Fitch thinks margin cuts threaten credit ratings of non-profit hospitals

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The credit ratings of the nation’s non-profit hospitals will be at risk this year as investment losses and rising costs hurt profits, according to a new report from Fitch Ratings.

The cash and investment portfolios provided a significant rating cushion and helped hospitals cope with significant operational challenges in 2022. However, this cushion has decreased due to the decrease in the value of the portfolio as a result of the market decline.

Operating margins have been hit hard over the past year by cost inflation, especially for staff, and weaker liquidity will mean operations may have even less flexibility to cover higher costs. Cash flow could cushion the portfolio decline, but continued spending pressure this year is likely to limit this cash-generating flow.

Fitch notes that healthcare systems with comparatively weaker balance sheets for a given rating category are more likely to face negative rating pressure.

WHAT INFLUENCES

Higher-rated loans tend to have stronger balance sheets, with a cash-to-adjusted debt ratio of 249.1% for AA loans compared to 102.3% for BBB loans, based on the 2021 median.

Higher-rated loans also tend to be larger, scalable systems with competitive positioning, which reduces balance sheet squeeze if investment performance declines, Fitch notes.

Although not as common, small institutions may have a larger financial cushion indicative of a high investment grade, which in turn may allow them to withstand higher asset volatility in investment portfolios.

“While alternative investments may be part of a broader investment strategy, non-fixed income asset classes have increased as a percentage of highly rated issuer portfolios over the past few years in search of yield,” Fitch writes. “Aggressive portfolio allocation is likely to result in more balance sheet volatility in a tight economic environment.”

Over the past few years, average investment income has generally been around 2% of revenue, measured as operating revenue and non-operating income, for all Fitch-rated non-profit hospitals.

BIG TREND

Fitch’s findings are in line with a trend the ratings agency identified in August 2022 when it downgraded its outlook for non-profit hospitals and healthcare systems to “worse”.

Employment has been the sector’s biggest hurdle, according to Fitch, and broader macro-inflationary pressures make the sector even more vulnerable to future stresses.
This was most felt in nurses, who were already in high demand before the pandemic, and COVID-19 has only exacerbated the woeful shortage of nurses.

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