Declining Patient Volumes Threaten Not-for-Profit Bond Ratings

A Moody's Investors Service executive says she expects downgrades will continue to outpace upgrades in the fourth quarter of 2013 for many of the approximately 500 not-for-profit hospitals and health systems that it rates.

Declining patient volumes and other bottom line pressures continue to pose a challenge for not-for-profit hospitals and there is no indication that things will get better any time soon, Moody's Investors Service says.

The bond rating agency reported 10 ratings downgrades affecting $2.7 billion in debt in the third quarter of 2013 that were due primarily to declines in admissions averaging 5.3% when compared with fiscal 2011-2012. Providers cite the ongoing shift away from admissions and toward reimbursement-draining observation stays as the key driver behind the decline, followed by rising co-pays and deductibles that are causing patients to defer medical care.

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Moody's Senior Vice President Lisa Martin expects that downgrades will continue to outpace upgrades in the fourth quarter of 2013 for many of the approximately 500 not-for-profit hospitals and health systems that it rates.

"The activity that we are seeing is consistent with the outlook that we have on the sector, and one of the factors in our negative outlook for the sector is the decline in patient volumes," Martin says. "That is not the only reason but one of the main reasons for the rating downgrades in this last quarter. And in 2013 we are seeing large variations in volume trends and in some markets significant declines in admissions that are due to a number of different factors."

Offsetting the downgrades were eight upgrades affecting $2.4 billion in debt in 3Q 2013, mostly driven by improving patient volumes and cost cutting strategies. Of the eight upgraded providers, six had positive volume trends and multiple years of financial improvements and were considered market leaders in their regions. Five of the upgrades had average admissions growth of 3.7% from FY 2011 to FY 2012.

Martin says downgrades signal the continuing difficulty that some, but not all, hospitals and health systems have with the fundamental shift away from fee-for-service volume-based care and towards reimbursements that reward outcomes and population health.

"It really varies by market," she says. "That is very difficult to quantify because it is a very slow start in terms of the industry trying to make this shift. We don't think it is going to happen quickly. But in certain markets where the volume declines are disproportionately large, there may be some of that dynamic going on."

Martin says lower volumes are not a temporary phenomenon that will improve with a rebounding economy, but are "more related to a fundamental shift in the industry."

"As we have emerged from the recession, technically you would have expected volumes to at least stabilize, because during the recession part of the volume decline was related to higher co-pays and higher deductibles," she said.

"While that may be still the same reason, it is because employers are fundamentally changing their commitment levels to providing healthcare insurance. Some of that early evidences of that are what you are starting to hear about in terms of employers turning to private exchanges. It is still very early on, but that is an example of an underlying shift in the industry. While caused by a number of issues, it is more of a fundamental change in the industry than a temporary one."

With three quarters in the books, Martin says 2013 is meeting predictions that it would be a "difficult year for the industry as a whole."

"Once we get the numbers for the whole year, our expectation is that volumes are down, obviously, and revenue growth rate is going to be down. We are expecting to see margins decline," she says.

Moody's reports that:

• Over the first three quarters of 2013, there have been 30 downgrades affecting $10.3 billion in debt affected, nearly double the 18 upgrades affecting $4.8 billion in debt for a ratio of 1.7 to 1.
• 18 rating changes were made in 3Q 2013, one fewer than 3Q 2012. Downgrades outpaced upgrades by a ratio of 1.3 to 1, compared to an anomalous 0.6 to 1 in 2012 when there were 12 upgrades and seven downgrades.
• As of Sept. 30, six ratings were under review for downgrade, affecting $1.3 billion of debt. One rating is under review for upgrade, impacting $22.5 million of debt.
• 72 ratings were affirmed, which represented 80% of all rating activity, affecting approximately $42.5 billion of debt and consistent with the long-standing historical trends. Of the 72 affirmations, seven were accompanied by negative outlook changes and four by positive outlook changes.

"There are some health systems that are doing well and are generally stable or maybe slightly improving and that is in part due to their efforts around cost reductions to offset some of the revenue challenges. In some cases it's due to operating in favorable markets where there is limited competition and/or population growth."

With healthcare reform and bottom line demands favoring economies of scale and market share that come with size, Martin says mergers and acquisitions "will continue at a high pace because of these pressures."

"There are some smaller hospitals that maybe because of their dominance in their market may be able to go it alone for a certain period but in the long run they may need to partner."