The Big Three credit rating agencies (Standard & Poor’s, Fitch, and Moody’s) issued rating median reports on nonprofit hospital systems late this summer. Most medians were stable to slightly negative.
More specifically, balance sheet metrics, such as days cash on hand and cash-to-debt, remained at or near post-recession highs due to better performing investments, prudent capital investment and refrain from issuing new debt.
According to Fitch, operating profitability metrics, such as operating margin and EBITDA margin, improved slightly overall in 2012 due to effective cost management and revenue enhancement initiatives. S&P offered similar sentiment referencing steady profitability metrics as improved operating efficiencies and system growth were offset by operating burdens related to healthcare reform, growing costs, lower volumes, rising bad debt, increased costs from employed physicians and weak reimbursement rate increases. Moody’s was the most bearish on 2012 performance citing weaker operating performance after three years of stability. This downward trend was a result of lower volumes and revenue growth, high exposure to government payers and increased expenses.
A tough row to hoe
What’s the outlook for hospitals in 2014?
Moving forward, the skies are a little darker. Fitch’s outlook is guarded as it anticipates a narrowing in operating margins, as expense reduction efforts will likely fail to keep pace with reimbursement and volume declines.
Moody’s is similarly pessimistic, predicting operating performance will remain weak. The industry-wide transition to a value-based reimbursement system will be highly disruptive. Their report predicts lower reimbursement and volumes, as there are no overriding factors that will drive increased admissions. Lastly, continued sequestration and Medicare reductions will hamper performance largely driven by poor net reimbursements.
S&P also offered a negative sentiment, predicting ratios will gradually soften in the next year or two. It also cites incremental pressures due to healthcare reform, as the same level of cost cutting that hospitals have employed the last few years is not sustainable.
What’s the lowdown?
Reviewing the credit rating agencies’ median reports can be a beneficial exercise for analyzing past performance and predicting future industry trends. By noting potential headwinds, hospitals can attempt to stay one step ahead of the ever-changing landscape when trying to navigate these difficult times.
From this particular cycle of reports, several tidbits of advice can be offered to hospitals on maintaining stable operations moving forward, despite the generally negative consensus on hospital trends.
- Industry downgrades highlight the need for senior management and boards to be thorough and disciplined in the budgeting and planning process. This includes maintaining a strong balance sheet moving forward so there is a financial buffer to manage downturns. Failing to plan is planning to fail.
- Appropriately managing new expenses, such as labor, employed physicians and electronic medical records, will be crucial to controlling expenses. Since the recession, most hospitals have already picked the low-hanging fruit in regard to expense reductions; therefore, hospitals now need to be more creative in seeking further expense reductions and managing new expenses.
- Better management of the payment cycle also can offset rising expenses. Increasing cash flow will improve a hospital’s liquidity position.
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Lastly, all three CRAs expect the gap in strong credits and weaker credits to grow. If the force of the negative trends is too much to overcome, hospital boards should seriously consider consolidation via affiliation, merger or acquisition. Given the expected headwinds, geographic diversity, pricing power and economies of scale become even more important. S&P’s rating distribution evidences the strength of consolidation as hospital systems account for more than 70 percent of credits rated A+ or higher and less than 15 percent of credits rated BBB or lower when compared to stand-alone hospitals.