Credit and equity market gains in recent months may have restored healthcare borrower finances, but the sector's outlook remains shaky.
Analysts outlook uncertain for hospital borrowers
One major credit agency announced last week that it would expand its measures of liquidity—money not tied up by donor restrictions or longer-term investments—for not-for-profit borrowers. The heightened focus on liquidity comes after large amounts of cash evaporated from balance sheets during the credit crisis and bank distress left healthcare borrowers with the risk of paying off some bonds very quickly.
Though less popular since the crisis, bonds backed by banks—sold to short-term investors able to exit deals quickly—still rank as one of many threats to hospital balance sheets and margins as the economy emerges from the worst downturn since the Great Depression, analysts said in recent reports on the sector's outlook for 2010.
Healthcare borrowers face other pressures as well, analysts noted in reports on the sector's 2010 outlook. State Medicaid budgets are likely to be cut, while capital spending slowed last year and hospitals face pent-up demand to invest in technology, buildings and equipment.
Not all news is dour. Some systems have benefited from last year's rebound in tax-exempt credit markets. Catholic Health East went to investors last week for $412 million, mostly to refinance existing bonds at a lower interest rate.
As markets improved in late 2009, the system moved to take advantage of ebbing interest rates, should the conditions continue into the new year, said Randal Schultz, vice president and capital strategy management. They did. Favorable interest rates prompted the system to increase its bond by $14 million, he said. “We could refund more bonds than we originally expected,” Schultz said. Last week's refinancing should shave $27 million off the 23-hospital system's total debt costs, he said.
During the downturn, hospitals successfully cut costs to offset lost revenue from fewer patients and more unpaid bills, but whether hospitals can maintain existing cuts or find new ways to curb costs is unclear, Fitch Ratings noted in February.
Standard & Poor's analyst Martin Arrick, in a conference call last week, said 2010 stands to offer the not-for-profit sector a brief respite from the market and economic distress of 2009 and looming fiscal and health policy pressures in coming years. “But right now it is a little bit of an island of calm,” said Arrick, a managing director for the ratings agency.
That calm may not last in the face of a continued weak job market, Arrick said. One immediate threat to hospital operations are struggling state budgets and an end to extra federal aid for Medicaid—which states jointly finance with the federal government—scheduled for December, he said.
Hospitals face “one of the toughest environments in decades,” Moody's Investors Service analysts noted in January. Severe state budget woes threaten to squeeze Medicaid spending. High unemployment has left fewer privately insured and more patients without benefits or dependent on public subsidies for coverage. Federal aid for state Medicaid budgets will expire in December and workers laid off after March will no longer qualify for insurance subsidies unless Congress acts.
Demand for Medicaid has surged, and states must balance their budgets, which “have not bottomed yet” despite the overall economy's tentative recovery, the National Association of State Budget Officers said last month.
States squeezed $90 billion from 2010 budgets, but that has failed to erase deficits, said a February survey by the association and the National Governors Association. Revenue for 2010—which ends June 30 for all but four states—has fallen short of projections in 41 states, leaving another $19 billion in gaps. States face another $55 billion in gaps for the coming year, the survey found.
Arrick echoed health policy experts and industry executives who have said state budget pressure could prompt cuts to Medicaid benefits, eligibility or reimbursement after December, when federal relief expires.
Under the American Recovery and Reinvestment Act of 2009, which provided $87 billion through the end of 2010 to aid Medicaid budgets, states that accepted aid could not tighten eligibility or benefits for the safety net insurance.
Hospital executives and governors have lobbied for additional aid. President Barack Obama's 2011 budget called for another $25 billion in Medicaid relief for states.
The potential end to federal health insurance subsidies for laid-off workers poses another potential drag on hospital operations, which appears to have stabilized after executives cut costs and curbed capital spending in response to the credit upheaval and recession, Arrick said.
He also noted some healthcare borrowers have adjusted investment portfolios, which have rebounded from lows in early 2009 to better preserve access to cash. “Not only has liquidity come back, it has come back in a more liquid way,” Arrick said.
The move by Moody's to report more detailed ratios of cash underscores how the credit crisis exposed risks on hospital balance sheets. Moody's unveiled four new measures of available cash to a list of 25 financial ratios that analysts may consider when evaluating not-for-profit healthcare borrowers' credit strength.
John Nelson, a Moody's managing director, said financial statements often fail to reflect how much cash is readily available and how much is locked into less-liquid investments, such as real estate, private equity or hedge funds. “Given the experience of the credit markets and the financial crisis of 2007, 2008, we felt like it's no longer just acceptable to describe unrestricted cash and investments as liquid,” he said.
Initially, the ratings agency will include four new liquidity ratios. Moody's will now measure cash available within one month and how long the hospital could operate using those funds, or monthly days cash on hand. Analysts will also calculate the ratio of monthly liquidity to demand debt, or debt that must be repaid should investors choose to exit, such as variable-rate demand bonds or commercial paper. The same two measures will also be calculated for one year.
Existing ratios, such as overall cash to debt, measure wealth, not liquidity, Nelson said.
Analysts note a shift among hospitals and health systems toward more conservative and less volatile debt and investment portfolios.
Last April, CentraCare Health System, based in St. Cloud, Minn., converted $80 million of bank-supported bonds to debt that needs no bank backing and adopted a more conservative and liquid investment policy following the market's upheaval to minimize risk, said Greg Klugherz, chief financial officer of CentraCare.
The changes curbed CentraCare's investments in equities and real estate to 55% and 5%, respectively. Previously, equities accounted for 71% of the three-hospital system's portfolio and real estate made up 13% of its investments. Klugherz said the system, which hired an investment adviser, made the switch after an analysis of its balance sheet risk.
Moody's noted the change when analysts raised the system's credit rating on strong operations, investment gains and the return of collateral from an interest-rate hedge. Moody's analysts downgraded the system in April 2009, despite strong operations, after plunging equity markets and the hedge collateral siphoned off 40% of its liquidity between June 2008 and February 2009.
Klugherz said such volatility may have eased, but uncertainty remains, citing pressure on Medicaid and safety net insurance spending from Minnesota's struggling budget and potential health reform.
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