Overall sector trends led Fitch to conclude providers will continue to focus on increased size, scale, and geography—which has implications for M&A.
Sept. 24—Not-for-profit hospitals’ operating profitability appears to have peaked two years ago, a rating agency concluded, as it maintained a negative outlook for the sector.
In December 2017, Fitch Ratings first issued a negative outlook for not-for-profit (NFP) hospitals in 2018, and the agency maintained that outlook in a special report issued in September. Also in December, Moody’s revised its outlook for the NFP and public healthcare sectors from stable to negative.
The factors that led Fitch to recently maintain its dim view include:
- Operational pressures and uncertainty in operating margins
- Labor and wage pressures for experienced staff amid a tight labor market and increasing need for clinicians
- The ongoing transition to population health and risk-based contracting
On a related note, in August a Moody’s reportconcluded operating margins for NFP hospitals fell to 1.6 percent in FY17, the lowest level the rating agency has ever found in its tracking.
The agency also noted a dichotomy between a second year of across-the-board deterioration of operating margins and continued credit strength, as defined by balance sheet metrics. Such conventional metrics (days’ cash on hand, cash to debt, and leverage) all remain at all-time highs “and it remains to be seen whether we are at a peak or if there is further room to improve,” the Fitch report noted.
Revenues increased by 6 percent in FY18, which was sharply lower than the 11.5 percent increase in the previous year. That decline could signal the beginning of top-line revenue contraction, Fitch said.
However, volumes generally are still stable, despite decade-long pressures and overall trends to reduce inpatient admissions.
“Reasons vary and include simple population growth in many markets, the effective capture or stealing of market share from competitors and, to a certain extent, the more selective nature of our issuer base, which has largely implemented successful strategies,” Fitch noted.
Recently, managed care contract negotiations have become more adversarial as providers look to greatly offset the impact of comparatively weaker governmental payment through their commercial contracts, the rating agency concluded. Volume impacts and bad-debt impacts are expected from the continued shifting of healthcare costs by employers onto employees through high-deductible health plans.
The NFP outlook ran counter to expectations at for-profit hospitals, for which Moody’s maintained a positive outlook as of May.
An improved U.S. economy and falling unemployment rates have caused labor markets in most areas to tighten, resulting in overall pressure on salary and wages, Fitch noted. Competition for clinicians in most markets has increased due to the movement toward population health management and a growing focus on chronic disease management.
“Increased use of agency, overtime, and pay differential is still a common pressure on expenses,” Fitch noted.
As of September, the hospital rate of job creation was on track with the monthly rate of 7,800 over the last 12 months, when those organizations added a total of 94,600 positions, according to the latest figures from the Bureau of Labor Statistics.
Although federal data tracking newly created positions lags by more than a year, as of May 2017 the most common jobs created in the healthcare sector were registered nurse positions. The number of registered nurses (RNs) in health care reached more than 2.9 million that month. Separate Census Bureau data found that total nurse employment increased by about 20 percent from 2010 to 2017, reaching more than 3 million, according to an analysis by Montana State University.
Large-system providers still have a longer-term goal of cutting billions of dollars from their expense bases through a combination of “basic” cost-cutting (efficiency), clinical efficacy (waste elimination), and a rethinking of how health care is delivered (transformation) to become break-even or better on Medicare rates, Fitch noted.
“And Fitch continues to assert that higher rating credits have the resources available to allow ongoing focus on improving both clinical and nonclinical efficiencies to help offset the impact of compressed commercial rate increases and little, if any, net rate increases from Medicare and Medicaid,” the report stated.
In contrast, poorly rated hospitals are less able to trim expenses or to negotiate higher rates from commercial insurers as a must-have provider in their markets.
Cost control eclipsed revenue growth as the top priority among health system CEOs, according to Advisory Board’s Annual Health Care CEO Survey. The nationwide survey of 146 C-suite executives, conducted between December 2017 and March 2018, found 62 percent “were extremely interested” in cost control.
Overall sector trends led Fitch to conclude that providers will continue to focus on increased size, scale, and geography to enact a practical long-term strategic plan for each specific market.
“As such, consolidation and alignment activity is expected to continue,” Fitch wrote. “Size, scale and market presence remain key themes among providers in an effort to extract greater efficiencies, gain contract leverage with payers and suppliers, and build adequate capabilities to support population health.”
Fitch noted that size and scale alone do not necessarily result in success, but “consolidation is a logical outcome, given CMS’s value-based payment models, growing Medicare and Medicaid populations, increasing wage pressures and what we view to be a more adversarial managed care contracting environment.”
Indicating a hospital deal slowdown, a Kaufman Hall analysis found only 20 deals in the second quarter of 2018—down from 30 in the first quarter. Similarly, tracking by Ponder found that hospital deals in the second quarter decreased by nearly 50 percent from the first quarter, to 21 transactions. That was the smallest number identified by Ponder since the fourth quarter of 2016.
However, Ponder expected the volume of hospital M&A activity to be high in upcoming quarters since many health systems are in the beginning stages of discussions.
Rich Daly is a senior writer/editor in HFMA’s Washington, D.C., office. Follow Rich on Twitter: @rdalyhealthcare