Category Archives: Bond Rating Agency

Three Must-Haves for Every Rating Presentation

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Creating a great rating agency presentation is imperative to telling your story. I’ve probably seen a thousand presentations across the past three decades and I can say without a doubt that a great presentation will find its way into the rating committee. Show me a crisp, detailed, well-organized presentation, and I’ll show you a ratings analyst who walks away with high confidence that the management team can navigate the industry challenges ahead.

During the pandemic, Kaufman Hall recommended that hospitals move financial performance to the top of the presentation agenda. Better presentations chronicled the immediate, “line item by line item” steps management was taking to stop the financial bleeding and access liquidity. We still recommend this level of detail in your presentations, but as many hospitals relocate their bottom line, management teams are now returning to discussing longer-term strategy and financial performance in their presentations.

Beyond the facts and figures, many hospitals ask me what the rating analysts REALLY want to know. Over those one thousand presentations I’ve seen, the presentations that stood out the most addressed the three themes below:

  1. What makes your organization essential? Hospitals maintain limited price elasticity as Medicare and Medicaid typically comprise at least half of patient service revenue, leaving only a small commercial slice to subsidize operations. The ability to negotiate meaningful rate increases with payers will largely rest on the ability to prove why the hospital is a “must-have” in the network. In other words, a health plan that can’t sell a product without a hospital in its network is the definition of essential. This conversation now also includes Medicare Advantage plans as penetration rates increase rapidly across the country. Essentiality may be demonstrated by distinct services, strong clinical outcomes and robust medical staff, multiple access points across a certain geography, or data that show the hospital is a low-cost alternative compared to other providers. Volume trends, revenue growth, and market share show that essentiality. A discussion on essentiality is particularly needed for independent providers who operate in crowded markets.
  2. What makes your financial performance durable? Many hospitals are showing a return to better performance in recent quarters. Showing how your organization will sustain better financial results is important. Analysts will want to know what the new “run rate” is and why it is durable. What are the undergirding factors that make the better margins sustainable? Drivers may include negotiated rate increases from commercial payers and revenue cycle improvements. On the expense side, a well-chronicled plan to achieve operating efficiencies should receive material airtime in the presentation, particularly regarding labor. It is universally understood that high labor costs are a permanent, structural challenge for hospitals, so any effort to bend the labor cost curve will be well received. Management should also isolate non-recurring revenue or expenses that may drive results, such as FEMA funds or 340B settlements. To that end, many states have established new direct-to-provider payment programs which may be meaningful for hospitals. Expect questions on whether these funds are subject to annual approval by the state or CMS. The analysts will take a sharpened pencil to a growing reliance on these funds. 

    The durability of financial performance should be represented with highly detailed multi-year projections complete with computed margin, debt, and liquidity ratios. Know that analysts will create their own conservative projections if these are not provided, which effectively limits your voice in the rating committee. 

    We also recommend that hospitals include a catalogue of MTI and bank covenants in the presentation. Complying with covenants are part of the agreement that hospitals make with their lenders, and it is the organization’s responsibility to report how it’s performing against these covenants. General philosophy on headroom to covenants also provides insight to management’s operating philosophy. For example, is it the organization’s goal to have narrow, adequate, or ample headroom to the covenants and why? As the rating agencies will tell you, ratings are not solely based on covenant performance, but all rating factors influence your ability to comply with the covenants.
  3. What makes your capital plan affordable? Every rating committee will ask what the hospital’s future capital needs are and how those capital needs will be supported by cash flow, also known as “capital capacity.” To answer that question, a hospital must understand what it can afford, based on financial projections. Funding sources may require debt, which requires a debt capacity analysis with goals on debt burden, coverage, and liquidity targets. Over the years, better presentations explain the organization’s capital model, outline the funding sources, and discuss management’s tolerance for leverage.

There is always a lot to cover when meeting with the rating agencies and a near endless array of metrics and indicators to provide. As I’ve written before, how you tell the story is as important as the story itself. If you can weave these three themes throughout the presentation, then you will have a greater shot at having your best voice heard in rating committee.

Three Things Board Members Should Know When Attending Rating Agency Meetings

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I am often asked how board members can play a helpful role in rating agency meetings if they are invited to attend.

Below are three ways in which board members can add value to the rating presentation:

1) Acknowledge the organization’s challenges. Too many times the key issues that need to be addressed upfront are left to the end, when time is short. Examples may include a covenant violation, unfavorable variance to budget, downturn in liquidity, or an unexpected change in management. A rating should be able to endure the ups and downs of a business cycle but large swings in performance or covenant violations challenge the bandwidth of tolerance and need to be addressed early. Better meetings acknowledge these issues upfront before the analysts ask about them (said another way: the best defense is a good offense). If the analysts leave the meeting with the sense that management is on top of the issues, then that same confidence is brought forward to the rating committee.

Covenant violations have been on the rise since 2022 and board members should be well versed in the ramifications when there is a breach. In its simplest form, a bond is a promise to pay. To ensure full and timely repayment of that bond, hospitals agree to maintain certain financial covenants that serve as financial guardrails. Covenants are typically measured on an annual basis but may be measured more frequently per the terms of the agreements. The penalties for violating a covenant can range from a consultant call-in to an event of default with acceleration provisions. In any circumstance, covenant violations require an inordinate amount of time and resources to address and should be understood, even if at a basic level, by the board.

To that end, board members should maintain a basic understanding of hospital reimbursement and the ongoing challenges hospitals face, namely: inadequate reimbursement levels, labor shortages, perennial scrutiny over tax-exempt status, and the need to improve access and equity in healthcare. An informed trustee is a great trustee. One of the most impressive board members I met in my years as a ratings analyst was a business executive who was chair of a 25-bed critical access hospital and well-versed on the complexities of reimbursement. (You read that correctly: a 25-bed hospital, not a 500-bed hospital, academic medical center, regional or national system). Despite large-scale challenges as a small facility, that hospital continued to show good financial performance. Knowledgeable governance, working in tandem with management, had something to do with that.

2) Address how the organization will absorb additional debt if adding leverage. Ratings express the ability of a hospital to repay its debt; when debt increases, the ability to repay that debt can weaken. A board member or senior management should explain how they got comfortable adding leverage to the organization and what the benefits are of using debt to fund the projects, rather than, say, cash. Detailed, multi-year financial projections should show how the hospital will rebuild the balance sheet and absorb higher debt service. Projections are especially important when the size of the construction project or acquisition funded with the debt is material. This is also an opportunity for boards to demonstrate how the various skills and expertise they bring to the organization can be helpful. For example, individuals with real estate or construction experience can bring their experience to large projects. Individuals with experience in highly regulated or highly unionized industries can also bring their know-how to senior leadership.

3) Share the organization’s succession plan. Succession planning is one of the most important responsibilities of the board. Sam Altman’s wild ride (he’s in/he’s out/he’s in, again) as CEO of OpenAI and the mutiny his departure would have caused is a timely example of why succession planning is essential. From a ratings perspective, curating the very best leadership is viewed as a best practice of high-performing organizations. A good example of strong succession planning is Texas Children’s Hospital, the largest pediatric provider in the U.S. Earlier this year, the board and the CEO created the separate role of President (this title was previously combined with the CEO’s title) and launched a search that was completed in September. The new President will report to the CEO, who will continue in his role. The Chair of the Texas Children’s Board of Trustees notes that the new structure is intended to prepare the organization for its “next evolution in leadership.” The opportunity for the new President to work with Texas Children’s long-serving CEO should ultimately provide for a smooth leadership transition.

If we’ve learned anything from the past four years, it is the importance of strong governance and management. Undoubtedly, board members will be called upon for their guidance and expertise as turbulent times continue for the industry. Maintaining a basic understanding of the hospital’s financial challenges, supporting management, and building a succession playbook will be integral to the organization’s long-term success.