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The use of alternative financing products such as bank loans and direct-purchase debt has increased among not-for-profit healthcare providers in the United States. Although there are benefits to using some of these alternative financing products, such as low cost of capital and less traditional “put” risk, we believe it is important to highlight the risks of these new products and reiterate the need for greater transparency to rating agencies and debt markets.
With greater use of these direct-purchase obligations and a more diverse group of banks and financial institutions entering into these types of financings, the terms and covenants in the agreements are less clearly defined and less uniform than many of the traditional documents used in fixed- or variable-rate capital market financing. This situation creates, in our view, the potential for considerable credit risk exposure. Of particular concern to us is the frequent absence of disclosure of these agreements’ existence and their terms in a timely manner, notwithstanding whether privately placed debt carries legal disclosure obligations. Although the impact of the Affordable Care Act is increasing financial pressures on healthcare providers, bank loans with attractive terms should be considered carefully by issuers and disclosed in full whether or not they are on parity with outstanding debt issuance.
Private placements or direct-purchase obligations can have substantial implications for the credit quality of an obligor’s capital market debt. Implications can include, among others, acceleration and the potential for cross–default provisions between privately placed debt and capital market debt. Some documents contain events of default provisions or covenants that, in our view, favor the lender over existing capital market bondholders, and as a result may subordinate the claims of an issuer’s capital market lenders relative to those of the private placement lender, thereby increasing the potential for triggering the financing’s remedies. Combined with cross-default provisions and “most favored nations” clauses, breached covenants and default events could accelerate not only privately placed obligations, but also capital market debt. This effect could in turn create a liquidity crisis for the issuer and potentially have multi-notch negative rating implications.
Disclosure of privately placed debt is critical to the ratings process, because where event-driven risk exists, we evaluate the likelihood of the issuer triggering acceleration, termination payment, or collateral posting requirements. We further assess management’s capacity to respond to these types of liquidity demands, whether through available balance sheet liquidity, capital market access, or lines of credit. We also assess the relationship of the current rating to rating triggers in the covenants, cure periods, and the financing’s other specified terms that define default events. If, in our view, the likely demand on liquidity is high and available liquidity is inadequate to cover repayment risk, we could consider a negative rating action or outlook change. The extent to which management both demonstrates an understanding of the risks that direct-purchase bonds and loans could present and has plans or policies to mitigate them plays an important role in our assessments of the credit quality implications of these types of financings.
We believe that delayed disclosure of any financing does not serve the market well, particularly where the financing’s covenants could pressure liquidity and potentially lead to negative rating implications. This is particularly true for healthcare providers facing new and often unpredictable financial burdens—such providers should be erring on the side of full disclosure and assessment now more than ever.
Martin Arrick is a managing director at Standard & Poor’s Ratings Services.
Martin Arrick is a scheduled feature speaker at ANI 2014: The HFMA National Institute in Las Vegas, June 22-27. His presentation, “The Capital Markets and the Health System Sector,” will address how implementation of the Affordable Care Act and recent trends in the private sector have affected the capital markets’ views of the hospital and health system sector.
Publication Date: Friday, March 28, 2014
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