Ratings pressure on both large and small hospitals could mount into next year as the sector confronts a perfect storm from an ongoing labor shortage, inflationary costs, and equity losses amid waning federal relief.
Double-digit increases in patient revenue last year as volumes rebounded from 2020 pandemic scars drove some of the highest median operating margins in recent years, S&P Global Ratings said in a review of 2021 medians. The 2021 recovery, helped by record investment returns, drove healthier liquidity, reserves, and debt service coverage ratios.
S&P, which maintains a stable outlook on the sector, doled out more downgrades than upgrades in 2020, with 2021 marking a recovery as the number slightly favored upgrades and outlook improvements.Through August, though, outlooks have trended toward the negative and downgrades have outnumbered upgrades.
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“This has been a volatile time for the sector,” S&P analyst Chloe Pickett during a webcast on the 2021 medians and look ahead. “Through August 31, 2022, we are seeing downgrades outpace upgrades and notably the amount of rating actions through this point in time may indicate that total rating actions in 2022 may exceed the previous years.”
The 2021 margins provide a picture of how credits were able to or not able to bounce back after a very difficult 2020 and how much flexibility they had coming into 2022 relative to peers from a balance sheet perspective so they have helped manage the 2022 storm.
“It’s certainly been a challenging 2022 … particularly around the labor question,” said Suzie Desai, S&P sector lead. “There’s a lot of uncertainty now. We are probably going to see the trend of negative bias on the pace of rating outlooks and downgrades. I think the pace of the change and recovery is probably the next question … we think 2023 is going to be another challenging year — hopefully not as acute as it was for 2022.”
At the forefront is the nursing shortage and need to use agency staffing at high payment rates. Pressures to raise salaries and recruit and keep employees overall, as well as inflationary costs throughout the supply chain, are pressuring balance sheets on the expense side.
“The labor noise is probably a little louder and is probably going to be with us for longer than we expected in late 2021 and is probably going to result in lower margins for a bit of time,” Desai said.
On the revenue side, hospitals face challenges in seeking rate hikes with insurers or government payors because of long-term contracts or set government rates, although Medicaid did lift rates this year.
“The cash flow is really pressured across the board,” Desai said. The balance sheet struggles have hit across the sector, although children’s hospitals and systems in growth regions are faring better.
Debt issuance is hard to predict in the near-term. Inflation is hitting construction costs and that’s prompted some hospitals to pull back on capital spending. As interest rates increase and cash flow is strained, debt issuance could be further put off despite needs.
Industry consolidation through mergers, acquisitions, or partnerships has held steady in recent years with pandemic-induced wounds driving some strategy shifts. A cloud hangs over consolidation from the Biden Administration’s anti-competitive crackdown. “Scrutiny over mergers may limit options for certain challenged credits and those seeking future strategic options,” S&P said.
While larger systems typically can weather cash-flow strains due to their scale, investment losses are felt more acutely given their large portfolios.
“Large losses recently reported by some of the biggest and highest-rated nonprofit hospital systems demonstrate that the fiscal strains facing the sector are not limited to smaller and weaker entities,” Municipal Market Analytics said in a recent weekly Outlook report. “Negative rating actions are likely to pick up over the near-to-medium term.”
While smaller, rural, and speculative grade hospital ratings still stand to suffer the most, MMA said it expects the credit strains to extend to larger systems. MMA noted recent reported losses from big systems like the Cleveland Clinic, Providence Health, Advocate Aurora Health, UPMC, and Mass General with investment losses driving much of their red ink.
Nuveen sees pressures on the sector ahead in a recessionary scenario, but overall strengths will help tamp down the impacts.
“The combination of inflation and lingering staffing shortages may well delay full recovery from” weaker margins, Nuveen Municipal Credit Research said in a sector outlook report. “A recessionary environment would provide headwinds, potentially slowing improvement in margins. However, strong balance sheets and robust demand for services should be more than adequate to shield most hospitals from any severe erosion in credit quality. As a sector, hospitals remain solid and well-positioned to adjust to changing circumstances.”
Small, rural hospitals will remain most at risk. “Those that cannot partner with larger providers are likely to struggle and face increased ratings pressure,” Nuveen wrote.
Moody’s Investors Service also released this month its 2021 median report. “While not-for-profit hospitals’ financial performance is trending weaker this year, 2021 operating results improved to pre-pandemic levels,” Moody’s said. Northeast margins still trailed other regions despite 2021 rebound while margins on both spectrums of the largest and smallest rebounded from 2020.
“Government relief grants and cost-cutting initiatives in response to the pandemic, coupled with some volume recovery, drove an increase in profitability at the 50 largest and smallest hospitals in fiscal 2021,” according to Moody’s data.
The median operating cash-flow margin improved to 8.7% from 7.3%, driven by CARES Act funds and volume improvement. Forty-one hospitals — 18% of the sample — reported operating losses in 2021 compared with 77 — 33% of the sample — in 2020.
Fitch Ratings last month assigned a “deteriorating” outlook to the sector.