Fitch Ratings is projecting a stable outlook for the not-for-profit hospital market this year, but all bets are off after 2006.
"We are definitely concerned about the environment after 2006, and it stems from the revenue picture," said John Wells, senior director for the rating agency.
In a special report scheduled to be posted on its Web site later this week, Fitch said it expects 2006 operating margins to be no worse than the 2005 median 2.1% operating margin among its 250 rated hospitals and systems. Hospital downgrades also are expected to slightly outpace upgrades 1.41 to 1, as they did last year. For the first three quarters of 2005, upgrades exceeded downgrades, but the fourth quarter reversed that trend for the year, Wells said.
Fitch said it will weigh good management and governance practices as they play an important role in financial performance, in addition to market share and payer mix. It expects hospitals will increasingly disclose financial and operational improvement and provide detailed public information about community benefits for the uninsured, compliance with Sarbanes-Oxley and a "vigorous internal audit function" that reports to the board of directors.
"Disclosure practices have just improved significantly. There is an increased area of transparency ... which we think benefits health systems, particularly as they go to the market to borrow money," Wells said.
Hospitals also are expected to face greater state and federal scrutiny of their tax-exempt status with questions about their charity-care, billing and collection practices for self-pay and uninsured patients, and executive compensation. Fitch believes that "good disclosure is a key indication of management strength and will continue to comment in its rating reports about the quality of a hospital's disclosure," according to the report.
Michael Peregrine, a partner at law firm McDermott Will & Emery, agreed that while regulations won't necessarily change, he expects state attorneys general and the Internal Revenue Service to hold not-for-profit directors more accountable for their actions. States especially are being more aggressive in seeking to remove directors from boards "for perceived breaches in oversight," Peregrine said. Congress and other regulatory bodies will be thinking hard about what it means to be a tax-exempt charity. "The not-for-profits have got to be able to clearly demonstrate why they are deserving of tax-exempt status," Peregrine said.
Despite comparatively easy access to capital for the financially healthiest hospitals, Fitch said it remains concerned in 2006 about insufficient capital spending. The median average age of plant facilities-9.8 years in 2004-and capital expenditures as a percentage of depreciation expense are trending negatively, according to Fitch. Fitch said it doesn't expect any significant improvement in the average age of hospital plants over the short term.
In addition, Fitch said it expects limited merger and acquisition activity in 2006, as there was in 2005, with some activity chilled by the Federal Trade Commission's recent ruling ordering Evanston (Ill.) Northwestern Healthcare to sell Highland Park (Ill.) Hospital (Oct. 24, 2005, p. 6).
Competition with physicians over the development of outpatient and free-standing specialty facilities also remains a concern for Fitch, but "generally speaking it is a fairly stable environment" for not-for-profit hospitals, Wells said. "Some of the results in 2005 exceeded our expectations, but we are concerned about an expected instability in the sector as we" go beyond 2006.