Less Restrictive Bond Covenants. Bond documents include covenants, which are the financial compliance
requirements that the borrower must meet on an annual, and sometimes quarterly, basis. For example,
bond covenants frequently define the minimum number of days cash on hand or debt service coverage
ratio that the borrowing organization must maintain. If the organization does not meet the covenants,
the bonds governed by the covenants will be in “technical default,” which has associated consequences.
Covenants can limit an organization’s financial flexibility, for example its ability to respond quickly to an
acquisition opportunity that would reduce to below required levels, at least temporarily, liquidity
indicators, such as days cash on hand. Lower-rated organizations are held to more stringent covenant
standards, which limit their financial and perhaps operating flexibility.
Ability to Be Market Consolidators. A solid credit rating also can provide a major strategic and financial
advantage. Market consolidators are always creditworthy organizations. In the current health care
environment, strong organizations are consolidating markets by acquiring or merging with weaker
competitors that are often no longer able to compete because of a lack of access to cost-effective
capital. Because these organizations can offer excess capital capacity and lower capital costs,
organizations with the highest credit ratings are attractive partners to those with lower ratings.
Nevertheless, smaller hospitals that have strong credit positions will be less dilutive, or perhaps will
even be accretive, to the credit position of larger potential partners. Whether as “consolidator” or
“consolidate,” bringing a strong credit profile to a partnering discussion will favorably impact the
organization’s ability to secure the best possible transaction for its community.
Credit Position Conclusions. Hospitals’ trustees and management teams of smaller hospitals should do
everything possible to preserve the strength of their organization’s credit rating. In the long run,
hospitals are only as strong as their own credit position. This is a “domino environment.” A weak or
deteriorating position can trigger more restrictive bond and bank document covenants, limit flexibility
and access to different types of financing, and increase cost of capital. This results in decreased debt
capacity and more difficult access to debt capital, which ultimately threatens independence. Executives
must avoid knocking over the first domino.
Take Aways Over the next decade, as market changes occur and health reform regulations are defined, the quantification of impacts and risks will be more important than ever for hospitals. Every hospital should assess the expected impact of health reform and market forces on an ongoing basis and develop appropriate response strategies. Preparedness for change by organizations at all credit levels is by itself a competitive advantage. Action Items
1. Using objective market and financial data, accurately assess the hospital’s current strategic and financial position, where it needs to go, and if it has the resources to get there. 2. Through sound financial management, do everything possible to preserve the strength of the hospital’s credit position.
Implications for Smaller Hospitals
The challenge for many small hospitals is whether they have the scale and financial resources needed to
secure a public credit rating. If they do, the next question is whether the public rating they secure is
high enough to be helpful to their capital formation effort. A public rating usually is helpful, but it is not
always necessary. Many of the strategies described throughout this guide involve the use of credit
intermediaries, such as banks, the FHA, or other alternatives, which do not necessarily require a public
rating for access to that financing alternative.
A Guide to Financing Strategies for Hospitals