Moody's Watching Hospitals' Debt Structure

CHICAGO - A nonprofit hospital's debt structure - particularly its variable-rate debt exposure and associated liquidity risks - is one of several credit factors that Moody's Investors Service will pay special attention to in 2009, the rating agency said in a report released yesterday.

Moody's identified three factors that pose particular risks as hospitals struggle with declining finance. According to the report, titled "Not-for-Profit Healthcare Rating Roadmap: Hospitals Under Stress, but Strong Management and Federal Stimulus May Mitigate Risks," the factors are debt structure; weaker market demand and declining cash flow margins; investment losses and weaker balance sheets; and problems accessing the capital market,

"This is meant to provide some guidance and transparency to investors and hospitals as to when we may move forward with a rating review and when we may wait," said analyst Lisa Goldstein, chief author of the report.

"These are four risk factors we are paying more attention to in 2009 given the economic realities that we're all facing," Goldstein said. "They have also been factors in some of the downgrades we've had that have been at elevated levels in the fourth quarter of 2008 and first quarter of 2009."

Moody's, like Standard & Poor's and Fitch Ratings, maintains a negative outlook on the nonprofit health care sector, which is especially vulnerable to fallout from the economic downturn.

The higher the share of variable-rate debt in a hospital's portfolio, the more risks facing the issuer, Moody's said. Variable-rate debt means increased bank renewal risks for the liquidity such debt needs, interest rate risks, accelerated repayment risks, and counterparty risks, according to Goldstein.

"VRDO is a real concern in 2009," she said.

For double-A rated hospitals, Moody's looks for no more than 50% variable-rate debt in its portfolio; for A-rated hospitals, no more than 35%; and for Baa-rated credits, no more than 20% variable-rate debt, according to the report.

An increasing number of fiscally stressed hospitals have come close to violating covenants in bank agreements, though only a few have actually defaulted so far, Goldstein said. A default could trigger an accelerated payment schedule by a bank.

"At this point we haven't seen any banks accelerate their payment schedules, but there are many hospitals that are in heavy negotiations," she said.

Hospitals with limited "headroom" under their bank covenants could face rating or outlook pressure, Moody's said 50% chance of covenant violation could result in a one-notch downgrade depending on the severity of the consequences of the violation, Moody's said.

"If that risk increases to a 90% chance of a covenant violation, we may downgrade the rating closer to where it would be after acceleration [of a payment schedule]," the agency said. "In the event of an actual acceleration by the bank, the rating impact may be very severe, with a downgrade well into the below-investment grade categories."

Hospitals often refinance their debt to avoid some of the risks associated with variable-rate debt, but that could be difficult amid lack of interest among many traditional health care investors, especially for lower-rated hospital credits. Higher-rated hospitals that have been able to enter the market with fixed-rate debt have found themselves facing higher costs than in previous years.

Strong management can offset many of these risks. Some issuers, for example, are trying a number of strategies to preserve liquidity, including securing commercial bank credit for capital needs, terminating interest-rate swaps, and amending standby bond purchase agreements to shed financial guarantors with credit problems, Moody's said.

Hospitals over the next two years can also expect a boost from the American Recovery and Reinvestment Act of 2009, which includes $87 billion in increased federal Medicaid funding, Moody's said.

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Healthcare industry
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