A proposed accounting rule would flip certain debt from non-current to current, and some hospital leaders say the change—affecting tens of millions of dollars in some cases—could throw their debt ratios out of whack.
The Financial Accounting Standards Board said the proposed standard, Topic 470, is meant to simplify debt classification on balance sheets and comes after stakeholders complained the current method is unnecessarily complex. In essence, the rule would replace current guidance with uniform principles for determining debt classification, according to an FASB explainer.
Under the proposal, a letter of credit could no longer be used to classify a type of bond called a variable-rate debt obligation as current. Today, VRDOs can be treated as long-term obligations so long as they're remarketed, or have long-term letters of credit.
"People look at your company differently when you all of a sudden have an extra $75 million in short-term liability," said Jared Grant, senior director of financial reporting for St. Luke's Health System in Boise, Idaho.
About $75 million of the $900 million in debt offerings St. Luke's reissued last year were VRDOs backed by letters of credit, Grant said. That debt is classified as non-current on the health system's balance sheet. Grant has not calculated what the change would do to St. Luke's debt ratio, but he thinks it would be significant. He's worried it could even have a negative effect on St. Luke's bond ratings.
"It's a large chunk," he said. "If that went to current treatment all of a sudden, that would be a large shift."
VRDOs backed by letters of credit make sense for some health systems because they allow them to obtain financing at attractive rates, said Norman Mosrie, a partner with DHG Healthcare and chair of the Healthcare Financial Management Association's principles and practices board.
Some of the VRDOs on today's balance sheets are legacy deals. The method lost popularity in recent years as borrowers turned to fixed-rate bonds to lock in low interest rates, he said. Back in 2014, the VRDO market was worth $222 billion, according to the Municipal Securities Rulemaking Board.
"This has been an important financing mechanism for health systems over the years," Mosrie said.
Mosrie expressed concern over whether bondholders would accommodate potential negative impacts to bond covenants under the proposed rule, or whether credit-rating agencies would move to downgrade based on the large amount of debt classified as current.
Rating agency representatives, however, said they would not hold it against a company's rating. At S&P Global Ratings, the current practice is to classify VRDOs as long-term debt even if they're listed as current on balance sheets, said Kenneth Gacka, a senior director and analytical manager in Standard & Poor's not-for-profit healthcare division.
"I don't think it will affect anything in terms of the presentation of our ratios, because we already make that adjustment whenever it is present," he said.
Similarly, Kevin Holloran, a senior director with Fitch Ratings, wrote in an email that his agency would also consider that a long-term obligation. That said, a casual reader could potentially be misled, he said.
Mosrie hopes the FASB, a not-for-profit organization that sets standards that companies must abide by if they follow generally accepted accounting principles, continues to allow long-term letters of credit linked to debt-financing transactions be classified as non-current. The FASB is accepting comments on the rule until Oct. 28. This proposal is an updated version of an earlier proposed rule released in 2017. The new version is based on substantial feedback.
FASB spokeswoman Christine Klimek wrote in an email that consistent with the goal of simplifying guidance, the board proposed precluding consideration of unused, long-term financing arrangements to provide financial statement users with more consistent and transparent information about the contractual maturities of debt arrangements.
If the rule ultimately does take effect, Rick Kes, a partner and healthcare industry senior analyst with RSM, said he thinks health systems with this type of debt will renegotiate it and change the terms.
"I think most health systems that can do it would rather not have current debt on their balance sheet if they can avoid it," he said.
That's what Doug Coffman, chief financial officer of West Virginia United Health System, said would likely be his course of action. Otherwise, his 10-hospital health system with more than $2 billion in annual revenue would see its debt ratio drop from about 2.5%, well above its peer group, to about 2%, right in the middle of the pack. Almost $80 million of WVU Medicine's $1.3 billion in outstanding debt obligations is in VRDOs, Coffman said.
Coffman thinks the potential effects of the change extend beyond health systems and could hit the banks that issue letters of credit and bond underwriters if the VRDO market becomes less attractive.
"I'm not sure that FASB fully grasped that possible impact as they drafted this, but maybe they did," he said.
WVU Medicine chose VRDOs for two reasons: interest rate diversification and some of the system's fixed-rate swap agreements require that it have some variable-rate debt, Coffman said.
When St. Luke's was going over its financing options, investment bankers presented VRDOs backed by letters of credit as one of multiple long-term debt vehicles, Grant said. The health system chose it as one of the five vehicles it used, in part to diversify and because the price was competitive.
If the proposed rule takes effect, Grant said St. Luke's will consider getting out of VRDOs.
"I think eventually it would poison this vehicle a little bit from health systems on wanting to ever really even touch it if this was the guidance," he said.