Suffering margins threaten credit ratings for nonprofit hospitals, finds Fitch

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Credit ratings for the nation's nonprofit hospitals will be under threat this year due to investment losses and rising expenses eating into margins, according to a new report from Fitch Ratings.

Cash and investment portfolios have provided a significant rating cushion and helped hospitals weather significant operational challenges in 2022. That cushion, though, has diminished, with lower portfolio values as a result of market declines.

Operating margins have been hit hard over the past year due to cost inflation, particularly staffing, and weaker liquidity will mean operations may have even less flexibility to address higher expenses. Cash flow could mitigate portfolio declines, but continued expense pressures this year will likely constrain this cash flow generation.

Health systems with comparatively weaker balance sheets for the rating category are more likely to face negative rating pressure, said Fitch.

WHAT'S THE IMPACT?

Higher-rated credits generally have stronger balance sheets, with cash to adjusted debt of 249.1% for AA category credits, versus 102.3% for BBB category credits, based on 2021 medians. 

Higher-rated credits also tend to be larger, scaled systems with competitive positioning that mitigates balance sheet compression if investment performance weakens, said Fitch. 

While not as common, smaller organizations may have a large financial cushion, indicating high-investment-grade ratings, which in turn may allow them to withstand higher asset volatility in investment portfolios.

"While alternative investments can be part of a wider investment strategy, non-fixed-income asset classes have increased as a percentage of highly rated issuer portfolios over the past few years in the search for yield," wrote Fitch. "An aggressive portfolio allocation is likely to result in more balance sheet volatility in a stressed economic environment."

Over the past few years, median investment income has been generally around 2% of revenue, measured as operating revenue and nonoperating gains, for all Fitch-rated nonprofit hospitals. 

THE LARGER TREND

Fitch's findings track with a trend the rating agency identified in August 2022, when it downgraded its outlook for nonprofit hospitals and health systems to "deteriorating."

The biggest impediment to the sector has been labor, and broader macro inflationary pressures are rendering the sector even more vulnerable to future stress, according to Fitch.

Where this was the most felt was in nursing. Nurses were already in high demand pre-pandemic, and COVID-19 only exacerbated a glaring shortage of nursing staff.
 

Twitter: @JELagasse
Email the writer: Jeff.Lagasse@himssmedia.com