Few industries have felt as big an impact from the coronavirus pandemic as health care providers – not only from the risks taken on by front-line medical workers but also because of the significant disruption of their operations.
The question is made more complicated over how to account for funding from the CARES Act.
On June 30, there will be a reckoning of sorts. That’s when the quarterly financial results from many health care providers with publicly traded bonds will be measured, with public disclosure of those results typically lagging 30 to 60 days.
It will provide a window into their financial condition and whether the providers that took on debt to fuel their growth will be able to meet their bond covenants. This year, that question is made more complicated by the funding from the CARES Act, and how health care providers will account for that money in their operating statements
How health care providers account for and report CARES Act money will have a potential impact on whether those providers meet or violate their debt covenants.
The extraordinary turn of events for health care providers began in March, when health care providers across the country started to delay non-emergency procedures and office visits to make critical resources available for a potential surge in coronavirus patients.
Many of RSM’s health care client executives told us that they had no objection to the delays – some of which were ordered by state governments – saying that it was a national priority to address the growing pandemic.
The delays, though, came with a steep cost. For example, the American Hospital Association estimated that hospitals could lose $161.4 billion from March to June, or about $1.3 billion a day.
There are signs, however, that things are turning around. Last week, Tenet Healthcare presented its mid-quarter operational update to investors. The results showed that through the first half of June, volumes appear to be heading closer to the pre-COVID levels.
All of this will come into focus on June 30, when many health care providers will have to attest whether they continue to meet their bond covenants.
Many health care providers are subject to a bond covenant requiring maintenance of a minimum debt service coverage (DSC) ratio, which is a measure of the cash flow that is available to meet debt obligations. It provides a view of how many times a borrower is able to pay annual debt service (usually defined as required principal and interest payments) using operating income, adjusted for certain noncash items.
The FASB model
It’s an especially important question for the many health care providers that accepted money from the federal government through the CARES Act. Under the Financial Accounting Standards Board (FASB) reporting model, providers may be able to include their CARES Act money in their DSC calculation if they can demonstrate that they have met the terms and conditions of the funding before their balance sheet date.
But some FASB reporting entities may not be able to include their stimulus funding in their DSC calculation based on how their covenants are defined in their bond agreements or in certain other scenarios.
The GASB model
In addition to the FASB model, there are several health care providers that report under the Governmental Accounting Standards Board (GASB) model.
The GASB issued a proposed technical bulletin that if the organization can demonstrate it has met the terms and conditions of the funding from the CARES Act the stimulus funding would not be included as operating income. Rather, it would most likely be included in non-operating activities, which could cause many GASB reporting entities to exclude the CARES Act stimulus funding from their DSC calculation.
One example
Below is a hypothetical example of the effects of how the accounting treatment of the stimulus funding could affect calculations. This hypothetical example involves a $1 billion health system that received $20 million from the CARES Act stimulus payments.
In this example, a 50% reduction of revenue is assumed in the second half of March. Also assumed is a 50% reduction of revenue in April, a 30% reduction in May, and a 10% reduction in June. Expenses were reduced starting in April by 10%, in May by 15%, returning to an average pre-COVID level in June.
Given the plunge in revenue as a result of COVID-19, the rising cost of supplies and labor, and the inability to adjust much of the fixed costs of running a provider like a health system, it is possible that some health care providers could be in the unusual position of failing their bond covenants.
Beyond the bond covenants, there is also a question of how the rating agencies will view the CARES Act stimulus funding and how that could affect their rating evaluation.
The takeaway
For health care providers, the question of how to account for and report CARES Act money could have a potentially significant impact on their ability to meet their debt covenants and achieve the financial performance that they envisioned when they issued the debt.
For more information on how the coronavirus is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
