Strains weigh on prognosis for healthcare sector

Looming clouds, from a possible recession that could dampen investment revenue and philanthropy to potential federal actions and Medicaid changes, threaten the not-for-profit healthcare sector’s stable outlook this year, S&P Global Ratings warns.

S&P is the most positive among three sector outlooks.


Fitch Ratings assigned a negative outlook to the sector in December, though it also assigned a stable credit outlook. Moody’s Investors Service also in December maintained its negative view on the sector. It revised its outlook to negative from stable for 2018.

Despite pressures that could accelerate, S&P said in its report Thursday the decision to leave the sector with a stable outlook reflects continued balance-sheet strength, a long-term trend of improving business profiles mostly from mergers and acquisitions, and a growing array of diversifying joint ventures.

“Preliminary evidence indicates that operating margins are stabilizing or improving across the rating spectrum, although there are numerous individual exceptions," said S&P analyst Martin Arrick.

Balance sheets remain solid with days' cash on hand and unrestricted reserves to debt generally stable over the past four years, while debt levels improved, and reflect more asset-light and fewer capital-intensive strategies.

But increasing participation in federal healthcare programs from the federal Medicaid expansion and an aging population moving into Medicare coverage limit future revenue flexibility as reimbursements are set by the states and federal authorities. In addition, ballot initiatives to expand

Medicaid in Idaho, Nebraska, and Utah all passed in the recent elections. Medicaid participation can help lower bad debt levels, but also limit revenue growth.

In 2018, S&P saw a generally even level of upgrades and downgrades and less of a gap between favorable and unfavorable outlook changes compared to 2017. In 2018, S&P upgraded 40 credits and downgraded 47. More than 80% of rated healthcare providers carry a stable outlook.

“We recognize the sector as a whole faces risks, which a three-year trend of increasing negative outlooks and declining positive outlooks reflects,” S&P added.

Factors that could pressure credit profiles include a potential recession, continued Medicaid changes, increased traction from non-traditional competitors, and heightened cost and revenue pressure in part due to an aging population.

Analysts also expect federal administrative changes to the Affordable Care Act will have an impact. “The potential ramifications of a recent court ruling that the ACA is unconstitutional could be severe if upheld, although, in our view, this threat would likely be a factor in 2020 or later," Arrick said.

The sector has benefits from mergers and acquisitions and they drove about one-third of 2018 upgrades, but there too challenges loom as state and federal regulatory intervention, which has blocked some proposed combinations in recent years over anti-competition concerns, could intensify, S&P said.

Strains may weigh most heavily on lower-rated systems in the BBB category that have seen more downgrades and negative outlook assignments than their AA peers. The lower-rated systems are less able to manage through challenges.

Fitch said its negative sector outlook reflects a “longer term view that not-for-profit hospitals and health systems will continue struggling with operating profitability and larger industry challenges.”

The stable rating outlook stems from the expectation that most rating actions will fall under the affirmation category.

Moody’s negative position on the sector “amid glimmers of stability” stems from concern that operating cash flow will be flat or decline by up to 1% during the 12-18 month outlook period while revenue growth is expected to be constrained by weak volume trends, low-single-digit reimbursement rate increases and more Medicare patients.

On the plus side, expense growth is anticipated to ebb aided in part by cost-cutting initiatives and lower increases in drug prices. Moody’s also believes merger and acquisition activity will remain strong “allowing hospitals to expand geographically and offer more services.”

Healthcare borrowing last year landed at $25 billion, down from $38 billion in 2017, $39.7 billion in 2016, and $24.9 billion in 2015.

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