S&P - Public Finance Criteria (2007). - The Global Clearinghouse

Not-For-Profit Health CareStandard & Poor’s also expects that the unsecuredGO pledge remains the senior debt of thecredit group. The permitted lien test and its25% limit on lien debt that can run to the parentand designated or restricted affiliates asopposed to the system as whole, should remainin force at all times. Compliance should exist atall times, not just at the time of a new debttransaction. A common mistake is to treat thisas a transaction test instead of a default test. Ifapplied only at the time of a transaction, subsequentundesignations could leave the remainingmembers of the credit group in violation of thisprinciple. When properly structured, this testwill safeguard against the parent undesignatingaffiliates in such a way as to leave the systemwith too much senior lien debt. By making thisan on-going requirement, it precludes a violationof the test and, as a result, the rated unsecureddebt cannot fall to a junior lien positionwhen measured against the 25% allowed limit.Off-Balance Sheet DebtNonprofit health care organizations are increasinglyusing off-balance sheet debt to finance certainassets. How this usage is viewed from a credit perspectivevaries for a number of reasons. Some ofthe questions Standard & Poor’s asks to determinethe credit impact include:■ What are the assets being financed?■ Are they critical to the ongoing welfare and missionof the organization?■ What is the legal structure of the deal?■ Is there a moral or legal obligation involved?■ Are there true contingent liabilities being undertakenby the organization?The answers to these questions, combined withan obligor’s fundamental credit strength, are usedto gauge the potential rating impact of any offbalance-sheettransaction. In certain cases theimpact is significant; in others slight. In eithercase, Standard & Poor’s needs to be informed ofall off-balance-sheet transactions because theremay be financing risks that could have credit consequences.Issuers and obligors often perceive offbalance-sheetfinancing as a means to preservedebt capacity and enhance operating flexibility,with no impact on their senior debt rating—a freelunch, if you will. However, this is clearly notalways the case.Broadly speaking, off-balance sheet debt refers to ahost of different financing structures. These include:■ Sale/leaseback transactions;■ REIT financings;■ Various types of operating leases or guarantees;■ Contribution agreements between unrelated partiesto finance jointly owned assets; and■ Public/private joint ventures or partnerships,many with a real estate developer.The common element is that the repayment obligationdoes not appear as a liability on the ratedorganization’s balance sheet and, in some cases,may appear as an operating lease.Standard & Poor’s ascertains the risks of offbalancesheet transactions—regardless of thelegal structure—when a rated non-profit organizationis involved and the transaction is deemedimportant to the organization’s ongoing welfareor mission. Once the potential off-balance-sheetrisk is identified, Standard & Poor’s review of arated organization factors in the relevant risks,which include additional debt-service costs oroperating lease payments related to the financing.The potential of having to “step up” to a guaranteeis also assessed. The impact on a rated obligor’sdebt could range from minimal to high, inwhich case it is treated as the equivalent of anobligation on parity with the obligor’s own debt.This range reflects the legal structure as well asthe degree to which an organization, as a whole,is legally or equally as important, morally obligatedon the transaction. The importance of theasset being financed via the off-balance sheet tothe overall mission and strategy of the organizationis also central in determining the extent ofthe rating impact.The potential risks of off-balance-sheet financingsinclude:■ The potential dilutive effects on the rated obligor’sbondholder security;■ Risks associated with the ownership and controlof the asset being financed;■ Potential liability and poor public relations if theoff-balance sheet financing encounters financialproblems;■ Strained managerial resources resulting fromadministration of an off-balance-sheet projectand related financing program; and■ Potential jeopardy of the rated issuer’s taxexemptstatus.Fueling the rise in off-balance-sheet financing arethe following one or more goals:■ Preserve debt capacity by only financing the mostmission-critical assets or programs with the obligor’sstrongest security;■ Enhance financial flexibility by proceeding on aspeedier time table than that required for a moretraditional bond financing;■ Increase risk sharing through joint ownership orother collaborative relationships;www.standardandpoors.com161