The article below is reprinted with permission from The Capital Issue, a quarterly newsletter published by Lancaster Pollard.
In today’s low interest-rate environment, debt financing should be top of mind for organizations. Efficient access to debt capital is imperative in order to expand and to renovate. One of the most important and often neglected factors when accessing debt capital is maintaining a balanced or well-rounded credit profile, especially between financings.
Organizations with a balanced profile have a greater ability to repay and display a more responsible use of debt; therefore, they are considered less risky to credit-enhancement providers, investors and lenders. Because all of these sources of debt capital balance their risk with interest rates, the more balanced the credit profile, the lower the interest rate on the financing and the lower an organization's cost over time.
Ratios demonstrate financial performance/position and are used in quantitative analyses. These ratios determine the financial fitness of an organization’s capital structure, liquidity position and operations. The most frequently used ratios can be grouped into simple categories and should be viewed in concert as a target. The closer an organization's ratios are clustered around the bull's-eye, the more balanced or "fit" the credit profile. These key categories for assessing credit worthiness are:
Liquidity — Liquidity is of paramount importance to all sources of debt capital today. It has become especially important to healthcare providers as it defines the strength of an organization's safety net underneath the uncertainty of healthcare reform. An example of balance-sheet liquidity is the days-cash-on-hand ratio. For example, an investment-grade-rated, senior-living provider should target 350 days or more while hospitals should focus on greater than 150 days.
Profitability — This category defines the success of an organization's operations, specifically on its ability to drive revenue and control expenses. Operating-margin and debt-service coverage are examples of profitability ratios. To sources of debt capital, they define an organization's ability to repay. An investment-grade-rated, senior-living provider should target a 2.0 percent margin and 2.0 times the coverage while hospitals should focus on a 1.5 percent margin and greater than one-and-a half times coverage.
Capital Structure — Ratios, such as debt to capitalization and cash to debt, show how responsible an organization is with debt by comparing their debt load to total capitalization or their cash position. An investment-grade-rated, senior-living provider should target 60 percent or less debt to capitalization and 50 percent or greater cash to debt, while hospitals should focus on 50 percent or less debt to capitalization and 80 percent or greater cash to debt.
The closer an organization's ratios are clustered around the bull’s-eye, the more balanced or "fit" the credit profile.
Qualitative factors, such as the economy, local market demographics, competition and an organization's management and board, also play an important role in credit assessment. Case in point, an organization in a rural area may have difficulty in accessing capital even though it has strong financial ratios. Or, on the other hand, qualitative analysis of an organization's long-term viability may be strong enough to allow it to access capital at a lower cost despite its mediocre quantitative profile.
Maintain a strong anchor: Building and maintaining balance sheet liquidity is highly valued by the capital markets today. A strong balance sheet anchors a well-rounded credit profile especially in these uncertain times. Many organizations, particularly non-profits, are wary of taking on debt, but instead spend down cash reserves to fund capital projects. If you know you have a large project on the horizon, consider borrowing to complete near-term projects, so you can maintain or increase liquidity in advance of a larger financing. A strong liquidity position and, in turn, a more balanced profile will attract more favorable terms on that future financing.
Quality matters: Organizations, in general but particularly in the healthcare industry, are seeing a proliferation of campaigns for quality and accountability and the financial markets take note. External reports from state or other agencies as well as internal reports often provide actionable commentary. Act on these recommendations. Show creditors strategic efforts to improve quality and you show them the discipline and commitment that they need to see to understand you as a competitive, financially reliable facility. Most importantly, quality outcomes will be monitored under healthcare reform and will directly affect an organization's reimbursement. Finally, organizations that embrace technology can improve outcomes and lower the cost of care.
Monitor the market: Staying abreast of current financing structures and available interest rates can reveal ways to improve your existing debt structure. Lowering debt service through a refinance will provide cash-flow savings which can be used to improve balance sheet ratios. In addition, strategically restructuring debt can mitigate future risk inherent in your old debt structure, such as bank-downgrade risk in a letter-of-credit structure.
Frequently assess and improve: Most elements of the credit profile are indirectly monitored as part of good business strategy. However, running a ratio analysis quarterly as well as an assessment of qualitative goals will keep an organization on track and, more importantly, keep one from becoming too imbalanced, especially between financings. Assessing the whole of your credit profile and acting on imbalances promotes continuous improvement. Large imbalances will be impossible to quickly correct if neglected until financing is desired.
Communicate well: Finally, be sure that management can articulate the organization's strengths and explain any weaknesses. This becomes particularly important within organizations that have leadership transitions either at the management or board level. New leadership should understand prior years' financial situations and be able to explain any dips or improvements in performance.
Senior leadership should view financial performance as a profile, not as segregated attributes. The ability to afford long-term debt is determined by decisions made during the strategic planning process, not when a financing need arises. Making decisions in that context will help you maintain a well-rounded credit profile, which will not only allow access to more attractive capital when taking on debt, but inherently promote a more stable and financially healthy organization.
Chris BlandaChris Blanda is a vice president with Lancaster Pollard Columbus. He may be reached at cblanda@lancasterpollard.com.
Mission Possible: Finding Capital for Standalone Hospitals
2012 U.S. Interest Rate Outlook
In today’s low interest-rate environment, debt financing should be top of mind for organizations. Efficient access to debt capital is imperative in order to expand and to renovate. One of the most important and often neglected factors when accessing debt capital is maintaining a balanced or well-rounded credit profile, especially between financings.
Organizations with a balanced profile have a greater ability to repay and display a more responsible use of debt; therefore, they are considered less risky to credit-enhancement providers, investors and lenders. Because all of these sources of debt capital balance their risk with interest rates, the more balanced the credit profile, the lower the interest rate on the financing and the lower an organization's cost over time.
Taking measure
An organization's credit profile or financial health is the most important factor in determining its cost of capital. Rating agencies, credit-enhancement providers, investors and lenders evaluate both quantitative and qualitative factors when measuring an organization's credit strength. Quantitative factors define a borrower's ability to repay debt, which places a borrower within a broad credit range. Qualitative factors supplement quantitative measures to determine long-term financial viability, which further defines an organization's place within the credit range. Credit analysis is considered both science and art.Ratios demonstrate financial performance/position and are used in quantitative analyses. These ratios determine the financial fitness of an organization’s capital structure, liquidity position and operations. The most frequently used ratios can be grouped into simple categories and should be viewed in concert as a target. The closer an organization's ratios are clustered around the bull's-eye, the more balanced or "fit" the credit profile. These key categories for assessing credit worthiness are:
Liquidity — Liquidity is of paramount importance to all sources of debt capital today. It has become especially important to healthcare providers as it defines the strength of an organization's safety net underneath the uncertainty of healthcare reform. An example of balance-sheet liquidity is the days-cash-on-hand ratio. For example, an investment-grade-rated, senior-living provider should target 350 days or more while hospitals should focus on greater than 150 days.
Profitability — This category defines the success of an organization's operations, specifically on its ability to drive revenue and control expenses. Operating-margin and debt-service coverage are examples of profitability ratios. To sources of debt capital, they define an organization's ability to repay. An investment-grade-rated, senior-living provider should target a 2.0 percent margin and 2.0 times the coverage while hospitals should focus on a 1.5 percent margin and greater than one-and-a half times coverage.
Capital Structure — Ratios, such as debt to capitalization and cash to debt, show how responsible an organization is with debt by comparing their debt load to total capitalization or their cash position. An investment-grade-rated, senior-living provider should target 60 percent or less debt to capitalization and 50 percent or greater cash to debt, while hospitals should focus on 50 percent or less debt to capitalization and 80 percent or greater cash to debt.
The closer an organization's ratios are clustered around the bull’s-eye, the more balanced or "fit" the credit profile.
Qualitative factors, such as the economy, local market demographics, competition and an organization's management and board, also play an important role in credit assessment. Case in point, an organization in a rural area may have difficulty in accessing capital even though it has strong financial ratios. Or, on the other hand, qualitative analysis of an organization's long-term viability may be strong enough to allow it to access capital at a lower cost despite its mediocre quantitative profile.
5 Tenets of a Well-Rounded Profile
As an organization understands its credit profile, it should be able to determine the best way to leverage its strengths and/or to use strategic enhancements to improve its position on the credit continuum. These five tenets of a well-rounded credit profile will serve to help any organization reach its target of financial fitness:Maintain a strong anchor: Building and maintaining balance sheet liquidity is highly valued by the capital markets today. A strong balance sheet anchors a well-rounded credit profile especially in these uncertain times. Many organizations, particularly non-profits, are wary of taking on debt, but instead spend down cash reserves to fund capital projects. If you know you have a large project on the horizon, consider borrowing to complete near-term projects, so you can maintain or increase liquidity in advance of a larger financing. A strong liquidity position and, in turn, a more balanced profile will attract more favorable terms on that future financing.
Quality matters: Organizations, in general but particularly in the healthcare industry, are seeing a proliferation of campaigns for quality and accountability and the financial markets take note. External reports from state or other agencies as well as internal reports often provide actionable commentary. Act on these recommendations. Show creditors strategic efforts to improve quality and you show them the discipline and commitment that they need to see to understand you as a competitive, financially reliable facility. Most importantly, quality outcomes will be monitored under healthcare reform and will directly affect an organization's reimbursement. Finally, organizations that embrace technology can improve outcomes and lower the cost of care.
Monitor the market: Staying abreast of current financing structures and available interest rates can reveal ways to improve your existing debt structure. Lowering debt service through a refinance will provide cash-flow savings which can be used to improve balance sheet ratios. In addition, strategically restructuring debt can mitigate future risk inherent in your old debt structure, such as bank-downgrade risk in a letter-of-credit structure.
Frequently assess and improve: Most elements of the credit profile are indirectly monitored as part of good business strategy. However, running a ratio analysis quarterly as well as an assessment of qualitative goals will keep an organization on track and, more importantly, keep one from becoming too imbalanced, especially between financings. Assessing the whole of your credit profile and acting on imbalances promotes continuous improvement. Large imbalances will be impossible to quickly correct if neglected until financing is desired.
Communicate well: Finally, be sure that management can articulate the organization's strengths and explain any weaknesses. This becomes particularly important within organizations that have leadership transitions either at the management or board level. New leadership should understand prior years' financial situations and be able to explain any dips or improvements in performance.
Senior leadership should view financial performance as a profile, not as segregated attributes. The ability to afford long-term debt is determined by decisions made during the strategic planning process, not when a financing need arises. Making decisions in that context will help you maintain a well-rounded credit profile, which will not only allow access to more attractive capital when taking on debt, but inherently promote a more stable and financially healthy organization.
Chris BlandaChris Blanda is a vice president with Lancaster Pollard Columbus. He may be reached at cblanda@lancasterpollard.com.
More Articles by Lancaster Pollard:
Guard Against Inflation: Preserving the Purchasing Power of Your AssetsMission Possible: Finding Capital for Standalone Hospitals
2012 U.S. Interest Rate Outlook