S&P’s rating action has elicited a variety of angry responses. The agency is being accused of making political judgments rather than economic assessments, and reactions have ranged from asserting that the U.S. will “always be a triple-A country” (President Obama), to proposing incarceration of S&P executives (Michael Moore). While the truth may be found somewhere in between these two extremes, we think responses show a basic lack of appreciation for the rating process.
Rating agencies rate the likelihood that a borrower will make timely debt service payments. Nothing less, nothing more. Making timely payments requires ability and willingness. Ability is obviously a major factor: without sufficient operating cash flows, a hospital will eventually go into default. How quickly is a function of how much cash is on hand, which incidentally is why DCOH is the single largest determinant of bond ratings. But willingness is also critical. Imagine a situation where there is visible disagreement within hospital management about making debt service payments. This may be infrequent, but when it happens, the conservative response from a rating agency will be a negative outlook and/or a downgrade.
Unlike the federal government, most hospitals and health systems don’t usually broadcast that they may skip a few debt payments here and there, so agencies have to take their cues from somewhere else. That’s why when going through the rating process, management must demonstrate internal consensus, including full board support. This point is taken for granted by some hospitals whose executives and board chair never meet or even talk with rating agencies. It also doesn’t hurt to have a sound and clearly articulated business case, although this may unfairly raise the bar on our federal government.
And in the current environment, we would recommend against taking Michael Moore to your next meeting with rating agencies, particularly S&P.
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