A proposed accounting rule would shift some debt from non-current to current, and some hospital executives say the change — affecting tens of millions of dollars in some cases — could throw their debt ratios out of whack.
The Financial Accounting Standards Board said the proposed standard, Topic 470, aims to simplify the classification of debt on balance sheets and comes after stakeholders complained that the current method is unnecessarily complex. Essentially, the rule would replace current guidelines with uniform principles for determining debt classification, according to a FASB explainer.
Under the proposal, a letter of credit could no longer be used to classify a type of obligation called floating rate debt as current. Today, VRDOs can be treated as long-term bonds as long as they are remarketed or have long-term letters of credit.
“People look at your business differently when you suddenly have an additional $75 million in current liabilities,” said Jared Grant, senior director of financial reporting for St. Luke’s Health System in Boise, Idaho.
About $75 million of the $900 million in debt offerings reissued by St. Luke last year were VRDOs backed by letters of credit, Grant said. This debt is classified as non-current on the balance sheet of the health system. Grant did not calculate what the change would do to St. Luke’s debt ratio, but he thinks it would be significant. He even fears that it will have a negative effect on St. Luke’s bond rating.
“It’s a big chunk,” he said. “If it switched to the current treatment all of a sudden, that would be a big change.”
VRDOs backed by letters of credit make sense for some healthcare systems because they allow them to obtain financing at attractive rates, said Norman Mosrie, partner at DHG Healthcare and chair of the Healthcare Principles and Practices Council. Financial Management Association.
Some of the VRDOs on current balance sheets are legacy transactions. The method has lost popularity in recent years as borrowers have turned to fixed-rate bonds to secure low interest rates, he said. In 2014, the VRDO market was worth $222 billion, according to the Municipal Securities Regulatory Commission.
“It’s been an important funding mechanism for health systems over the years,” Mosrie said.
Mosrie expressed concern about whether bondholders would adjust to potential negative covenant impacts under the proposed rule, or whether credit rating agencies would switch to a downgrade based on the large amount of debt classified as current.
Rating agency representatives, however, said they would not oppose a company’s rating. At S&P Global Ratings, current practice is to classify VRDOs as long-term debt even if they are listed as current on balance sheets, said Kenneth Gacka, senior manager and chief analytical officer of the nonprofit healthcare division. profit from Standard & Poor. .
“I don’t think it will affect anything in terms of how our ratios are presented, as we already make this adjustment whenever it’s present,” he said.
Similarly, Kevin Holloran, senior director at Fitch Ratings, wrote in an email that his agency would also view this as a long-term obligation. That said, a casual reader could potentially be misled, he said.
Mosrie hopes the FASB, a nonprofit organization that sets standards companies must meet if they follow generally accepted accounting principles, will continue to allow long-term letters of credit tied to debt financing transactions to be classified as non-current. The FASB is accept comments on the rule until October 28. This proposal is an updated version of a proposed rule previously published in 2017. The new version is based on substantial comments.
FASB spokeswoman Christine Klimek wrote in an email that, in keeping with the guidelines’ goal of simplification, the board has proposed to exclude consideration of unused long-term financing agreements in order to provide users of financial statements with more consistent and transparent information on the contractual maturities of debt agreements.
If the rule does eventually take effect, Rick Kes, partner and senior health sector analyst at RSM, said he thinks health systems with this kind of debt will renegotiate it and change its terms.
“I think most health systems that can do that would prefer not to have current debt on their balance sheet if they can avoid it,” he said.
That’s what Doug Coffman, chief financial officer of West Virginia United Health System, said is likely his course of action. Otherwise, its health system of 10 hospitals with over $2 billion in annual revenue would see its debt ratio fall from around 2.5%, well above its peer group, to around 2%, right in the middle of the pack. Nearly $80 million of WVU Medicine’s $1.3 billion in outstanding debt is in VRDOs, Coffman said.
Coffman thinks the potential effects of the change extend beyond healthcare systems and could affect banks that issue letters of credit and bond underwriters if the VRDO market becomes less attractive.
“I’m not sure the FASB fully grasped this possible impact when writing this document, but maybe they did,” he said.
WVU Medicine chose VRDOs for two reasons: interest rate diversification and some of the system’s fixed-rate swap agreements require it to have floating-rate debt, Coffman said.
When St. Luke’s was considering its financing options, investment bankers touted VRDOs backed by letters of credit as one of multiple long-term debt vehicles, Grant said. The health system chose it as one of five vehicles it used, in part to diversify and because the price was competitive.
If the proposed rule goes into effect, Grant said St. Luke would consider pulling out of VRDOs.
“I think eventually it would poison this vehicle of health systems a bit by even really wanting to touch it if that was the advice,” he said.