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FEATURE
The Influential Big Three
Credit Rating Agency Forecasts
W
ho is the most influential “Big Three” in the U.S. Although the hospital market remains mostly stable, the trend
today?
is negative as downgrades exceeded upgrades across the
board. Most of the negative pressure involves profitability
No, it’s not LeBron James, Kevin Love and Kyrie Irving of metrics as all three CRAs cited a decline in income statement
the Cleveland Cavaliers. Although that trio is sure to make strength throughout the sector. Both highly rated and nonnoise this coming season, the most influential Big Three is investment grade hospitals felt the pain as Fitch observed a
undoubtedly the three credit rating agencies (CRAs) that hold decline in operating profitability across all rating categories
approximately 95% of the world market share for ratings: for the first time in six years.
Moody’s Investor Service, Fitch Ratings and Standard &
Poor’s (S&P).
The income statement pressure is twofold as both revenue
and expense trends have been negative. On the revenue side,
These agencies issue annual reports that analyze past the 3.9% growth cited by Moody’s is an all-time low. Many
performance and provide forecasts for the upcoming year: reasons for the revenue pressure have been citied; softness in
Moody’s on hospitals; Fitch on hospitals and senior living; volumes, especially the more profitable in-patient services,
and S&P on hospitals and housing. These reports provide are most commonly cited. Specifically, inpatient admissions
illuminating overviews that can help industry leaders adjust were down 1.3% according to Moody’s. Increased exposure
to current trends and prepare for future developments.
to Medicaid at the expense of commercial payers also hurt
revenue growth. Lastly, the sun-setting of some one-time or
Hospitals
nonrecurring revenue enhancements, such as meaningful use
Officially signed into law three-and-a-half years ago, the payments and the Medicare rural wage settlement, have also
Affordable Care Act (ACA) continues to keep the health hindered revenue growth.
care sector in the spotlight. As the market has slowly
accepted that the ACA is likely here to stay, the conversation Although the year-over-year expense rate growth slowed,
has shifted from appeal attempts to how the law impacts the expense growth exceeded revenue growth for the period
financial landscape of hospitals. The hospital median reports reviewed. Considering the financial pressures hospitals have
recently released by the three largest CRAs provide ample been under the past few years, hospitals are struggling to find
opportunity to do just that.
additional expense cuts and much of the low-hanging fruit
has already been picked. Increased personnel costs related to
S&P Nonprofit Health Care System Upgrades vs. Downgrades
implementation of ACA provisions, training for electronic
*Represents rating actions between issuance of two reports (approximately July-June)
health records (EHR) and the eventual transition to ICD-10
20
have all provided additional expense pressure. The result is a
18
net operating margin of 9.0%, another all-time low according
to Moody’s.
16
14
12
Upgrades
10
Downgrades
8
6
4
2
0
2007
2008
2009
2010
2011
2012
2013
2014
The negativity of the profitability metrics has been partially
offset by the strengthening of the liquidity metrics, which
have provided a much needed cushion for hospitals. The
median cash and investments balance increased in 2013
to 11% according to Moody’s (growth was in the single
digits in the several years prior). Other positives included
stable leverage metrics, a slight increase in days in accounts
receivables, and improved cash-to-debt ratios. A strong stock
market, aggressive revenue cycle management and decreased
capital expenditures have contributed to this improvement.
The rating agencies have also touched on topics to monitor
moving forward that could potentially impact the hospital
sector. For example, will more states participate in the
Medicaid expansion? The general consensus is that Medicaid
expansions help the bottom line of hospitals, so the positive
impact of the individual mandate may mitigate some of the
slowdown in revenue growth, although likely not realized
until 2015.
increase entrance fees for the first time since the recession.
Similar to the hospital sector, CCRCs also benefited from
strong investment returns, further strengthening the balance
sheet metrics. For example, the days cash on hand median for
investment grade CCRCs increased from 442 days last year
to 476 days this year. Similarly, cash to debt increased from
65.6% to 75.1% the past year.
Another issue to monitor is how the increase in popularity
of high deductible health care plans will impact hospital
operations. According to a Kaiser Family Foundation
survey, the number of employees enrolled in high deductible
plans has increased five-fold from 4% in 2006 to 20% in
2013. First, these plans may mean consumers wait longer
to seek care by delaying procedures. Once consumers make
their way to hospitals, high deductible plans mean hospitals
will incur an increased burden of collecting deductibles.
This could compress admissions as hospitals become more
selective and inflate bad debt as some of the deductibles
will need to be written off. High deductible plans could
also highlight pricing transparency as patients become more
price sensitive and shop services across different hospitals.
Income statement metrics were largely stable. For investment
grade credits, the median operating ratio deteriorated slightly
from 96.9% to 97.3% year-over-year, while the net operating
margin improved from 21.4% to 21.7%.
The impact of robust mergers and acquisitions within
the hospital sector driven by health care reform is also
something to monitor. Often times, the rich will get richer
as hospitals with larger revenues and greater admissions
tend to have higher ratings. An example of this impact is the
fact that Fitch’s median rating in its portfolio has increased
from “A-” to “A” despite the pressure previously discussed,
mostly as a result of upgrades due to a higher rated hospital
absorbing a lower rated hospital.
What does all this mean for the hospital sector moving
forward? The general consensus is that the overall outlook on
the sector is poor. Fitch has a negative outlook on the sector,
predicting that a more difficult operating environment is
likely to persist. As such, Fitch expects downgrades to exceed
upgrades, especially for lower-rated hospitals due to further
narrowing in operating profitability. Similarly, Moody’s
expects continued financial weakening due to volume
declines in a predominately fee-for-service environment,
reinforcing their negative outlook on the nonprofit hospital
sector. Lastly, S&P expects a continued weakening of
income statement metrics for the next two years, with
volume trends playing a greater role in deteriorating margins.
S&P also states the growing dependence on non-operating
income is concerning because of its short-term nature and
the expectation is that operating margins will continue to
compress this year and beyond.
Senior Living
Fitch’s report “2014 Median Ratios for Nonprofit
Continuing Care Retirement Communities (CCRCs)”
cited continued improved performance, especially for
those projects already rated within Fitch’s higher-rated
categories. The strengthening of the sector was sparked by
increased liquidity due to the growth of entrance fees, as the
improving U.S. housing market has allowed providers to
Through the first eight months of the year, Fitch has not
downgraded any CCRC credits and has upgraded five. Fitch
expects this stability to remain as facility occupancies and the
U.S. housing market continue to improve, offsetting a lagging
overall economy and projected increased capital borrowing
within the sector. This is the second consecutive year Fitch
has placed a stable outlook on the sector. Longer term, the
sector will benefit from the rapidly growing population of
the senior market.
Housing
In its report “Housing: A Slow Return to Normal,” S&P
describes a housing sector that is steadily continuing its
gradual recovery. After a harsh winter, the spring saw a
surge in housing starts that leads S&P to expect 1 million
starts in 2014, which is an improvement from recent years
but still trails the annual average of 1.25 to 1.5 million units.
S&P expects starts to return to the 1.5 million level in 2015.
Multifamily units are accounting for an increasing portion of
those starts as the younger generation continues to postpone
purchasing homes due to several issues including stricter
credit standards and high student loan payments.
S&P believes that the government-sponsored enterprises
(GSEs), Fannie Mae and Freddie Mac, are crucial participants
of the U.S. housing sector, noting that they hold 90% to 95%
of mortgages. S&P acknowledges the existing proposals
in congress to wind down the programs, but believes such
legislation, even if agreed upon and passed, would be a
multi-year process and as such the GSE’s prominence will
continue in the near future. Overall, S&P cites the continued
decline in delinquency levels, coupled with the ongoing
increase in home prices, as it projects a stable outlook for the
housing sector.
Overall, the Big Three forecast continued steady
improvement for the senior living and housing sectors
while the hospital sector faces a more challenging future as
operating difficulties persist.
Kevin Laidlaw is a vice president with Lancaster
Pollard in Columbus. He may be contacted at
[email protected].