Category Archives: Debt Service Coverage Ratio

Financial Literacy: A Leadership Prerequisite

Posted on by • Posted in Accessible Liquidity, Board, Board Purpose, Debt Levels, Debt Service, Debt Service Coverage Ratio, Financial Literacy, Financial Vital Signs, Leadership, Leadership Continuity, Leadership Learning, Operating Expenses, Operating Income, Operating Margin, Operating Margin Drivers, Operating Metrics, Operating Revenue, Revenue Diversification, Revenue Growth, Unrestricted Cash • Leave a comment

https://www.kaufmanhall.com/insights/blog/financial-literacy-leadership-prerequisite

In last month’s blog, we discussed the importance of financial planning, both for internal audiences—including the leadership team and the board of trustees—and for external audiences—including prospective students and their families, rating agencies, alumni and other stakeholders. This month, in the first of a series of blogs focused on key finance-related issues, we’re turning our attention to a broader and deeper internal audience, asking the question, “What is your institution’s financial literacy?”

The terms described in this blog will be very familiar to members of college and university finance teams and to many institutional leaders as well.

The point is that these terms should be familiar to as many individuals as possible throughout the institution: they form the foundation of a basic financial literacy that every college and university should foster across its faculty and staff.

What is financial literacy?

Financial literacy is the ability to understand where an institution stands at any given time with respect to key elements of its balance sheet and income statement. To state it simply, financial literacy means an understanding of the vital signs that describe the financial health of the institution. In medicine, the basic vital signs are body temperature, pulse rate, respiration rate, and blood pressure. In finance, the vital signs include measures of unrestricted cash, revenue, expenses, debt, and risk.

In medicine, there are professionals whose job is to dig deeper if any of the body’s vital signs are deteriorating. Similarly in finance, it is the job of the CFO and finance team to monitor the vital signs of the institution’s financial health and to seek causes and solutions of current troubles or to use changes in the vital signs to address potential future issues. For most of us—in medicine or finance—the goal should be a basic understanding of what the vital signs measure and whether they point to good health.

There are some key considerations for each financial vital sign:

  • Unrestricted Cash. The critical question related to unrestricted cash (also termed liquidity) is whether the institution has enough accessible liquidity to meet its daily expenses if its cash flow was unexpectedly interrupted. Days cash on hand is a balance sheet metric that is typically used to assess this issue: days cash on hand literally measures how long unrestricted cash reserves could cover the institution’s operating costs if its cash flow suddenly stopped. 

    The emphasis on “accessible liquidity” is an important element of this financial vital sign: it speaks to the ability to distinguish between institutional wealth versus liquidity. In higher education, an endowment can be an important source of the institution’s wealth, but many of the funds within an endowment cannot be easily accessed—they are, by and large, not liquid funds or are highly restricted as to their use. Readily available, unrestricted cash reserves are what an institution must rely on to meet its day-to-day expenses should cash flow be interrupted or reduced.
     
  • Revenue. Because an institution needs to maintain or grow its cash reserves and allocate them sparingly, the amount of revenue coming in—from tuition and fees and from other sources of additional income (see below)—is also an important vital sign. An institution should obviously be taking in enough revenue to cover its expenses without drawing on its cash reserves. 

    Additionally, however, given continued growth in expenses, revenue growth (through enrollment growth, student mix, and/or program mix) is a significant measure of ongoing vitality.

    Financial health is also enhanced if an institution does not rely too heavily on a single revenue source. For schools with an endowment, for example, the amount of income the endowment can generate to support operations is an important source of additional income. More generally, additional income can come from such auxiliary revenue sources as residential fees, fundraising, special events, concessions, and a host of other sources. These additional revenue sources, while potentially small on an individual basis, can be material on a cumulative basis.
     
  • Expenses. How much does it cost to produce the education that a college or university provides to its students? If that cost is approaching—or worse, surpassing—the net tuition revenue and additional income that the institution brings in, what is being done—or could be done—to reduce those costs? Expenses are perhaps most similar to body temperature in medical vital signs; if they get too high, they must be brought down before the health of the institution begins to decline. And the measure of expenses should be viewed overall for the institution as well as on a per student basis to communicate the “value” of different student types to the organization.
     
  • Debt. Debt is an essential component of the funding of significant capital projects that colleges and universities must undertake to maintain updated and competitive facilities. Just as most people need to take out a mortgage to afford a home purchase—spreading the cost of the home over a multiyear payment period—so too do institutions often need debt to finance large capital expenditures. But the amount of debt (also termed “leverage”) can also be an indicator of the institution’s financial health. That health begins to decline if the amount of debt relative to an institution’s assets or annual income grows too large, or if the amount required to pay for the debt (i.e., to meet the scheduled principal and interest payments—the debt service) puts too much of a burden on the cash flow generated from the institution’s day-to-day operations. If the debt service becomes too high relative to cash flow, the institution may face onerous legal requirements, or even default, which may severely constrain its ability to provide the range of programs desired and expected by its student population.
     
  • Risk. Risk is an indicator that identifies potential weaknesses in any of the preceding indicators that could jeopardize the institution’s financial health. For basic financial literacy, only the most significant risks need to be identified: over-reliance on tuition revenue in a market with declining enrollments, for example, or over-reliance on endowment income in the event of market instability. Once an institution consistently measures its risks, it can begin to determine what level of risk is appropriate and address strategies to manage that risk.

Why does financial literacy matter?

Promoting financial literacy throughout an institution cultivates a common understanding of financial health that provides context for leadership’s decisions and a common language to address issues. If tuition revenue is declining, for example, financially literate faculty members should better understand the need to prioritize academic programs that not only meet the academic needs of their students, but also can draw more students or produce healthier margins. If cost-cutting measures are required to reduce expenses, financially literate staff should understand the genesis of the need for reductions and why the institution cannot simply draw on its endowment to close the gap. Furthermore, acknowledging and describing the most significant risks an institution faces using a common language makes clear the need for action if one or more of those risks begins to materialize.

Financial literacy is also an important tool for cultivating the next generation of faculty leaders. When faculty members rise to leadership positions, it is essential that they understand that academic growth and strategic initiatives cannot succeed without sufficient resources to support them, or if they cannot generate the revenue needed to cover—or exceed—their costs.

By promoting financial literacy across the institution, the institution can help ensure that future leaders are acquiring the foundation needed for them to grow into informed decision-makers who understand the need to maintain the institution’s financial health.

Fitch says lower operating margins may be the new normal for nonprofit hospitals

Posted on by • Posted in Credit Downgrade, Credit Quality, Credit Ratings, Debt Capacity, Debt Levels, Debt Service, Debt Service Coverage Ratio, Financial Reserves, Financial Stewardship, Financial Strength, Financial Viability, Financially Distressed, Health System, Hospital, Hospital Industry, Operating Expenses, Operating Income, Operating Margin, Operating Margin Drivers, Operating Performance, Operating Revenue, Outpatient Migration, Strategic Imperative • Leave a comment

https://mailchi.mp/09f9563acfcf/gist-weekly-february-2-2024?e=d1e747d2d8

On Monday, Fitch Ratings, the New York City-based credit rating agency, released a report predicting that the US not-for-profit hospital sector will see average operating margins reset in the one-to-two percent range, rather than returning to historical levels of above three percent. 

Following disruptions from the pandemic that saw utilization drop and operating costs rise, hospitals have seen a slower-than-expected recovery.

But, according to Fitch, these rebased margins are unlikely to lead to widespread credit downgrades as most hospitals still carry robust balance sheets and have curtailed capital spending in response. 

The Gist: As labor costs stabilize and volumes return, the median hospital has been able to maintain a positive operating margin for the past ten months. 

But nonprofit hospitals are in a transitory period, one with both continued challenges—including labor costs that rebased at a higher rate and ongoing capital restraints—and opportunities—including the increase in outpatient demand, which has driven hospital outpatient revenue up over 40 percent from 2020 levels.

While the future margin outlook for individual hospitals will depend on factors that vary greatly across markets, organizations that thrive in this new era will be the ones willing to pivot, take risks, and invest heavily in outpatient services.

Three Must-Haves for Every Rating Presentation

Posted on by • Posted in Board, Bond Default Risk, Bond Rating, Bond Rating Agency, CFO, Credit Quality, Credit Rating Committee, Credit Rating Process, Credit Ratings, Debt Capacity, Debt Covenant Default, Debt Default, Debt Issuance, Debt Levels, Debt Service Covenants, Debt Service Coverage Ratio, Health System, Hospital, Hospital Industry, Key Credit Metrics, Key Metrics, Key Performance Indicators, Key Ratios, Leverage, Non-Recurring Revenue or Expenses, Operating Expenses, Operating Income, Operating Margin, Operating Margin Drivers, Operating Metrics, Operating Performance, Operating Revenue • Leave a comment
https://www.kaufmanhall.com/insights/blog/three-must-haves-every-rating-presentation?utm_source=mkto&utm_campaign=lisa-blog&utm_medium=em&utm_term=240213&mkt_tok=NjU0LUNOWS0yMjQAAAGRQfSwr9Ko8xY6xvplhP7oPiD8w2ozAvGxvApt5QPNxC39ZC_Wh1AETTXmy-uVnpveuYHzTdZfqDA7hLAOqMLHgwjovy2d0UA1ZrKhjC70Odi5

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.

Inside Rating Committee: Five Things to Know

Posted on by • Posted in CEO, CFO, Credit Quality, Credit Rating Committee, Credit Rating Process, Credit Ratings, Debt Capacity, Debt Service, Debt Service Covenants, Debt Service Coverage Ratio, Debt Structure, Debt Swap, Health System, Hospital, Hospital Industry, Investment Banking • Leave a comment
https://www.kaufmanhall.com/insights/blog/inside-rating-committee-five-things-know?utm_source=mkto&utm_campaign=lisa-blog&utm_medium=em&utm_term=230816&mkt_tok=NjU0LUNOWS0yMjQAAAGNnaAfQ4HxVh8e0sc5F8PmNxGh2e1V8weDyXipzBIVnLL5LzUR1VYmjhi3ii6i_oTv2W6o4VwtoMExlHJBWj0BzJXcVLwcuQL8QCtWH_IxwFSI

Rating agencies have done a great job in increasing transparency around how ratings are determined. Detailed methodologies, scorecards, and medians are a big part of that effort.

Central to the rating process is the rating committee. All rating decisions are made by a rating committee, not an individual. The rating committee provides a robust discussion of various viewpoints as it deliberates, votes, and assigns ratings to the debt instrument.

Here are five things to know about what happens in a rating committee.

1. Rating committees are presided over by a Rating Committee Chair.

The Chair’s primary responsibility is to check that the committee follows numerous processes that meet company and SEC-mandated guidelines. For example, the Chair must verify that the correct methodology is being used to determine the rating, or if a rating requires additional methodologies (such as short-term rating methodologies on variable rate debt). The Chair must confirm that the rating decision will be based on verifiable facts or assessments (such as an audit) and that voting members are free of conflicts. Committees can be subject to internal and external reviews after the fact to ensure that decisions were made impartially and documented correctly.

The Chair ensures that the committee is populated with voting members who possess in-depth knowledge about the sector or related-credit knowledge (such as a higher education analyst in the case of an academic medical center) and are skilled in credit assessment. Each voting member has one vote and an equal vote. Serving as a voting member of a rating committee or as a Chair is a privilege and must be earned.

2. The rating committee discussion centers around the ability of a borrower to repay its obligations, or said another way, the likelihood of payment default.

As such, debt structure is integral to the rating committee. Detailed information provided in the committee package will include information on outstanding and proposed debt (if a bond financing is imminent), debt structure risks (fixed versus variable, for example), debt service schedule (level payments or with bullets), maturities and call dates, taxable and tax-exempt debt, bank lines and revolvers, counterparty risk and termination events, derivative products such as interest rate swaps and collateral thresholds, senior-subordinate debt structures, bond and bank covenants, obligated group, and security pledge, to name a few. Leases and pension obligations are also considered, particularly when liabilities outsize the direct debt.

Rating committees review hundreds of financial metrics to assess recent financial performance and an organization’s ability to pay debt in the future. Audited financial statements, year-to-date results, and annual budgets and projections are the basis for computing the financial ratios. Non-quantitative factors include success with past strategies and capital projects, market position and essentiality, management, governance and corporate structure, workforce needs, and local economic data. Confidential information provided by the organization is also shared. The job of the lead analyst is to distill all the information and present an organized credit story to the rating committee.

3. Rating consistency is paramount.

An “A” should be an “A” should be an “A.” Comparables (or “comps”) are an important part of the rating committee. Comps may include the other hospitals and health systems operating in the same state given shared Medicaid and state regulations (such as Certificate of Need or state-mandated minimum wage), workforce environment (such as the presence of active unions), and similar economic factors. Like-sized peers in the same rating category also populate comps. The type of hospital being evaluated is also important. For example, health systems that own health plans would be compared to other integrated delivery systems; likewise for children’s hospitals, academic medical centers, or subacute care providers. Medians are also a part of the comps and provide relativity to like-rated borrowers by highlighting outliers.

4. Rating committee spends time reviewing the draft report to make sure the committee’s views are accurately expressed and check that confidential information was not inadvertently revealed. If you want to know what was discussed in the rating committee, read the last rating report.

Over the years, many executives have asked to speak directly to the rating committee. While that is not possible, you can bring your voice to the discussion with an informative, well-crafted rating presentation. That brings me to my final “inside rating committee” point.

5. Rating presentations matter.

Effective, informative presentations that encapsulate your organization’s strengths will be shared with the rating committee. Every slide in your presentation should send a clear message that the organization’s ability to repay the debt and exceed covenants is strong. Emphasize the positives, acknowledge the challenges, and share what your action plan is to address them. Do your homework and review what you shared with the analysts last year; they will be doing the same to prepare. Provide updates on how the strategic plans are going. If you exceeded your financial goals, explain how. If you fell short, explain why.

How you tell the story is as important as the story itself. That’s how you can inform the discussion and ensure your voice is heard around the rating committee table.

Unlocking Value in Non-Core Healthcare Assets

Posted on by • Posted in Capital Formation, Capital Structure, Cash, Cash Reserves, Days Cash on Hand, Debt Capacity, Debt Service Covenants, Debt Service Coverage Ratio, Health System, Hospital, Hospital Industry, Liquidity, Non-Core Assets, Non-Core Services • Leave a comment

Click to access Industry_Insights_6.1.23.pdf

Inflation, labor pressures, and general economic uncertainty have created
significant financial strain for hospitals in the wake of the COVID pandemic.
Compressed operating margins and weakened liquidity have left many
hospitals in a precarious economic situation, with some entities deciding to delay or even cancel planned capital expenditures or capital raising. Given these tumultuous times, hospital entities could look to the realm of the higher education sector for a playbook on how to leverage non-core assets to unlock significant unrealized value and strengthen financial positions, in the form of public-private partnerships.


These structures, also known as P3s, involve collaborative agreements between public entities, like hospitals, and private sector partners who possess the expertise to unlock the value of non-core assets. A special purpose vehicle (SPV) is created, with the sole purpose of delivering the responsibilities outlined under the project agreement. The SPV is typically owned by equity members. The private sector would be responsible for raising debt to finance the project, which is secured by the obligations of the project agreement (and would be non-recourse to the hospital). Of note, the SPV undergoes the rating process, not the hospital entity. Even more importantly, the hospital retains ownership of the asset while benefiting from the expertise and resources of the private sector.


Hospitals can utilize P3s to capitalize on already-built assets, in what is known as a “brownfield” structure. A brownfield structure would typically result in an upfront payment to the hospital in exchange for the right of a private entity to operate the asset for an agreed-upon term. These upfront payments can range from tens of millions to hundreds of millions of dollars.


Alternatively, hospitals can engage in “greenfield” structures where the underlying asset is either not yet built or needs significant capital investment. Greenfield structures typically do not result in an upfront payment to the hospital entity. Instead, (in the example of a new build) private partners would typically design, build, finance, operate and maintain the asset. The hospital still retains ownership of the underlying asset at the completion of the agreed upon term.


P3 structures can be individually tailored to suit the unique needs of the hospital entity, and the resulting benefits are multifaceted. Financially, hospitals can increase liquidity, lower operating expenses, increase debt capacity, and create headroom for financial covenants. These partnerships provide a means to raise funds without directly accessing the capital markets or undergoing the rating process. Upfront payments represent unrestricted funds and can be used as the hospital entity sees fit to further its core mission. Operationally, infrastructure P3s offer hospitals the opportunity to address deferred maintenance needs, which may have accumulated over time. Immediate capital expenditure on infrastructure facilities can enhance reliability and efficiency and contribute to meeting carbon reduction or sustainability goals. Furthermore, these structures provide a means for the hospital to transfer a meaningful amount of risk to private partners via operation and maintenance agreements.


For years, various colleges and universities have adopted the P3 model, which is emerging as a viable solution for hospitals as well.
Examples of recent structures in the higher education sector include:

  • Fresno State University, which partnered with Meridiam (an infrastructure private equity fund) and Noresco (a design builder) to
    deliver a new central utility plant. The 30-year agreement involved long-term routine and major maintenance obligations from
    the operator, with provisions for key performance indicators and performance deductions inserted to protect the university.
    Fresno State is not required to begin making availability payments until construction is completed.
  • The Ohio State University, which secured a $483 million upfront payment in exchange for the right of a private party to operate
    and maintain its parking infrastructure. The university used the influx of capital to hire key faculty members and to invest in their
    endowment.
  • The University of Toledo, which received an approximately $60 million upfront payment in exchange for a 35-year lease and
    concession agreement to a private operator. The private team will be responsible for operating and maintaining the university’s
    parking facilities throughout the term of the agreement.

  • Ultimately, healthcare entities can learn from the successful implementation of infrastructure P3 structures in the higher education sector. The experiences of Fresno State, The Ohio State University, and the University of Toledo (among others) serve as compelling examples of the transformative potential of P3s in the healthcare sector. By unlocking the true value of non-core assets through partnerships with the private sector, hospitals can reinforce their financial stability, meet sustainability goals, reduce risk, and shift valuable focus back to the core mission of providing high-quality healthcare services.

  • Author’s note: Implementing P3 structures requires careful consideration and expert guidance. Given the complex nature of these partnerships, hospitals can greatly benefit from the support of experienced advisors to navigate the intricacies of the process. KeyBank and Cain Brothers specialize in guiding entities through P3 initiatives, providing valuable expertise and insight. For additional information, please refer to a recording of our recent webinar and associated summary, which can be accessed here:
    https://www.key.com/businesses-institutions/business-expertise/articles/public-private-partnerships-can-unlock-hospitals-hiddenvalue.html

Financial Reserves and Credit Management

Posted on by • Posted in Credit Management, Credit Quality, Credit Ratings, Days Cash on Hand, Debt Capacity, Debt Issuance, Debt Service, Debt Service Covenants, Debt Service Coverage Ratio, Financial Reserves, General Obligation Bonds, Health System, Hospital, Hospital Industry, Municipal Debt, Revenue-backed Municipal Bonds • Leave a comment

Click to access KH_AHA-Essential-Role_Financial_Reserves_Not-for-Profit_Healthcare_2023-04.pdf

For large capital projects—construction of a new cancer
treatment center, for example, or replacement of an
aging facility—issuance of municipal debt is one of the
most affordable ways for not-for-profit hospitals and
health system to finance the project.

The affordability of that debt is, however, partly contingent on the
organization’s ability to maintain a strong credit rating,
and financial reserves—again measured as Days Cash on
Hand—are a significant component of that credit rating.


There are two basic forms of municipal debt:


Ÿ General obligation bonds are backed by the full
taxing power of the issuing municipal authority and
are considered relatively low risk. Hospitals that are
owned by a city or county can be funded by general
obligation bonds, although there are practical
limitations on their ability to issue these bonds,
including in many instances the need to obtain voter
or county commissioner approval. Organizations

without municipal ownership—including most
not-for-profit hospitals and health systems—
cannot issue general obligation bonds.


Ÿ Revenue-backed municipal bonds are backed by
the ability of the organization borrowing the debt
to meet its obligation to make principal and interest
payments through the revenue it generates over the
life of the bond. Because revenues can be disrupted
by any range of factors, revenue-backed bonds are
higher risk for investors. Most healthcare bonds
are revenue-backed municipal bonds.


When determining whether to invest in revenue-backed
municipal healthcare bonds, investors will look to the
credit rating of the hospital or health system that is
borrowing the debt. Credit ratings—issued by one or
more of the three major credit rating agencies (Fitch
Ratings, Moody’s Investors Service, and S&P Global
Ratings)—provide an assessment of the probability

that the hospital or health system will be able to meet
the terms of the debt obligation. These ratings are
tiered. A credit rating in the AA tier is better than a credit
rating in the A tier, which is better than a rating in the
BBB tier. Ratings below the BBB tier are considered sub-investment grade.

Organizations with a sub-investment
grade rating can still access various forms of debt,
but the amount of debt they can access generally will
be lower, the cost of the debt will be higher, and the
covenants that lenders require will be more stringent
than for investment-grade rated organizations.


Financial reserves and credit ratings


Days Cash on Hand is one of the most important factors
credit rating agencies use because it is an indicator
of how long the rated organization could withstand
serious disruption to its operations and cashflow.
The rating agencies issue median values for the various
metrics they use to determine credit ratings. Median

values for Days Cash on Hand increased significantly
across most rating categories for all three agencies
in 2020 and 2021; this reflects the temporary inflow
of pandemic relief funding through, for example,
the Coronavirus Aid, Relief, and Economic Security
(CARES) Act.


We anticipate these medians will move
closer to pre-pandemic levels as relief funds are
exhausted and hospitals repay remaining balances
on Medicare’s COVID-19 Accelerated and Advanced
Payment (MAAP) program funds. But even before
the pandemic, organizations in 2019 had a median
Days Cash on Hand of 276 to 289 days at the AA level,
173 to 219 days at the A level, and 140 to 163 days at
the BBB level.


In other words, the Days Cash on Hand
benchmark for organizations seeking to maintain an
investment-grade rating would be well over 100 Days
Cash on Hand, and well over 200 Days Cash on Hand for
organizations seeking to achieve a higher rating level.
Again, these reserves are proportionate to the operating
expenses of the individual hospital or health system.

Impact of credit ratings on access to capital


Organizations that can achieve a higher rating can
also borrow money at more affordable interest
rates. Figure 3 shows average interest rates for
municipal bonds across a range of maturities as of
mid-December 2022 (maturity is the term in years
for repayment of the bond at the time the bond is
issued). Lower-risk general obligation municipal bonds
are shown as the baseline, with lines for AA, A, and
BBB rated healthcare revenue-backed bonds above
it. As a reminder, most hospitals and health systems
cannot borrow money using general obligation bonds;
instead, they use higher-risk revenue-backed bonds.
Because revenue-backed bonds are a higher risk for
investors than tax-based general obligation bonds,

even hospitals and health systems with a strong
AA credit rating will pay a higher interest rate than
would a city or county that could back repayment of
the bond with tax revenues (see the line for AA rated
Healthcare Revenue Bonds compared to the line
for AAA rated General Obligation bonds). But there
is also a significant gap between the interest rate a
hospital with an AA credit rating would pay compared
to the interest rate available to a hospital with a lower
BBB rating. Here, the difference is approximately
three-fourths of a full percentage point. When the
amount borrowed for a major new hospital project
can run into the hundreds of millions of dollars,
that difference represents significant savings for
organizations with a higher credit rating.

Financial reserves and debt capacity


Financial reserves and the funds they generate—
including investment income—also help define an
organization’s debt capacity: essentially, the amount of
debt an organization can assume without jeopardizing
its current credit rating. There are two key ratios here:


Ÿ The first is total unrestricted cash and investments
to debt. In general, the more favorable that ratio is,
the more latitude a hospital or health system has to
take on additional debt, especially if the organization
is toward the middle to top end of its rating tier.

Ÿ The second is the debt service coverage ratio,
which measures the organization’s ability to
make principal and interest payments with funds
derived from both operating and non-operating
(e.g., investment income) activity. A higher ratio
here means the organization has more funds
available to service debt.


The ability to assume additional debt is an important
safety valve if, for example, an organization needs to
mitigate poor financial performance to fund ongoing
capital needs or strategic initiatives.

KEY TAKEAWAYS

Not-for-profit hospitals and health systems often
borrow debt through revenue-backed municipal
bonds, meaning that the debt obligations will be
met by the revenue the organization generates
over the life of the bond.


Ÿ Because revenue-backed bonds are higher
risk than general obligation bonds backed by a
municipality’s taxing authority (revenues can
be disrupted), investors seek assurance that an
organization will be able to meet its obligations.


Ÿ Credit ratings offer investors an assessment of
an organization’s current and near-term ability to
meet these obligations.

Ÿ Days Cash on Hand is an important metric in
assessing the organization’s credit rating, and a
higher rating generally requires a higher number of
Days Cash on Hand.


Ÿ A higher credit rating allows organizations to
borrow money at more affordable interest rates.


Ÿ A higher level of financial reserves and investment
income in relation to existing debt obligations also
increases an organization’s debt capacity, creating
an important safety valve if an organization has
to borrow money to mitigate poor operating or
investment performance.