Although few would claim that credit is flowing freely to the majority of healthcare companies these days, bankers know they can't ignore an industry that represents about $1 trillion of the national economy, or about 13% of the U.S. gross domestic product.
"As bankers, as lenders, healthcare is almost impossible to avoid," says Vincent Kelly, senior vice president of healthcare services at Bank One in Chicago, who manages a multimillion-dollar healthcare portfolio for his organization. He spoke about bankers' view of the industry at a recent Chicago conference of lenders sponsored by Philadelphia-based RMA: The Association of Lending and Credit Risk Professionals.
Many factors have combined in recent years to make healthcare a greater credit risk, including a dramatic downturn in the nursing home industry, a slide in hospital profits, declining reimbursements from the federal government, the growth of government investigations into the sector, the corporatization of physician practices and increasing drug costs.
In the first quarter, healthcare continued to lead the list of least-attractive industries for lenders, according to a national survey by Phoenix Management Services (April 3, p. 22). It was the fourth consecutive quarter that healthcare ranked at the bottom.
"The strong are suffering too," Kelly says of the current environment, noting that even some of the largest hospital systems have suffered declining profits and credit downgrades in recent years, sometimes seeing their credit risk rise through mergers and acquisitions that were intended to make them stronger.
In the hospital sector, many facilities continue to be good business for bankers. To find the strong hospitals and weed out those that are poorly run, lenders need to look at a combination of indicators, Kelly says.
What makes a hospital or healthcare system a good credit risk ranges from flexible management to a high liquidity level to having sources of investment income. Of particularly critical importance, according to Kelly, is whether the hospital in question is one that patients like to use.
"Having critical mass in a particular market has a direct effect on credit strength," Kelly says.
Pamela Federbusch, a senior vice president at New York-based Moody's Investors Service and the author of the credit-rating agency's annual outlook on the not-for-profit hospital sector, agrees.
"I think market leadership is an issue," she says.
Market leaders generally have a healthy amount of cash on hand. As demand for services grows and the tight labor market continues, those with greater liquidity will be better able to weather the changes in market dynamics, Kelly says. Liquidity gives a hospital flexibility to pay down debt, deal with hiring shortages and cope when managed-care companies stretch out the length of time it takes to pay claims.
Cash-flow generation and its consistency are crucial in determining creditworthiness, Federbusch says.
The median number of days' cash on hand for a hospital with an Aa rating from Moody's, one of the top ratings available without insurance, is 255.2 days. For an A rating, the median is 200.5 days; for a Baa rating, it's 100.2 days. While Moody's doesn't set thresholds for each rating, overall financial performance is one of six categories the firm considers when determining a rating. The others are management team, medical staff, competition, legal structure and services of the rated hospital or system.
The ratio of cash-to-debt is also generally high in successful systems with low credit risk: for an Aa rating, the median is 183.6%; for an A rating, it's 115.4%; and for a Baa rating, it's 64.8%, according to Moody's (See chart).
Moody's rates about 500 not-for-profit hospitals and health systems with more than $60 billion in outstanding debt. The average median rating for the hospital sector is A3, an investment-grade rating.
Bottom-line margins are obviously important indicators, too. Lenders need to examine operating margins, total profit and the composition of investment income, Kelly says. If a hospital is relying heavily on investment income, knowing whether that income is weighted toward fixed-payment, stable investments or more-volatile investments is an important predictor of credit risk.
Management is one area where hospitals have shown weakness, Kelly says.
"We need to be much more fleet-of-foot on the provider side in dealing with this rapidly changing market," he says.
Primarily, lenders should be concerned with whether management is truly managing or, in other words, with whether executives are in control of the business.
"Last year, we saw many hospitals were very successful in forecasting the impact of the Balanced Budget Act of 1997 on them, but not as successful in forecasting the impact of managed-care problems," Kelly says.
Federbusch says Moody's also pays close attention to top management.
"Having a strategy for the future and being able to anticipate change rather than react to change--strategic vision-is very important to us," she says.