While not-for-profit health care providers are increasingly embracing Energy as a Service (EaaS) to protect their balance sheets, we believe the arrangements could carry credit risks.
U.S. not-for-profit health care providers are more frequently entering into energy asset concession or lease arrangements as a means of catching up on deferred infrastructure spending while preserving balance-sheet flexibility. These arrangements can include benefits beyond those of direct capital investment, but a primary consideration for management, in our view, is keeping associated debt off their balance sheets. While this trend is perhaps in the early stages of growth across the sector, S&P Global Ratings has maintained a consistent analytical approach to off-balance-sheet obligations when assessing credit risk. In our view, the provider's unconditional pledge to make annual payments, as well as the corresponding liability, are factors capable of diminishing credit quality. Put simply, we view these arrangements as debt substitutes.
What's Happening
Although balance sheets remain a principal strength of the sector, pressure has built in recent years as a result of compressed operating cash flow and ongoing capital needs. This, coupled with a tendency on the part of management to prioritize revenue-generating projects over core infrastructure, has left many providers operating with dated, or perhaps unreliable, energy infrastructure on their hospital campuses. As a result, more providers are expressing an openness to asset monetization and nontraditional financing arrangements.
Why It Matters
These arrangements can finance critical infrastructure investments, allowing for more efficient energy usage, often with some savings guaranteed. However, they formalize an obligation for the provider to a third party through an unconditional thermal services agreement (TSA) payment that ultimately secures outstanding debt and covers certain costs. Other cited benefits include transferring risk of maintenance and operations for these assets, as well as certain tax advantages; however, in our opinion, the primary motivation for providers is balance-sheet defense: preserving existing reserves while not increasing master trust indenture (MTI) debt.
Once providers enter into these arrangements, a new liability is typically presented on the balance sheet reflecting future payment commitments or deferred revenue. We do not add this to long-term debt as we view it as too great a departure from accounting treatment. However, we do conduct a pro forma analysis for the effect on leverage and unrestricted reserve coverage over debt, as if the debt were carried on-balance-sheet. S&P Global Ratings also assesses the potential for increased contingent liabilities should any termination payments be required to retire the debt. If we consider the effect material and the overall financial profile becomes inconsistent with the rating or outlook, we will act accordingly through a downgrade or negative outlook revision. In addition, even in instances where such action would not be warranted, we may view the provider as having less debt capacity at the current rating due to the increased off-balance-sheet debt.
What Comes Next
We anticipate that these arrangements will grow in prevalence given sector profitability pressures and as they become more accepted by stakeholders, investors included.
In previous instances when we have assigned a rating to debt held by the off-balance-sheet special purpose entity, we have linked it to that on the health care provider given the strength of the obligation and the critical nature of the assets involved. Securing a rating on par with a rating on MTI debt is in step with our view that these transactions are formal obligations of the issuer and incorporated into its financial profile analysis accordingly. A provider's failure to make TSA payments, or termination fees, on time and in full would result in us reassessing its willingness to pay MTI obligations.
Assignment of any rating linked to that on a health care provider first requires a full review of our rating and outlook on the health care provider, including a discussion with management, reflecting both the dynamic nature of the sector as well as our need to reassess the provider's liability position inclusive of the contemplated energy asset arrangement.
This report does not constitute a rating action.
| Primary Credit Analyst: | Patrick Zagar, Dallas + 1 (214) 765 5883; patrick.zagar@spglobal.com |
| Secondary Contacts: | Blake C Fundingsland, Englewood + 1 (303) 721 4703; blake.fundingsland@spglobal.com |
| Stephen Infranco, New York + 1 (212) 438 2025; stephen.infranco@spglobal.com | |
| Suzie R Desai, Chicago + 1 (312) 233 7046; suzie.desai@spglobal.com |
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