Since 2022, S&P Global Ratings has tracked an increase in violations of debt agreements as macro economic pressures and low operating margins challenge providers.
Dive Brief:
The number of nonprofit health systems violating their financial agreements with lenders or investors has increased since 2022 as providers struggle to meet debt obligations amid challenging operating conditions, according to a new report from credit agency S&P Global Ratings.
This year, nonprofits will continue to be at heightened risk of violating covenant agreements, or conditions of debt that are put in place by lenders. Recently, the most common violations among nonprofits have been debt service coverage — the amount of days-cash-on-hand to debt ratios — as the sector continues to weather high expenses and weak revenues.
Most nonprofits have recently received extra time to remedy finances in the form of waivers or forbearance agreements, but other systems have merged with more financially stable organizations to meet lending agreements, according to the report.
Dive Insight:
Financial covenant violations among nonprofits began to increase at the onset of the COVID-19 pandemic.
In the early stages of the pandemic, violations were often tied to one-time pressures on operating income, such as mandatory stoppages of services.
However, violations have since evolved and now reflect nonprofits’ struggles with ongoing labor shortages and inflationary pressures, according to the report.
Providers in the speculative rating category were more likely to have violated financial covenants over the past two years and accounted for 60% of violations in S&P’s rated universe.
Creating a great rating agency presentation is imperative to telling your story. I’ve probably seen a thousand presentations across the past three decades and I can say without a doubt that a great presentation will find its way into the rating committee. Show me a crisp, detailed, well-organized presentation, and I’ll show you a ratings analyst who walks away with high confidence that the management team can navigate the industry challenges ahead.
During the pandemic, Kaufman Hall recommended that hospitals move financial performance to the top of the presentation agenda. Better presentations chronicled the immediate, “line item by line item” steps management was taking to stop the financial bleeding and access liquidity. We still recommend this level of detail in your presentations, but as many hospitals relocate their bottom line, management teams are now returning to discussing longer-term strategy and financial performance in their presentations.
Beyond the facts and figures, many hospitals ask me what the rating analysts REALLY want to know. Over those one thousand presentations I’ve seen, the presentations that stood out the most addressed the three themes below:
What makes your organization essential? Hospitals maintain limited price elasticity as Medicare and Medicaid typically comprise at least half of patient service revenue, leaving only a small commercial slice to subsidize operations. The ability to negotiate meaningful rate increases with payers will largely rest on the ability to prove why the hospital is a “must-have” in the network. In other words, a health plan that can’t sell a product without a hospital in its network is the definition of essential. This conversation now also includes Medicare Advantage plans as penetration rates increase rapidly across the country. Essentiality may be demonstrated by distinct services, strong clinical outcomes and robust medical staff, multiple access points across a certain geography, or data that show the hospital is a low-cost alternative compared to other providers. Volume trends, revenue growth, and market share show that essentiality. A discussion on essentiality is particularly needed for independent providers who operate in crowded markets.
What makes your financial performance durable? Many hospitals are showing a return to better performance in recent quarters. Showing how your organization will sustain better financial results is important. Analysts will want to know what the new “run rate” is and why it is durable. What are the undergirding factors that make the better margins sustainable? Drivers may include negotiated rate increases from commercial payers and revenue cycle improvements. On the expense side, a well-chronicled plan to achieve operating efficiencies should receive material airtime in the presentation, particularly regarding labor. It is universally understood that high labor costs are a permanent, structural challenge for hospitals, so any effort to bend the labor cost curve will be well received. Management should also isolate non-recurring revenue or expenses that may drive results, such as FEMA funds or 340B settlements. To that end, many states have established new direct-to-provider payment programs which may be meaningful for hospitals. Expect questions on whether these funds are subject to annual approval by the state or CMS. The analysts will take a sharpened pencil to a growing reliance on these funds.
The durability of financial performance should be represented with highly detailed multi-year projections complete with computed margin, debt, and liquidity ratios. Know that analysts will create their own conservative projections if these are not provided, which effectively limits your voice in the rating committee.
We also recommend that hospitals include a catalogue of MTI and bank covenants in the presentation. Complying with covenants are part of the agreement that hospitals make with their lenders, and it is the organization’s responsibility to report how it’s performing against these covenants. General philosophy on headroom to covenants also provides insight to management’s operating philosophy. For example, is it the organization’s goal to have narrow, adequate, or ample headroom to the covenants and why? As the rating agencies will tell you, ratings are not solely based on covenant performance, but all rating factors influence your ability to comply with the covenants.
What makes your capital plan affordable? Every rating committee will ask what the hospital’s future capital needs are and how those capital needs will be supported by cash flow, also known as “capital capacity.” To answer that question, a hospital must understand what it can afford, based on financial projections. Funding sources may require debt, which requires a debt capacity analysis with goals on debt burden, coverage, and liquidity targets. Over the years, better presentations explain the organization’s capital model, outline the funding sources, and discuss management’s tolerance for leverage.
There is always a lot to cover when meeting with the rating agencies and a near endless array of metrics and indicators to provide. As I’ve written before, how you tell the story is as important as the story itself. If you can weave these three themes throughout the presentation, then you will have a greater shot at having your best voice heard in rating committee.
Rating agencies have done a great job in increasing transparency around how ratings are determined. Detailed methodologies, scorecards, and medians are a big part of that effort.
Central to the rating process is the rating committee. All rating decisions are made by a rating committee, not an individual. The rating committee provides a robust discussion of various viewpoints as it deliberates, votes, and assigns ratings to the debt instrument.
Here are five things to know about what happens in a rating committee.
1. Rating committees are presided over by a Rating Committee Chair.
The Chair’s primary responsibility is to check that the committee follows numerous processes that meet company and SEC-mandated guidelines. For example, the Chair must verify that the correct methodology is being used to determine the rating, or if a rating requires additional methodologies (such as short-term rating methodologies on variable rate debt). The Chair must confirm that the rating decision will be based on verifiable facts or assessments (such as an audit) and that voting members are free of conflicts. Committees can be subject to internal and external reviews after the fact to ensure that decisions were made impartially and documented correctly.
The Chair ensures that the committee is populated with voting members who possess in-depth knowledge about the sector or related-credit knowledge (such as a higher education analyst in the case of an academic medical center) and are skilled in credit assessment. Each voting member has one vote and an equal vote. Serving as a voting member of a rating committee or as a Chair is a privilege and must be earned.
2. The rating committee discussion centers around the ability of a borrower to repay its obligations, or said another way, the likelihood of payment default.
As such, debt structure is integral to the rating committee. Detailed information provided in the committee package will include information on outstanding and proposed debt (if a bond financing is imminent), debt structure risks (fixed versus variable, for example), debt service schedule (level payments or with bullets), maturities and call dates, taxable and tax-exempt debt, bank lines and revolvers, counterparty risk and termination events, derivative products such as interest rate swaps and collateral thresholds, senior-subordinate debt structures, bond and bank covenants, obligated group, and security pledge, to name a few. Leases and pension obligations are also considered, particularly when liabilities outsize the direct debt.
Rating committees review hundreds of financial metrics to assess recent financial performance and an organization’s ability to pay debt in the future. Audited financial statements, year-to-date results, and annual budgets and projections are the basis for computing the financial ratios. Non-quantitative factors include success with past strategies and capital projects, market position and essentiality, management, governance and corporate structure, workforce needs, and local economic data. Confidential information provided by the organization is also shared. The job of the lead analyst is to distill all the information and present an organized credit story to the rating committee.
3. Rating consistency is paramount.
An “A” should be an “A” should be an “A.” Comparables (or “comps”) are an important part of the rating committee. Comps may include the other hospitals and health systems operating in the same state given shared Medicaid and state regulations (such as Certificate of Need or state-mandated minimum wage), workforce environment (such as the presence of active unions), and similar economic factors. Like-sized peers in the same rating category also populate comps. The type of hospital being evaluated is also important. For example, health systems that own health plans would be compared to other integrated delivery systems; likewise for children’s hospitals, academic medical centers, or subacute care providers. Medians are also a part of the comps and provide relativity to like-rated borrowers by highlighting outliers.
4. Rating committee spends time reviewing the draft report to make sure the committee’s views are accurately expressed and check that confidential information was not inadvertently revealed. If you want to know what was discussed in the rating committee, read the last rating report.
Over the years, many executives have asked to speak directly to the rating committee. While that is not possible, you can bring your voice to the discussion with an informative, well-crafted rating presentation. That brings me to my final “inside rating committee” point.
5. Rating presentations matter.
Effective, informative presentations that encapsulate your organization’s strengths will be shared with the rating committee. Every slide in your presentation should send a clear message that the organization’s ability to repay the debt and exceed covenants is strong. Emphasize the positives, acknowledge the challenges, and share what your action plan is to address them. Do your homework and review what you shared with the analysts last year; they will be doing the same to prepare. Provide updates on how the strategic plans are going. If you exceeded your financial goals, explain how. If you fell short, explain why.
How you tell the story is as important as the story itself. That’s how you can inform the discussion and ensure your voice is heard around the rating committee table.
Inflation, labor pressures, and general economic uncertainty have created significant financial strain for hospitals in the wake of the COVID pandemic. Compressed operating margins and weakened liquidity have left many hospitals in a precarious economic situation, with some entities deciding to delay or even cancel planned capital expenditures or capital raising. Given these tumultuous times, hospital entities could look to the realm of the higher education sector for a playbook on how to leverage non-core assets to unlock significant unrealized value and strengthen financial positions, in the form of public-private partnerships.
These structures, also known as P3s, involve collaborative agreements between public entities, like hospitals, and private sector partners who possess the expertise to unlock the value of non-core assets. A special purpose vehicle (SPV) is created, with the sole purpose of delivering the responsibilities outlined under the project agreement. The SPV is typically owned by equity members. The private sector would be responsible for raising debt to finance the project, which is secured by the obligations of the project agreement (and would be non-recourse to the hospital). Of note, the SPV undergoes the rating process, not the hospital entity. Even more importantly, the hospital retains ownership of the asset while benefiting from the expertise and resources of the private sector.
Hospitals can utilize P3s to capitalize on already-built assets, in what is known as a “brownfield” structure. A brownfield structure would typically result in an upfront payment to the hospital in exchange for the right of a private entity to operate the asset for an agreed-upon term. These upfront payments can range from tens of millions to hundreds of millions of dollars.
Alternatively, hospitals can engage in “greenfield” structures where the underlying asset is either not yet built or needs significant capital investment. Greenfield structures typically do not result in an upfront payment to the hospital entity. Instead, (in the example of a new build) private partners would typically design, build, finance, operate and maintain the asset. The hospital still retains ownership of the underlying asset at the completion of the agreed upon term.
P3 structures can be individually tailored to suit the unique needs of the hospital entity, and the resulting benefits are multifaceted. Financially, hospitals can increase liquidity, lower operating expenses, increase debt capacity, and create headroom for financial covenants. These partnerships provide a means to raise funds without directly accessing the capital markets or undergoing the rating process. Upfront payments represent unrestricted funds and can be used as the hospital entity sees fit to further its core mission. Operationally, infrastructure P3s offer hospitals the opportunity to address deferred maintenance needs, which may have accumulated over time. Immediate capital expenditure on infrastructure facilities can enhance reliability and efficiency and contribute to meeting carbon reduction or sustainability goals. Furthermore, these structures provide a means for the hospital to transfer a meaningful amount of risk to private partners via operation and maintenance agreements.
For years, various colleges and universities have adopted the P3 model, which is emerging as a viable solution for hospitals as well. Examples of recent structures in the higher education sector include:
Fresno State University, which partnered with Meridiam (an infrastructure private equity fund) and Noresco (a design builder) to deliver a new central utility plant. The 30-year agreement involved long-term routine and major maintenance obligations from the operator, with provisions for key performance indicators and performance deductions inserted to protect the university. Fresno State is not required to begin making availability payments until construction is completed.
The Ohio State University, which secured a $483 million upfront payment in exchange for the right of a private party to operate and maintain its parking infrastructure. The university used the influx of capital to hire key faculty members and to invest in their endowment.
The University of Toledo, which received an approximately $60 million upfront payment in exchange for a 35-year lease and concession agreement to a private operator. The private team will be responsible for operating and maintaining the university’s parking facilities throughout the term of the agreement.
Ultimately, healthcare entities can learn from the successful implementation of infrastructure P3 structures in the higher education sector. The experiences of Fresno State, The Ohio State University, and the University of Toledo (among others) serve as compelling examples of the transformative potential of P3s in the healthcare sector. By unlocking the true value of non-core assets through partnerships with the private sector, hospitals can reinforce their financial stability, meet sustainability goals, reduce risk, and shift valuable focus back to the core mission of providing high-quality healthcare services.
Author’s note: Implementing P3 structures requires careful consideration and expert guidance. Given the complex nature of these partnerships, hospitals can greatly benefit from the support of experienced advisors to navigate the intricacies of the process. KeyBank and Cain Brothers specialize in guiding entities through P3 initiatives, providing valuable expertise and insight. For additional information, please refer to a recording of our recent webinar and associated summary, which can be accessed here: https://www.key.com/businesses-institutions/business-expertise/articles/public-private-partnerships-can-unlock-hospitals-hiddenvalue.html
For large capital projects—construction of a new cancer treatment center, for example, or replacement of an aging facility—issuance of municipal debt is one of the most affordable ways for not-for-profit hospitals and health system to finance the project.
The affordability of that debt is, however, partly contingent on the organization’s ability to maintain a strong credit rating, and financial reserves—again measured as Days Cash on Hand—are a significant component of that credit rating.
There are two basic forms of municipal debt:
General obligation bonds are backed by the full taxing power of the issuing municipal authority and are considered relatively low risk. Hospitals that are owned by a city or county can be funded by general obligation bonds, although there are practical limitations on their ability to issue these bonds, including in many instances the need to obtain voter or county commissioner approval. Organizations
without municipal ownership—including most not-for-profit hospitals and health systems— cannot issue general obligation bonds.
Revenue-backed municipal bonds are backed by the ability of the organization borrowing the debt to meet its obligation to make principal and interest payments through the revenue it generates over the life of the bond. Because revenues can be disrupted by any range of factors, revenue-backed bonds are higher risk for investors. Most healthcare bonds are revenue-backed municipal bonds.
When determining whether to invest in revenue-backed municipal healthcare bonds, investors will look to the credit rating of the hospital or health system that is borrowing the debt. Credit ratings—issued by one or more of the three major credit rating agencies (Fitch Ratings, Moody’s Investors Service, and S&P Global Ratings)—provide an assessment of the probability
that the hospital or health system will be able to meet the terms of the debt obligation. These ratings are tiered. A credit rating in the AA tier is better than a credit rating in the A tier, which is better than a rating in the BBB tier. Ratings below the BBB tier are considered sub-investment grade.
Organizations with a sub-investment grade rating can still access various forms of debt, but the amount of debt they can access generally will be lower, the cost of the debt will be higher, and the covenants that lenders require will be more stringent than for investment-grade rated organizations.
Financial reserves and credit ratings
Days Cash on Hand is one of the most important factors credit rating agencies use because it is an indicator of how long the rated organization could withstand serious disruption to its operations and cashflow. The rating agencies issue median values for the various metrics they use to determine credit ratings. Median
values for Days Cash on Hand increased significantly across most rating categories for all three agencies in 2020 and 2021; this reflects the temporary inflow of pandemic relief funding through, for example, the Coronavirus Aid, Relief, and Economic Security (CARES) Act.
We anticipate these medians will move closer to pre-pandemic levels as relief funds are exhausted and hospitals repay remaining balances on Medicare’s COVID-19 Accelerated and Advanced Payment (MAAP) program funds. But even before the pandemic, organizations in 2019 had a median Days Cash on Hand of 276 to 289 days at the AA level, 173 to 219 days at the A level, and 140 to 163 days at the BBB level.
In other words, the Days Cash on Hand benchmark for organizations seeking to maintain an investment-grade rating would be well over 100 Days Cash on Hand, and well over 200 Days Cash on Hand for organizations seeking to achieve a higher rating level. Again, these reserves are proportionate to the operating expenses of the individual hospital or health system.
Impact of credit ratings on access to capital
Organizations that can achieve a higher rating can also borrow money at more affordable interest rates. Figure 3 shows average interest rates for municipal bonds across a range of maturities as of mid-December 2022 (maturity is the term in years for repayment of the bond at the time the bond is issued). Lower-risk general obligation municipal bonds are shown as the baseline, with lines for AA, A, and BBB rated healthcare revenue-backed bonds above it. As a reminder, most hospitals and health systems cannot borrow money using general obligation bonds; instead, they use higher-risk revenue-backed bonds. Because revenue-backed bonds are a higher risk for investors than tax-based general obligation bonds,
even hospitals and health systems with a strong AA credit rating will pay a higher interest rate than would a city or county that could back repayment of the bond with tax revenues (see the line for AA rated Healthcare Revenue Bonds compared to the line for AAA rated General Obligation bonds). But there is also a significant gap between the interest rate a hospital with an AA credit rating would pay compared to the interest rate available to a hospital with a lower BBB rating. Here, the difference is approximately three-fourths of a full percentage point. When the amount borrowed for a major new hospital project can run into the hundreds of millions of dollars, that difference represents significant savings for organizations with a higher credit rating.
Financial reserves and debt capacity
Financial reserves and the funds they generate— including investment income—also help define an organization’s debt capacity: essentially, the amount of debt an organization can assume without jeopardizing its current credit rating. There are two key ratios here:
The first is total unrestricted cash and investments to debt. In general, the more favorable that ratio is, the more latitude a hospital or health system has to take on additional debt, especially if the organization is toward the middle to top end of its rating tier.
The second is the debt service coverage ratio, which measures the organization’s ability to make principal and interest payments with funds derived from both operating and non-operating (e.g., investment income) activity. A higher ratio here means the organization has more funds available to service debt.
The ability to assume additional debt is an important safety valve if, for example, an organization needs to mitigate poor financial performance to fund ongoing capital needs or strategic initiatives.
KEY TAKEAWAYS
Not-for-profit hospitals and health systems often borrow debt through revenue-backed municipal bonds, meaning that the debt obligations will be met by the revenue the organization generates over the life of the bond.
Because revenue-backed bonds are higher risk than general obligation bonds backed by a municipality’s taxing authority (revenues can be disrupted), investors seek assurance that an organization will be able to meet its obligations.
Credit ratings offer investors an assessment of an organization’s current and near-term ability to meet these obligations.
Days Cash on Hand is an important metric in assessing the organization’s credit rating, and a higher rating generally requires a higher number of Days Cash on Hand.
A higher credit rating allows organizations to borrow money at more affordable interest rates.
A higher level of financial reserves and investment income in relation to existing debt obligations also increases an organization’s debt capacity, creating an important safety valve if an organization has to borrow money to mitigate poor operating or investment performance.
Healthcare debt issuance remains incredibly light. How long can a capital-intensive industry tolerate limited capital generation? Is pressure building to some tipping point when the need for capital and liquidity will outweigh defending a credit-rating position or avoiding what seems like high-cost debt? The sector generated a lot of internal and external capital in 2020-2021, but the falloff across all channels has been dramatic and residual resource positions are deteriorating.
The Need for Enterprise Performance Improvement
Recent economic releases—jobs report to CPI to PPI to retail sales—all suggest that the Federal Reserve’s efforts to bring inflation into line are yielding slower than hoped for results. The expectation is continued Fed tightening (higher rates), with a range of voices suggesting the Fed will be forced to push rates high enough to trigger a recession. Every restaurant and shop in the small town I live near has a “we’re hiring” sign in its window and each was jam-packed with very active consumers this past Presidents’ Day weekend. If success in taming inflation requires a broad-based hiring and economic slowdown, it feels like we have a long way to go.
Markets keep doing their thing, which frequently seems disconnected from the Fed’s thing. Both 30-year Treasuries and MMD are just starting to bump up against 30-year averages, the 10-year Treasury has moved higher over the past several weeks but remains below Effective Fed Funds, and the Chicago Fed’s National Financial Conditions Index continues to suggest relatively accommodative overall financial conditions.
While I question the depth and reliability of fixed income markets, the funding environment doesn’t seem as bad as the very low debt issuance activity would suggest. Channeling Shakespeare, it seems that “the fault, dear Brutus, is not in our stars, but in ourselves,”
meaning that low debt issuance is coming out of healthcare’s very profound resource problem rather than externalities.
I concluded a long time ago that not-for-profit healthcare credit and capital management is about strategic resource allocation. Healthcare leaders continuously rebalance the allocation of resources embedded in operations, credit position, and retained fixed and financial assets; and there has never been as challenging a resource generation and allocation moment as the one we are in and are likely to remain in for an extended period.
The scary version of all this is that not-for-profit healthcare has entered a resource chasm that will fundamentally degrade the sector’s credit and capital foundation.
COVID and inflation have combined to expose the brittleness of the healthcare resource chassis. The engine—operations—is bumping up against the dual pressures of:
Labor-scarcity-driven strains on converting customer demand into realized financial resources; and
A business model that doesn’t allow the efficient transfer of increased costs onto customers.
The result is unprecedented resource compression that leads to dramatically lower internal and external capital formation;
existential covenant threats; and the temptation, if not the necessity, to use retained wealth (i.e., spend down balance sheet) to support current operations versus funding growth or protecting long-term resiliency.
Every organization must aggressively identify and pursue operating performance improvement initiatives. But every organization needs to extend the idea of performance improvement to balance sheet, with the goal of addressing three total enterprise considerations:
What Is Our Resource Portfolio?What is the catalogue of resources available to the organization? What form are those resources in? What is the roster of demands on those resources and is there balance or imbalance between the two? What are the consequences of imbalance and the costs of moving to balance?
What Are Our Resource Priorities?How dependent is your organization on balance sheet to achieve success? Is balance sheet a critical liquidity or credit buffer against elevated operating and strategic volatility—the bridge between today and a successfully implemented operations performance improvement plan? Is it a source of external capital to fund strategic initiatives or defend overall liquidity? Is it an actual funding source and is this a departure from past practice? Is it an independent and alternative source of (non-operating) cash flow? Is the balance sheet role changing and what does that mean to operations, credit, resiliency, etc.?
How Should Our Resources Be Positioned? Are balance sheet resources in their best form or is there a benefit from converting them into something different (like cash)? Will performance improvement initiatives alter positioning conclusions and, if so, does that improvement occur over an acceptable time frame? Can various resources be successfully converted today or are there cost or other impediments?
The need is to move out of siloed and into integrated and enterprise-centric performance improvement, which requires one consistent resource allocation mindset applied across operations, liabilities, real estate holdings, financial asset holdings, and every other class of organizational resources.
The need is to transition from thinking that balance sheet and operations can be disconnected thoughts to seeing them as two sides of the same coin.
Covenant threats continue to escalate, all centered on how reduced resource generation impacts debt service coverage.
We reiterate that it is critical for every organization to understand how its specific covenants work and to have a rolling forecast on expected performance.
As an example, many organizations now have coverage covenants where default requires two consecutive years of below the coverage ratio. This is an unconditionally good thing, but many of these same organizations may face a consultant call-in at year one and some of them may also confront year-two limitations on additional debt, merger, sale, disposition of assets, and a host of other important management levers. So, the good thing has conditions that are essential to understand and, perhaps, get ahead of. We have a robust library of covenant-related thought leadership on our website—ranging from written content to webinars—and our team is always ready to help.
The coronavirus is mainly affecting the credit outlook for the rest of the year and beyond as hospitals adapt to new financial realities.
While the COVID-19 coronavirus is likely to cause cash flow and liquidity issues for hospitals through the end of the year and into 2021, the credit outlook for the healthcare industry isn’t as dire as some had feared. While there have been some downgrades this year, most of those are attributable to healthcare financial performance at the end of 2019.
At a virtual session of the Healthcare Financial Management Association on Wednesday, Lisa Goldstein, associate managing director at Moody’s Investors Service, said the agency is taking a measured approach to issuing credit ratings and will “triage” these ratings based on factors such as liquidity and cash flow.
“Changes are happening daily, and sometimes hourly with funding coming from the federal government,” said Goldstein, “so we’re taking a very measured approach.”
Healthcare is among the most volatile industries being affected by the coronavirus due to the fact that it operates like a business, with a general lack of government support to pay off debt.
Credit downgrades are on the rise, but there’s historical precedent at play. Looking at data beginning with the 2008 financial crisis, there were consistently more downgrades than upgrades in the healthcare industry, owing to its inherent volatility. It was and has generally been subject to public policy and competitive forces. In any given year, downgrades exceed upgrades.
After passage of the Affordable Care Act, however, the number of uninsured Americans hit an all-time low. Hospitals grew in occupancy and revenues improved. The situation started to worsen once more when it became clear that there was a national nursing shortage, as well as top-line revenue pressure from government and commercial payers lowering their rates, but credit downgrades didn’t truly explode until this year. There have been 24 downgrades so far this year, already exceeding the 13 downgrades in all of 2019.
The rub is that it’s not the coronavirus’s fault.
“Most downgrades were in the first quarter of the year,” said Goldstein. “We did have a lot of downgrades in March, which is when the pandemic really started – when it became a pandemic – but even though there were 11 downgrades in March, it was based on what we’d seen through the end of 2019. There were problems that were appearing that had nothing to do with the pandemic.”
Basic fundamental operating challenges were becoming more pronounced during that time. A decline in inpatient cases, a rapid rise in observation stays, a decline in outpatient cases to competing clinics and health centers, and staffing and productivity challenges all contributed to material increases in debt.
COVID-19’s effects on hospital credit ratings are in the outlook for the rest of the year and beyond. Interestingly, in March, Moody’s changed its outlook from negative to stable.
“We haven’t seen anything like this,” said Goldstein. “The industry has been through shocks, but something this long in duration has been something we think will have an impact on financial performance going forward.”
Moody’s anticipates cash flow will remain low into 2021, mostly from the suspension of elective surgeries, rising staffing expenses and uncertainty around securing enough personal protective equipment. Liquidity is still a concern, but is more of a side issue due to Medicare funding providing a Band-Aid of sorts. The CARES act will help to fill some of that gap, but not all of it, said Goldstein.
She added that the $175 billion in stimulus funding is favorable, but modestly so, since it is estimated to cover only about two months’ worth of spending. The good news is that the opportunity to apply for grant money, which doesn’t have to be repaid, can help to fill some of the gap.
Some hospital leaders are concerned that if they violate covenants – also known as a technical default – their credit outlook will be downgraded. Goldstein sought to assuage those concerns.
“Debt service covenants are expected to rise, but an expected covenant breach or violation won’t have an impact on credit quality because it’s driven by an unusual event happening,” she said. “It doesn’t speak to your fundamental history as an operating entity.”
HENRY KOTULA 