Not-for-profit hospital downgrades surged in 2017

The ratio of not-for-profit hospital and health system credit downgrades to upgrades rose in 2017 to levels that were even higher than during the Great Recession in 2008 and 2009, according to a new report from Moody's Investors Service.

There were 41 downgrades and 12 upgrades in 2017, a ratio of 3.4-to-1. That's compared with 2.8-to-1 and 2-to-1 in 2008 and 2009, respectively. Last year's ratio was also higher than in 2016, a year that saw 32 downgrades and 21 upgrades, or a 1.5-to-1 ratio, according to Moody's.

"When we saw the ratio, we were like, 'Wait a second, wait a second, what's going on and what just happened?'" said Lisa Goldstein, an author on the report and an associate managing director with Moody's. "That's when we peeled a little bit of the onion back and said, 'It's the general pressures of the industry.'"

The Great Recession brought severe volume declines as people put off surgeries and other procedures, along with interest rate spikes driven by risky debt structures. Even though the country's economy is stronger today and more Americans have insurance, the healthcare sector is facing a whole new set of challenges.

Hospitals and health systems today are dealing with rising pharmaceutical, supply and labor expenses and difficult payer environments in which commercial payers in some cases steer members toward free-standing imaging and urgent-care centers, contributing to the ongoing issue of flat volumes at some hospitals. That leaves many systems with expense growth that outpaces revenue growth.

Importantly, more than 60% of last year's downgrades were among small to medium-sized hospitals and health systems with less than $1 billion in operating revenue, demonstrating that larger systems are better positioned to weather industry challenges. That's because systems that are spread across multiple cities or states can use sites that are performing well to subsidize those that are under stress, Goldstein said.

"Whereas if you're a single site, you're not going to have that diversification at least geographically to absorb if there is a down year," she said.

Twelve of the downgrades in 2017 were in Ohio and Pennsylvania, states where Moody's said health systems are further bogged down by lagging economies, aging demographics, a difficult payer environment and competitive service areas.

In Pennsylvania, half of the state's rural hospitals operated at a net loss in 2016, compared with 29% of hospitals overall, said Jeff Bechtel, senior vice president of health economics and policy for the Hospital and Healthsystem Association of Pennsylvania. And rural hospitals disproportionately rely on government programs like Medicare and Medicaid, which reimburse less than commercial payers, he said.

"In addition to the rural nature of the state, the older demographics, the difficult financial operating results, a lot of it I think is the disproportionate reliance on government programs," he said.

In Ohio, some providers are starting to adopt value-based reimbursement strategies, which can lead to acute operational challenges that rating agencies frown upon, said Mike Browning, chief financial officer of Toledo, Ohio-based ProMedica Health System. Moody's issued a downgrade for ProMedica one year ago affecting about $775 million of the health system's debt.

"We're making decisions that are good long-term decisions, but sometimes might have negative financial consequences in the short run," he said.

Browning said ProMedica's expensive Epic implementation in 2016 was a major contributor to the system's operating loss that year, which he described as being another temporary factor.

John Palmer, a spokesman for the Ohio Hospital Association, wrote in an email that the Moody's report reaffirms its deep concerns about the financial challenges hospitals in the state face. He said 61 Ohio hospitals have low or negative operating margins.

"The challenges facing not only this group, but all Ohio hospitals, are clearly driven by reimbursement pressure from Medicare and Medicaid, renewed efforts by commercial payers to exclude more services from payment, growing pharmaceutical and supply chain costs, physician and nursing shortages, and the costs of keeping up with new health care technology," he wrote.

Mergers and acquisitions had both a positive and negative impact on credit quality last year. Baptist Health South Florida was downgraded after acquiring Bethesda Healthcare System.

Similarly, the UMPC health system was downgraded after its merger with Pinnacle Health System. Other factors like revenue and expense pressures influenced both of those cases.

In its year-ahead outlook for the not-for-profit and public healthcare sector in December, Moody's downgraded the sector from stable to negative for 2018. Given that downgrade, Goldstein said she expects the downgrade-to-upgrade ratio to remain elevated this year.