NEW YORK--()--Fitch Ratings has revised its Outlook on the U.S. not-for-profit hospital sector to Negative from Stable. The Outlook revision reflects Fitch's observation and expectation of material weakening in several areas affecting hospital creditworthiness. Fitch expects that rating downgrades will exceed rating upgrades for the next 18 to 36 months.
While bond ratings contemplate a certain amount of performance variability due to business cycles and other reasons, the combined effects of investment portfolio losses, increasing uncompensated care, and higher capital costs are adversely affecting many hospitals' credit profiles. Further, state and federal budgetary pressures stemming from the economic downturn are anticipated to constrain governmental reimbursement programs, while the business sector is expected to continue to shift healthcare costs to its employees. These factors, coupled with projections for increasing unemployment over the next several months and declines in acute care utilization, are expected to depress operating profitability for the next few years.
The equity market downturn, which began over a year ago and accelerated this fall, has eroded the liquidity cushion that many hospitals amassed from 2004 to 2007. While unrestricted reserves in many cases are still substantial, observed drops in days cash on hand (DCOH) of 20%-30% from 2007 to 2008 are not uncommon. The credit rating implications vary from institution to institution, and partially depend on the absolute liquidity level. For example, a decline from 100 DCOH to 70 DCOH is more troubling than a drop from 250 DCOH to 175 DCOH.
As the economy slides into what many expect to be a prolonged and severe recession, hospitals have begun to observe two expected results: increasing uncompensated care and declining utilization. Both factors have reduced operating profitability, and are expected to do so over the next several months. Fitch also expects fiscal pressures at state and federal levels to curtail growth in governmental funding levels, further challenging bottom lines. Finally, hospitals' access to low cost capital is not expected to substantially improve over the near term. As a result, higher capital costs will be unavoidable for many institutions, as hospitals are forced to debt finance committed projects at higher interest rates, and as liquidity enhancement for variable rate demand obligations remains scarce and expensive.
These negative factors have not affected Fitch-rated hospitals equally. Generally, higher rated systems, which tend to be those that built up larger reserves of unrestricted cash and investments, those having geographic diversification sufficient to offset sharp losses in certain markets, and those that consistently posted strong operational profitability through effective management practices, are better equipped to withstand the effects of an economic slump and reimbursement pressures. These organizations also tend to have better access to capital, more financial flexibility, and ample resources to continue to make capital investments to ensure their competitiveness. However, the effect has been and is expected to be more severe for lower rated credits, which are often smaller and operate in single competitive markets, exhibit profit volatility, or show flat or declining utilization trends. Fitch expects to see rating downgrades moderately weighted toward lower rated hospitals, as well as an increase in merger activity as these more challenged providers seek to best serve their communities through partnerships with stronger entities.
In response to the events and conditions of the past several months, and in anticipation of continued economic and regulatory stress, most hospitals have taken steps to address the difficult operating environment's effect on creditworthiness by curtailing or deferring capital spending, reducing staffing to bolster profitability, and, in some cases, adjusting investment allocations to limit further equity losses. Fitch believes these actions, as well as the sector's substantial profitability and balance sheet strength built up over the past several years, should mitigate the brunt of the challenging headwinds for many hospitals.