Hospital sector’s struggles aren’t over but recovery progressing

Not-for-profit hospital balance sheets are on the mend from last year’s challenges that inflicted deep damage on balance sheets, but pressures persist and the recovery is slow going, according to reports published this week.

Hospital finances showed signs of stabilizing in May with some improvement in operating margins, declining expenses and notable increases in outpatient visits, Kaufman Hall reported in its National Hospital Flash Report for May.

Financial performance has rebounded from the inflationary, supply side, and labor cost scars that dragged down margins last year but the recovery is uneven with some credits lagging and outlook and ratings are still expected to trend toward the negative just at a slower pace in the second half of the year, S&P Global Ratings said.

Early 2023 financial results are mixed with revenues and demand generally healthy but expenses, both labor and non-labor, remain elevated for many and that’s driving S&P’s ongoing negative view of the sector.

“We expect a longer tail to recovery of a couple more years,” said S&P analyst Suzie Desai said in the rating agency’s midyear sector outlook.

S&P expects improvement from 2022’s operating losses for most providers over the remainder of 2023 and into 2024 although for some that simply means a reduction in losses or breakeven to just slightly positive margins. Improvements are being driven by better staffing trends, reduced use of costly nursing agencies, and related costs and some easing of inflationary pressures.

“That said, we expect that most providers will continue to underperform financially relative to pre-pandemic through the remainder of this year and going into 2024,” S&P said. “The ability of providers to demonstrate improved performance, despite the broad sector pressures, will be key to credit stability.”

Through May, S&P saw a rise in downgrades including some multi-notch drops mostly for ratings in the BBB category and below.  About 16% of rated health systems carry a negative outlook while 23% of stand-alone hospitals are negative.

Analysts will be watching for pace and sustainability of performance recovery; post=pandemic run rate for performance; and broader credit characteristics including financial flexibility and enterprise strength as they review specific credits.

Payor rates still lag inflationary expense growth and the end of the federal COVID-19 emergency adds to the pressure because it also eliminates some higher reimbursement rates. Labor costs remain a primary challenge.

“We continue to watch net hire trends, which are positive for many providers in 2023, despite turnover remaining above pre-pandemic levels. Given the significant staff turnover in the past few years coupled with increased demand from baby boomers, we expect it will take several years to get staffing to levels that adequately meet demand in a cost-effective way,” S&P said.

Reserves have stabilized, providing credit stability for many, with investment losses easing and capital spending slowed. Expense growth could chip away at that growth.

“We expect cash flow will be pressured and capital expenditures will continue to ramp up as teams refocus on strategic projects,” S&P said. “As a result, reserve growth could slow, and days’ cash on hand would have limited improvement (and could decline) given the rising expense base.”

The threat of covenant violations has eased but threats remain.

“To date, we’ve seen banks and bondholders willing to provide appropriate approvals and agreements, but there could be greater risk for the lower-rated and more challenged provider,” S&P said.

Covenant violations don’t necessarily trigger a rating change as analysts look at the issuer’s business position, overall balance sheet, particularly unrestricted reserve strength, and view of the viability of management’s plan to address underlying performance issues, S&P said.

Kaufman Hall’s monthly margin review reported a slow return to positive territory based on year-to-date medians at 0.3% in May, up slightly compared to 0.1% in April and March. While on the mend, they remain sharply below levels seen in the second half of 2021 as hospitals recovered from the pandemic-driven shutdown of some services in 2020.

Adjusted discharges per calendar day, emergency department visits and operating room minutes all rose between April and May 2023 and between May 2022 to May 2023, suggesting patients are more comfortable seeking services.

“Hospitals may no longer be experiencing the post-pandemic effect of pent-up demand for inpatient services, but patients are showing us they are becoming more comfortable with receiving care in this setting,” said Erik Swanson, senior vice president of data and analytics with Kaufman Hall. “Hospitals can expect a ‘new normal’ of slowly increasing margins that may never return to pre-pandemic levels without reevaluating how and where care is being delivered.”

The financial advisory’s firm’s National Hospital Flash Report relies on data from more than 1,300 not-for-profit and for-profit hospitals from Syntellis Performance Solutions.

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