CFO breaks down debt issues at Butler Health System
Butler Health System’s $150 million debt was refinanced in 2015, years before COVID-19 brought long-lasting problems to the industry — inflation, stagnant insurance reimbursements, and labor and supply shortages. A top hospital official recently outlined the system’s efforts to control the debt and reach certain financial benchmarks.
“The main obligation is that we pay our principal payments and our interest payments in full, and on time, when they’re due,” said Tom Albanesi, chief financial officer for Independence Health System. “And we’ve never missed a principal or interest payment.”
There are two sets of debt on Butler Health System’s books that are kept separately from Westmoreland-based Excela Health System, which merged with Butler Health System in early 2023 to create Independence Health System.
About $15 million is owed to Truist Bank, while the rest is owed to holders of hospital bonds issued in 2015. According to Albanesi, Butler Health took on this debt to fund a series of construction projects, including a new medical office building at Butler Memorial Hospital.
“The 2015 bonds are publicly traded. Those are owned by a bunch of mutual funds that own tax-exempt bonds … like T. Rowe Price and Vanguard and Fidelity,” Albanesi said.
He said the original $150 million has been whittled down to $120 million by 2024, and Butler Health has made over $81 million of principal and interest payments.
However, in addition to making its regular payments, Butler Health has to comply with a set of covenants. The Corporate Finance Institute defines covenants as “restrictions that lenders … put on lending agreements to limit the actions of the borrower.”
As a result of the economic challenges of COVID-19, Butler Health System has endured continuing negative cash flow, leading it to miss some of those requirements.
“In a nutshell, we need to operate more profitably than we have been,” Albanesi said. “This situation, where expenses are just rising crazily and revenues are flat … should that continue, we're always going to be in default.”
Tom Lin, a professor at the Beasley School of Law at Temple University in Philadelphia said, “If certain covenants are breached in a loan agreement, the borrower could be deemed in default, and adverse consequences can be initiated by the lender.
“Businesses that default on the debt or are under pressure to default on their debt can hurt their credit ratings and also be forced to make tough operational choices as their funding options become constrained,” Lin said.
One of the covenants is for Butler Health System to maintain a certain debt service coverage ratio, which measures an institution’s ability to cover its maximum annual debt service.
“It's an early warning indicator,” Albanesi said. “It's like that one of those lights that goes off on your dashboard. It doesn't mean you can't drive the car. It means, when you have time, get this thing looked at and check it out.”
To comply with this covenant, the health system would have to bring in 1.1 times the amount of its debt service with bondholders, and 1.25 times the amount of its debt service with Truist Bank by the end of the fourth fiscal quarter.
Truist Bank checks for compliance with the debt service covenant every quarter. According to Albanesi, Butler Health System last successfully met that covenant in September 2022, but has breached it in every quarter since. The covenant with the bondholders is tested once a year, at the end of June, and was breached in June 2023.
By the end of June 2023, Butler Health System wasn’t meeting either target, with a cash-to-debt ratio of 1 to 2.52 for bondholders and 1 to 2.15 for the bank. This means that in both cases, the health system had more than twice as much debt as cash on hand.
“We reacted to that the way we're supposed to,” Albanesi said. “The first thing we did was notify Truist Bank as soon as we learned about it.”
Kevin Broom, associate professor at the University of Pittsburgh’s School of Public Health, said there are multiple types of consequences an institution may face for tripping up on a debt service covenant.
“It could just mean additional monitoring and additional reporting,” Broom said. “It could mean that maybe an outside consultant is brought in to try and look at your operations and your financial performance. At the worst extreme, it could be that you're in default, and then your debt would be accelerated.”
A report the credit rating agency Moody’s issued in late March contends that Butler Health System may fail to meet the debt service covenant with bondholders again by the end of this June.
“There is a possibility that Butler Health System will breach its … debt service coverage covenant for the second year in a row at (fiscal year end) 2024,” the report reads.
According to the Moody’s report, more breaches with both the bank and the bondholders could trigger an event of default and an acceleration of the debt.
“That basically means you have to pay off everything now,” Broom said about debt acceleration.
Nevertheless, Albanesi says that Butler Health System currently has a good working relationship with Truist Bank despite the repeated breaches, and the hospital system has tried to be as transparent with the bank as possible.
“Truist has been an excellent partner,” Albanesi said. “They've exercised patience. They ask us good questions. We provide them with very thorough and transparent answers.”
In addition, Butler Health System announced in November 2023 that it was embarking on a financial improvement plan in conjunction with Washington, D.C.-based FTI Consulting, which could save millions of dollars.
“FTI is one of the premier names in health care consulting, and they do a lot of health care turnaround work,” Albanesi said. “They've been with us now for about a year, putting together various operational initiatives. All those initiatives are based on increasing revenue and decreasing expenses. We’ve identified over $150 million of opportunities at both Excela and Butler to improve financial performance.”
The consecutive months of missing the debt-service cover ratio targets have led the credit rating agency Moody’s to downgrade Butler Health System’s bond rating multiple times over the past year — most recently from Baa3 to Ba1 at the start of April.
In the Moody’s rubric, ratings of Ba1 or below are considered “speculative grade,” meaning that they represent more of a risk for investors. The lowest grade is C, which means that the bonds are in default and have little chance of recovery.
By contrast, ratings of Baa3 or above are considered “investment grade,” or lower-risk for investors. The highest grade is Aaa.
Albanesi said the downgrades from Moody’s and other credit rating agencies have a tangible effect on whether institutions will be willing to loan to them in the future.
“Moody's opinion doesn't really have any impact on the current debt that's out there,” Albanesi said. “What Moody's opinion affects is your next borrowing.”
For logistical reasons, both Butler Health and Excela Health are still filing separate financial reports more than a year after the Independence merger was consummated.
Although the two hospital systems share the same industry challenges, observers are slightly more optimistic about Excela. The same day that Moody’s downgraded Butler Health System to Ba1, they also downgraded Excela Health from Baa3 to Baa2. However, unlike with Butler Health, Moody’s kept their outlook for Excela at “stable” instead of negative.
Albanesi said the difference between the two situations is that Butler Health System includes its physician component in obligated figures, which are considered by lenders. Excela’s physician component is included in its consolidated figures, which include other elements of the systems, like hospital foundations, that are not considered by lenders.
Albanesi said the two institutions will merge their filings as soon as the market allows, but high interest rates have prevented them from refinancing as one merged unit.
“Many health systems, when they get put together, refinance all the existing debt. We couldn’t do that,” Albanesi said. “The interest rate environment, when we came together in January 2023, was so unfavorable compared to what it had been.”
In September 2023, Butler Health System reached an agreement with Truist Bank to waive its failure to comply with the debt service covenant in December 2022 and March 2023, and forgo testing for it altogether in June 2023. The health system has yet to reach a similar agreement with bondholders, but Albanesi says that they are still working on it.
“Our hope is, sometime this summer, to get something called a ‘forbearance,’” Albanesi said. “It means they're going to agree to give us a path and give us some time to cure these covenant breaches. We believe they're going to grant us ample time to turn the place around.”
Albanesi also pledged that the health system’s debt situation will not affect its commitment to providing quality care.
“We've been here for over 100 years. We plan on being here for another 100 years,” Albanesi said. “We want to continue to deliver high-quality care, close to home, in a very friendly and accessible way.”
