A year of rising expenses and investment losses have taken enough of a toll on nonprofit hospitals’ war chests to potentially begin harming their credit ratings, Fitch Ratings wrote in a recent report.
“Not-for-profit hospitals generally have strong liquidity relative to debt repayment obligations and business risk, but recent unrestricted liquidity erosion is expected to bring balance sheet metrics more in line with pre-pandemic historical averages,” the agency wrote in a Tuesday release. “Lower liquidity and lower operating margins could begin to have a negative effect on hospitals’ credit profiles.”
Hospitals’ investment portfolios boomed to “all-time highs” during 2021, resulting in median days’ cash on hand reaching 260 days, Fitch wrote. It also generated major headlines during earnings season, with big names like Kaiser Permanente’s $8.1 billion 2021 net profit buoyed by $7.5 billion in its “total other income and expenses” tab.
A turn in the investments market beginning at the top of 2022 wiped away those gains as millions in investment losses became the norm for nonprofit hospitals and systems quarter after quarter.
Fitch wrote that 2021’s strong performance had served as a “significant rating cushion” for nonprofit hospitals through 2022.
However, the subsector now enters the new year with weakened portfolio values and softer liquidity metrics, both of which the agency assesses during its ratings analyses. Fitch noted that its model takes “normal cyclical valuation changes” and “plausible market declines” into account but that “sustained declines beyond our expectations could result in negative rating action for credits with already weak liquidity.”
In lieu of its investment portfolio—and with equity trading off the table entirely—nonprofit hospitals will often turn to cash flow generation as a primary means of building liquidity. Here again, however, Fitch noted that hospitals’ operating margins have been hit by inflation and staffing expenses over the past year. Reduced liquidity from the markets also limits their ability to improve margins by investing capital into their operations or service lines, the agency added.
“While cashflow generation may mitigate portfolio declines and bolster key leverage metrics, the expectation of continued expense pressures in 2023 may constrain cashflow generation,” Fitch wrote. “Health systems with comparatively weaker balance sheets for the rating category are more likely to face negative rating pressure in the current environment.”
Though many were projected to end the year with operations in the red, hospitals and health systems have been making incremental process on their labor expenses in recent months, per industry analysts and federal employment numbers.
Lisa Goldstein, senior vice president at healthcare advisory firm Kaufman Hall, recently listed liquidity initiatives as a priority for hospital leadership going into the new year. While she said the path to strong liquidity varies from organization to organization, she urged nonprofit leaders to probe lenders in case another COVID-like emergency strikes and an emergency line of credit is needed.