Hospitals fear proposed accounting rule change will hurt debt ratios

If the rule does take effect, Rick Kes, a partner and healthcare industry senior analyst with RSM, said he thinks health systems with this type of debt will renegotiate it and change the terms.

A PROPOSED ACCOUNTING RULE would flip certain debt from non-current to current, and some hospital leaders 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, is meant to simplify debt classification on balance sheets and comes after stakeholders complained the current method is unnecessarily complex. In essence, the rule would replace current guidance with uniform principles for determining debt classification, according to an FASB explainer.

Under the proposal, a letter of credit could no longer be used to classify a type of bond called a variable-rate debt obligation as current. Today, VRDOs can be treated as long-term obligations so long as they’re remarketed, or have long-term letters of credit.

“People look at your company differently when you all of a sudden have an extra $75 million in short-term liability,” 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 St. Luke’s reissued last year were VRDOs backed by letters of credit, Grant said. That debt is classified as non-current on the health system’s balance sheet. Grant has not calculated what the change would do to St. Luke’s debt ratio, but he thinks it would be significant. He’s worried it could even have a negative effect on St. Luke’s bond ratings.

VRDOs backed by letters of credit make sense for some health systems because they allow them to obtain financing at attractive rates, said Norman Mosrie, a partner with DHG Healthcare and chair of the Healthcare Financial Management Association’s principles and practices board.

Some of the VRDOs on today’s balance sheets are legacy deals. The method lost popularity as borrowers turned to fixedrate bonds to lock in low interest rates, he said. In 2014, the VRDO market was worth $222 billion, according to the Municipal Securities Rulemaking Board.

Mosrie expressed concern over whether bondholders would accommodate potential negative impacts to bond covenants under the proposed rule, or whether credit-rating agencies would move to downgrade based on the large amount of debt classified as current.

Rating agency representatives, however, said they would not hold it against a company’s rating. At S&P Global Ratings, the current practice is to classify VRDOs as longterm debt even if they’re listed as current on balance sheets, said Kenneth Gacka, a senior director and analytical manager in Standard & Poor’s not-for-profit healthcare division.

Similarly, Kevin Holloran, a senior director with Fitch Ratings, wrote in an email that his agency would also consider that a long-term obligation. That said, a casual reader could potentially be misled, he said.

Mosrie hopes FASB, a not-for-profit organization that sets standards companies must abide by if they follow generally accepted accounting principles, continues to allow long-term letters of credit linked to debt-financing transactions to be classified as non-current. FASB is accepting comments on the rule until Oct. 28. This proposal is an updated version of an earlier one released in 2017.

If the rule does take effect, Rick Kes, a partner and healthcare industry senior analyst with RSM, said he thinks health systems with this type of debt will renegotiate it and change the terms.

That’s what Doug Coffman, chief financial officer of West Virginia United Health System, said he would likely do. Otherwise, his 10-hospital system with more than $2 billion in annual revenue would see its debt ratio drop from about 2.5%, well above its peer group, to about 2%, right in the middle of the pack.

Coffman thinks the potential effects of the change extend beyond health systems and could hit the banks that issue letters of credit and bond underwriters if the VRDO market becomes less attractive. “I’m not sure that FASB fully grasped that possible impact as they drafted this, but maybe they did,” he said. ●