How well are hospitals and health systems adjusting to change?
"Basically the story of 1996 will be financial stability," said Robert H. Muller, managing director of municipal bond research at J.P. Morgan Securities, New York. But he has some longer-term concerns about the fiscal health of urban hospitals.
Eighteen months ago, Muller began tracking the riskier end of the healthcare bond spectrum. His index of 35 "higher-yielding" hospitals and health systems, rated A or lower, includes a geographically diverse sample of institutions in large urban centers, small cities, suburbs and rural areas.
Muller is keeping the hospitals' names under wraps because some of the data are unaudited and some facilities prefer to remain anonymous.
His first report, dated January 1995, noted a "slight weakening in financial performance" in the quarter ended Sept. 30, 1994, compared with the year-ago quarter. The report uses "net margins," which reflect net income as a percentage of revenues.
For the quarter ended Sept. 30, 1994, the average net margin of the 35 higher-yielding hospitals rose to 4.56% from 4.32% in the year-ago quarter. The median net margin slipped to 3.84% from 4.17%. Eighteen hospitals saw net margins rise during the quarter, while 17 had decreased net margins.
The sample showed continued financial improvement throughout 1995. For the quarter ended June 30, 1995, the average net margin increased to 4.99% from 4.19% in the three months ended Dec. 31, 1994. The median net margin reached 4.53%, the highest level for any quarter in the previous 18 months. Meanwhile, the number of hospitals with increased net margins (21) outpaced the number with decreased net margins (14).
Muller's latest report, dated May 17, shows higher-yielding hospitals finished 1995 "in solid fashion." For the quarter ended Dec. 31, the median net margins rose to 4.57% from 4.27% in the year-ago quarter. The mean net margin jumped to 4.84% from 4.08%. In addition, 20 hospitals reported higher net margins than in the previous year.
Breaking the fourth-quarter 1995 results into urban, suburban and small and rural categories, Muller found substantial variation. Predictably, suburban hospitals did the best, with a median net margin of 4.71%. Rural facilities and small-city hospitals posted a median of 4.2%, "probably a reflection of lower cost structures and less managed-care penetration," he wrote. Urban hospitals ended the quarter with a weak median of 2.15%, half of what rural facilities and small city hospitals were able to do.
Five of the 35 hospitals in the original sample have merged since Muller created the index. The mergers occurred among the weaker hospitals in the group, he said. One of them, Tulsa (Okla.) Regional Medical Center, was purchased earlier this year by Columbia/HCA Healthcare Corp.
In the first 18 months of tracking "there were a lot of quickie marriages," Muller noted. Now that initial fears have eased a bit, the merger process has become more measured, he said.
In fact, Muller now is seeing a number of formal affiliations. He thinks a lot of big not-for-profits will do something short of absorbing other hospitals "because it will dilute their credit ratings," he said. For example, an A-rated hospital may be willing to affiliate with a B-rated institution, but an outright acquisition could be risky.
While the study hasn't formally tracked bond-rating changes among the sample hospitals, Muller thinks the ratio of upgrades and downgrades is about even.
Because of uncompensated-care costs and other difficulties of doing business in the inner city, Muller suspects urban hospitals may be the "least marriageable." While for-profit chains looking to enter new markets will buy some of them, lower-rated urban hospitals may need to offer a "compelling strategic advantage to be fully considered," he wrote.
Muller also expects Congress to revisit Medicare and Medicaid reductions in 1997 and 1998, which would have a disproportionate effect on urban hospitals.
Overall, there is no reason not to "selectively acquire" lower-rated hospital bonds, he said. Because spreads between yields of higher-yielding healthcare bonds and other A-rated municipal revenue bonds have narrowed, trading of tax-exempt healthcare bonds is somewhat improved. "But liquidity is still not great," Muller said.