To bond raters, cash is king.

It beats 'great stories' and innovative strategic plans

DEBT-RATING AGENCIES VIEW THE LONG TERM CARE INDUSTRY as risky. While assisted-living bond deals offer investors an alternative to the battered hospital and health care system credits that have been selling lately, the relative newness of the industry scares them partially because there is no real yardstick to measure how well such deals are faring as they mature. For this reason, most bond deals are given below investment-grade ratings or are left non-rated. The upshot: many offerings land in the high-yield sector.

If, however, you know the critical factors on which rating analysts focus--what it takes to achieve investment grade--you can proactively reduce your credit risk and thereby gain access to cheaper debt.

An investment grade rating speaks to an entity's ability to repay debt in a timely manner. Put simply, the higher the bond rating, the less risk of default to the bondholder. An investment grade rating is a rating of 'BBB-' or above. Fitch IBCA's investment grade ratings on long term care facilities currently range from 'A+' to 'BBB-,' with any rating below 'BBB-' considered higher risk or speculative.

Credit analysis focuses on the financial results of an organization as well as numerous qualitative factors such as competition, local economy, market demand, and management quality. Most of these qualitative aspects fall outside of a provider's immediate control. A borrower can do little to affect government regulations, service area characteristics, or the strength of other providers in the market. However, critical factors such as cash reserves and cash flow, management, and marketing are within your control.

Go with the flow

First and foremost, cash is king. Credit worthiness begins with an organization's ability to generate cash flow, as well as its ability to nurture healthy cash reserves. Credit rating analysis begins with an examination of a borrower's ability to cover debt service with cash flow, and overall liquidity relative to operating expenses and total long-term debt.

Great stories and innovative strategic plans are fine, but ultimately they are useless to a credit rating if they do not generate cash. So before seeking an investment grade bond rating, build up cash and improve liquidity.

Cash flow should be roughly two times maximum annual debt service. While this is easier said than done, borrowers should be aware that solid debt service coverage is a very revealing measure of risk in the minds of analysts.

Generating good debt service coverage without profitable operations is a difficult task. Maintain service prices that fully cover your operating and fixed costs. This requires a good knowledge of your target market, income levels, senior preferences, and the competitive menu of services and prices. A marketing team that maintains solid occupancy and also monitors and reacts to changes in the competitive market is worth its weight in gold, ensuring your success and making possible an investment-grade rating. Conversely, a marketing department that does not continually monitor your competitors hinders your chances at investment grade. For providers operating without an affinity group affiliation such as church or sustainable market niche such as Alzheimer's, a talented marketing staff is imperative.

All mission, no moolah

Not-for-profit borrowers that focus exclusively on their mission and wholeheartedly ignore their margins will have difficulty achieving investment-grade status. Particularly in assisted living, but for all long term care sectors, you must base your pricing structure on the amount of care a resident requires, adjusting prices as a resident's needs change. Resident needs should be monitored continually, and caution should be taken not to provide more services than the amount being billed out. Also critical is a good internal information system that provides up-to-date and detailed monitoring of operating expenses.

Significant cash reserves should be on hand to cover at least one half of a year's operating expenses. Huge resident turnover rates, particularly in assisted living and skilled nursing, are an intrinsic part of the long term care industry, and large cushions of cash can mitigate the financial risk associated with occupancy fluctuation. In addition, the industry can be volatile and unpredictable in other ways--third-party reimbursement, to name one notable example-and income from wisely invested cash reserves can effectively subsidize fluctuating operating results.

Debt be not proud

Ultra-conservative boards of directors should realize that some amount of debt on the balance sheet could be beneficial to an organization, although one pitfall to providers is becoming too highly leveraged. A manageable level of debt in relation to cash, revenues, and net assets is important to obtaining an investment-grade rating. CLTC 

Rob Wetzler is an associate director in the health care and higher education group of Fitch IBCA, an international rating agency based in New York.