How much do not-for-profit hospitals depend on a bullish stock market? A lot, say the nation's top credit-rating agencies.
More and more, hospitals that can't cover their expenses through operating income are using investment income to keep their bottom lines in the black. That trend is helping to erode the industry's credit ratings and tighten the credit crunch that many systems are already feeling.
Analysts for three major ratings agencies offered grim forecasts for hospital chief financial officers at a recent conference sponsored by Chicago-based consultant Kaufman Hall. The analysts cited numerous pressures, including declining reimbursement from Medicare and managed-care payers.
But they repeatedly noted that if the stock market loses steam, investment income, which offsets low or negative operating margins at many systems, may fall in the coming year.
That would accelerate the increase in credit downgrades.
A recent report from Standard & Poor's warned, "Given widespread softness in operating results, many systems are depending increasingly on investment income, raising the risk of further credit deterioration if the stock market turns down suddenly."
Median excess margins at hospitals and hospital systems have remained relatively stable for the past three years, according to data provided by New York-based Fitch IBCA and other credit-rating agencies.
That stability has resulted from systems' increasing reliance on investment returns to offset decreasing operating margins, said Jordan Melick, a Fitch analyst who spoke at the Kaufman Hall conference.
Examples of such systems include Catholic Health East, with an AAA rating. The system posted a 1% loss in 1998 but a total profit of 6.7%, largely because of strong investment income, according to Fitch.
Ascension Health-the company formed by the recently completed merger of Daughters of Charity National Health System and Sisters of St. Joseph Health System-has an AA rating and also relies on investment income for its fiscal health. Fitch's consolidated financial report for Ascension's fiscal 1999 shows operating losses of $56.7 million but a net profit of $190.1 million.
Catholic Health Initiatives has also relied on stock market returns to improve its financial performance.
But even CHI's substantial investment income-$119 million in fiscal 1999 ended June 30-couldn't erase its operating losses of $141 million. Those losses included $101 million in one-time charges, about half of which were from write-offs of impaired assets stemming from underperforming hospitals. Fitch recently downgraded CHI's debt to AA-.
Linda MacDonald, director of capital finance at CHI, said, "We do not accept this level of unprofitability. We cannot carry forth our mission with these losses."
She projected a slight positive operating margin for fiscal 2000, based on projected cost cutting, sales of physician practices and renegotiated contracts with managed-care plans. The $7 million projected operating income would balloon to a total positive bottom line of $115 million because of investment income, she said.
"Investment income is making up a larger portion of the bottom line with the squeeze of managed care and the Balanced Budget Act (of 1997)," said Anthony LoVaglio, a healthcare analyst at Fitch.
"We expect it to continue to the next year or two, but in the long term we do expect (hospitals and systems) to return to positive operating margins," he said.
Median operating margins for not-for-profit systems rated AA fell to 3.7% in 1998 from 6.1% in 1996. But during the same period, total excess margins dropped more slowly, to 7.7% from 8.8%, according to Fitch.
Total excess margins figure prominently in credit ratings, since agencies calculate debt coverage based on bottom-line profitability, LoVaglio said. But agencies pay special attention to operating margins, since a hospital's long-term viability depends on its management of operations rather than its investment strategy.
A cooling stock market could also affect liquidity, which in recent years has improved in the sector. Hospitals have had more days of cash on hand, partly because of strong investment returns. A decrease in available cash could precipitate credit downgrades.
Moody's Investors Service issued more downgrades in 1998 than in the entire prior decade, according to Dennis Farrell, a Moody's analyst who spoke at the conference. He said 1997 was a banner year for investment income and cautioned that total revenues in that year "masked programmatic problems."
The sector fared similarly under scrutiny by Standard and Poor's. For the first time in several years, the amount of debt downgraded in 1998 exceeded the amount upgraded, according to analyst Susan Hill. She noted that the downgrade trend would likely continue this year. Currently 11% of outlooks in healthcare are negative, and 5% are positive.