact.

Sahrbeck, of Ponder & Co., typically advises clients who want to drop a rating to do so at their next bond deal. If they have ratings outstanding for older bond issues, he tells them to request the agency withdraw the rating, either before or after the new transaction.

In the case of UMMS, the rating change came in conjunction with a roughly $750 million financing, which Pundarika said is the right time to do it.

“Rather than any old Tuesday, you’d do it when you do a financing,” she said.

That was also the case for Reno, Nevada-based Renown Health, Akron, Ohio-based Summa Health and Virginia Hospital Center in Arlington. All three providers dropped Moody’s ratings in conjunction with new issuances in recent years. They declined to elaborate on their decisions.

Health systems have also dropped ratings after mergers. That was the case with Chicago-based Northwestern Medicine, which had been rated by Moody’s and S&P prior to its merger with Palos Health, which was rated by Fitch. Last year, Northwestern Medicine had the Fitch rating withdrawn after it refinanced Palos’ legacy bonds, leading to no outstanding debt rated by Fitch.

“As you know, it’s not uncommon in the healthcare space to have two rating agencies, similar to other health systems such as Cleveland Clinic, Intermountain Healthcare, etc.,” Northwestern Medicine spokesperson Christopher King said in a statement.

Sioux Falls, South Dakota-based Sanford Health dropped its Moody’s rating after its 2019 merger with the Evangelical Lutheran Good Samaritan Society, which was rated by Fitch. “We only needed two bond ratings,” Sanford spokesperson Angela Dejene said.

Rating agencies differ on whether they’ll actually drop an existing rating in response to an issuer’s request, Sahrbeck said. Technically, it’s an independent opinion, so they have the right to continue publishing their research. That said, most stop once they’re no longer getting information beyond the public financial statements.

A health system that’s looking to drop a rating should take a broad look across all of its outstanding debt—not just tax-exempt, fixed-rate bonds—to ensure dropping a rating won’t impact those other agreements, said Chris Tucker, a managing director with PNC Healthcare. Many borrowers have shifted toward using direct placement loans with banks, some of which contain triggers attached to rating downgrades.

Systems that drop ratings after a downgrade risk causing investors to think they’re not being transparent, Tucker said.

“They’re eliminating the rating agency now,” he said, “and that could set off some alarm bells with institutional investors when you see that sort of withdrawal in the middle of a downgrade.”