Your hospital has a major capital project coming up and as CFO, you are asked to look at different ways to fund it: borrow all you can to preserve liquidity, take on less debt and use cash instead, maybe even shrink project size. How will each scenario affect your bond ratings and cost of funds? A private rating could provide the answer.
Your hospital has a major capital project coming up and as CFO, you are asked to look at different ways to fund it: borrow all you can to preserve liquidity, take on less debt and use cash instead, maybe even shrink project size. How will each scenario affect your bond ratings and cost of funds? A private rating could provide the answerRatings have become a major preoccupation for many healthcare borrowers, and for good reasons. The difference between rating notches can mean millions of dollars in additional interest expense. In some cases, being on the wrong side could even mean losing access to attractive financing structures (see July 2010 article What’s In Your Rating?).
As financial advisers, we are often asked by hospitals and health systems to estimate the impact of a specific financing scenario on ratings. It’s not easy. Everybody can build a credit model, but ratings involve much more than financial ratios. Qualitative factors usually play a large role and can be tricky to factor into the final rating analysis.
Mindful of the fact that some borrowers may need help when evaluating the impact of funding structures, a couple of the rating agencies offer rating evaluation and credit assessment services, also known as private ratings.
A private rating provides a written, confidential estimate of the expected impact of a given financial transaction on the borrower’s rating. The process usually involves a site visit, meeting with management, and a formal credit review covering financial position, project description, sources and uses, type of debt, etc. A full committee is convened and a letter issued. At that point, the hospital can decide what’s next. If the decision is to hold off, the rating is kept confidential. If it’s a go, the rating can be made public. This is different from the traditional rating process where once a committee has been convened, the rating is published whether the hospital likes it or not.
The additional cost of a private rating is usually minimal and is a function of the number of scenarios being evaluated. The hospital gets credited for a portion of the fees if a rating is published based on one of the scenarios already reviewed.
Transparency having become a hot issue in the municipal markets lately (see Feb 2011 article Is Your Hospital Bond Disclosure Up To Snuff?), the SEC has proposed rules to make rating disclosure mandatory, but so far that hasn’t gone anywhere. Nevertheless, some underwriters’ counsels have decided that private ratings should be disclosed in official statements, so this ought to be brought up in the financing team selection process to avoid any surprises later on.
A private rating is not for everyone, but can make sense in situations where a project is large enough to create the possibility of a downgrade, when access to the markets is already a concern, and any time bond ratings are of particular strategic importance. The price is usually right, and the hospital gets valuable insights on how each scenario will affect ratings and the resulting cost of debt. More importantly, the outcome can be reserved until the hospital is ready to move forward.