Providence could have rating downgrades if it doesn't explain its plan to right the ship after this month's separation with Hoag.
Two of the Big Three credit rating agencies, Fitch Ratings and S&P Global Ratings, have placed the 52-hospital, $26 billion health system on credit watch with negative implications. The alert is designed to be temporary, essentially letting investors know the agencies have questions.
"What we need to know is: Now what for Providence? Where do you go from here?" said Kevin Holloran, a senior director with Fitch. He said Fitch already has a meeting scheduled with Providence's top brass.
It's not just that Renton, Washington-based Providence is losing an important source of cash and revenue in Hoag, the small Southern California-based health system that sued to unwind its 2013 merger with Providence. Not-for-profit Providence has lost hundreds of millions of dollars on operations in recent years, mostly because of the COVID-19 pandemic. The health system declined to comment.
Providence lost more than $300 million on operations in 2020, a 1.2% loss margin. That's even with $957 million in federal COVID-19 relief grants. The health system cited an "unprecedented" drop in volumes combined with "significant" costs to support caregivers and serve patients, including increased labor, personal protective equipment and pharmaceutical spending.
That loss grew to more than $400 million in the first nine months of 2021, the latest period for which financial results are available. That's an even larger 2% loss margin.
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Providence explained in the 2021 report that it weathered two separate COVID-19 surges in the first 9 months of that year. Although net patient revenue grew 11% over the prior-year period, those increased admissions, emergency room visits and outpatient visits corresponded with higher labor costs and more frequent use of expensive travel nurses. Providence also noted that the $170 million in federal stimulus grants it recognized during the period was much lower than the $682 million recognized during the same period in 2020.
Fitch said in its report Friday announcing its Rating Watch Negative that Hoag represents 6% of Providence's operating revenue and 17% of its unrestricted cash and investments. Fitch wants to learn about the mechanics of the separation, which caps Hoag's legal effort that started in 2020 to dissolve the merger. For example, Holloran said he doesn't know whether the outstanding debt stays with Providence or goes with Hoag, nor how much cash goes with Hoag.
S&P said in its own report issued Jan. 19 it's placing Providence on CreditWatch with negative implications because of the Hoag separation. While Hoag is much smaller than Providence, the separation is likely to put financial strain on Providence, the report said.
"It has historically had weaker operations and the balance sheet has helped support that profile as they've been making investments and weathering the impact of COVID," said S&P credit analyst Suzie Desai. "It reflects just the sizable amount of reserves leaving the system. Does that current rating still hold where it is today?"
Fitch's report said it hopes to resolve the designation by the end of the first quarter. Desai said S&P aims to resolve the designation within 90 days. Both agencies said if a downgrade results, it probably wouldn't be more than one notch.
For its part, Moody's Investors Service has not made any rating changes on Providence's bonds since it assigned an Aa3 rating with a stable outlook in September.
On the bright side, Fitch wrote that Providence enjoys "excellent" market position in its key markets across its seven states, all with solid economic and demographic growth.
Providence has worked to position itself as a leader in the push toward revenue diversification. CEO Dr. Rod Hochman announced in early 2020 his system's goal of deriving $1 billion in revenue—with a minimum 30% earnings before interest, taxes, depreciation and amortization margin—from sources outside of patient care by 2022. The system didn't say Friday whether that had been achieved.
In any case, Providence has announced a number of ventures outside of healthcare delivery in recent years. It acquired Bluetree, a consulting firm that specializes in managing Epic electronic health record systems. It launched Ayin, a for-profit population health management company.
"They do that very effectively they're very innovative," Holloran said. "I'm always amazed and impressed when I see what they've been doing."
