Unlike consumers who stop rampaging Visigoths by pulling out a credit card, tax-exempt borrowers aren't so fortunate. In their world, where to borrow, how much, and on what terms is determined by bond ratings. Yet in managing ratings, borrowers often focus on key ratios and ignore the qualitative factors that go into the rating process. In doing so, they may end up with a suboptimal rating.
Indeed, a lot rides on a rating. Ratings have become so ubiquitous that most boards use them as scorecards for overall organizational and management performance. In spite of all the fingers pointing to the rating agencies following the subprime mortgage debacle, the municipal debt markets still rely primarily on ratings for pricing and other key terms. A rating not only impacts the cost of debt for both public and private debt, but can dictate what type of debt may be available, such as LOC-backed variable rate debt. This division between the “haves” and the “have-nots” has become more evident for healthcare borrowers in the last couple of years.
At its core, a bond rating is an independent assessment of credit worthiness, or the likelihood that bondholders will be paid back on time. Rating agencies perform this assessment for hundreds of healthcare borrowers based on various quantitative and qualitative factors, and they have no incentive to be overly optimistic.
Quantitative factors are relatively well known components of healthcare ratings. They include liquidity, debt service coverage, leverage, and other key ratios. While some ratios such as days’ cash on hand can buy a lot of time and have a significant impact on a rating, the combined effect of key ratios and other quantitative factors is limited. Periodically, various firms run regression analyses on published municipal healthcare ratings, in the hope that ratios turn out to be good predictors of ratings. They are disappointed to find a coefficient of determination (R-square) in the 0.40 to 0.50 range, meaning that only about half of a rating can be predicted based on quantitative factors.
Qualitative factors are the other half of the story, and their subjectivity introduces mystery and uncertainty to the rating process. Qualitative factors usually include competitive positioning, strategic plan, disclosure, track record, board oversight, management experience and its ability to respond to unforeseen changes. Rating analysts review these areas and make a number of judgment calls. For borrowers interested in looking beyond key ratios and put the qualitative side of a bond rating to work for them, here is some advice:
1. Get The Big Picture -- Rating agencies vary in their outlook, modus operandus, and approach to specific situations. Ask your financial advisor to give you some background on each and help you review any history with prior management, including positives and negatives. The rating process involves a lot of “rearview mirror” driving and to better understand it, you need to have all the pieces.
2. Have A Plan -- Develop a strategic plan for managing your ratings. If there is a large project on the horizon, build a clear and concise business case showing the project is accretive to the organization, from the strategic standpoint at a minimum. Remember that analysts will monitor your progress based on the information you provided, and they don’t like surprises, good or bad. Predictability and consistency are key.
3. Communicate -- Build a rapport with analysts beyond emailing them quarterly statements. An analyst could be dealing with dozens of credits, if you haven’t met or there has been a change in leadership or other major events, go up to New York or schedule a site visit to put a face to a name. If you’re preparing a major announcement, don’t let analysts read about it in the papers, call or email a day or two before.
4. Think Ahead -- Don’t wait to get a dialog going until the preliminary official statement is about to go out. Building relationships and helping an analyst get comfortable with qualitative factors takes time. If you expect to go to market in the next year or two, the time to start the ball rolling is now.
5. Manage With Your Ratings, Not To Them -- A strong rating is great, but should not be an end in itself. Hoarding cash to pump up ratings at the expense of critical capital investments is not the way to go, nor a story you are likely to get past most rating analysts. Analysts want to see a strategic vision and the plan to execute it.
6. Get Expert Help -- In the rating process as with the capital markets in general, it pays to enlist the help of someone experienced with the rating process and your particulars. Your advisor should have direct and recent rating category experience. Getting a lower investment grade hospital upgraded is a significantly more challenging endeavor than getting a single-A rating affirmed.
By their very nature, ratings will always involve some level of subjectivity. Borrowers who recognize this fact and pay attention to the qualitative aspects of the rating process are likely to get a favorable outcome and maximize their access to the debt markets.
This material is intended for general information purposes only and does not constitute legal advice. For legal issues, readers should consult legal counsel. To discuss this article or municipal advisory services, email or call 888-699-4830. HFA Partners, LLC is an Independent Registered Municipal Advisor registered with the Securities and Exchange Commission (SEC) and the Municipal Securities Rulemaking Board (MSRB) under the Dodd-Frank Act of 2010.
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