The quality and capability of leadership—including a hospital's board and management team—are primary aspects when determining not-for-profit hospital ratings, according to Moody's Investor Service.
"Management and governance is a core element that affects both ratings upgrades and downgrades," says Moody's Analyst Deepa Patel. "Without strong leadership, hospitals can easily suffer from inaction, late actions, or strategic missteps that lead to rating downgrades or even payment defaults."
A common characteristic of strong management teams has been their ability to effectively maintain cost structure and meet budgets, even in the face of financial adversity such as the recent downturn and subsequent credit crisis, according to Patel. "Now more than ever, these challenges require realistic and farsighted strategies that are ultimately determined by senior management and a hospital board of trustees."
Patel and her team have noticed some proactive strategies that top-performing organizations have employed such as scenario planning and cost reductions. For instance, an organization that operates in a region with high unemployment might project a situation in which the market was to tighten even further and determine in advance some cost-saving actions it would implement to deal with the situation.
Another effective strategy Moody's has witnessed is the creation of a balance sheet recovery plan. One organization came up with targets for critical financial metrics such as days cash on hand and liquidity and projected its operating cash flow levels required to meet its goals.
The flipside was true of underperforming hospitals. "We've seen other organizations that haven't taken a very strategic approach, which is reflected in their weak performance and could lead to a downgrade," according to Patel, who was quick to note that exceptions do exist.
"There are organizations that have struggled even though they have a very good management or governance team in place," she said. "It may simply be because of the function of the region they operate in, such as a high number of Medicaid patients."
Governance isn't the only factor contributing to ratings decisions. Organizations that are able to consistently grow operating cash flow as well as show stability in cash balances and liquidity are also prime candidates for upgrades, according to Patel.
In addition to management effectiveness and operating performance, Moody's bases its ratings decisions on the strength and liquidity of a hospital's investment portfolios, its management of debt structure, demographics and market share and organizational or legal structure changes.
Downgrades are most influenced by sudden or prolonged weakness in financial performance, which may be due to sizeable volume declines or flat/negative revenue growth; material decline in unrestricted cash and investments, as well as a lack of liquidity; risks to their debt structure; a sizeable increase in debt load; and material operating changes or event risks such as litigation claims beyond insurance coverage or worker strikes.
Overall, the last few years have been hard on nonprofit hospitals' credit ratings. Since the fourth quarter of 2007, Moody's has downgraded 155 hospitals compared with 92 upgrades. "Some hospitals and health systems have been able to absorb operating challenges, execute change and are strategically and financially better positioned for future changes, while others have struggled to develop a strategy toward longer-term viability," Patel noted.