S&P: Nonprofit Operating Margins Improve but Pressures Remain

The heightened risk of a recession next year ranks among the major challenges facing the sector.

Nonprofit provider organizations experienced overall operating margin improvements in 2018, according to an S&P report released Monday afternoon, though market pressures remain.

The report analyzed the financial medians of health systems, stand-alone hospitals, small hospitals, and children's hospitals on the basis of operating margins, days' cash on hand, ratings distribution, and balance sheet stability, among other key metrics.

Unlike the previous two years, the ratings distribution for nonprofit providers in August 2019 primarily centered around the 'A' rating. S&P added that outlooks remain stable despite a decline in ratings actions, as well as a slight rise in negative outlooks and the decline in positive outlooks.

Related: 3 Strategic Differences Between Nonprofit and For-Profit Hospitals

The strongest aspects of the sector are stabilizing operating margins, solid balance sheet performances, benefits from continued M&A activity, and "adaptive management teams."

Looking ahead to challenges for nonprofit provider organizations, S&P highlighted a 25% to 30% risk for a recession next year, the entrance of nontraditional players to the market, threats to the ACA, and the cost effects from Baby Boomers retiring.

Below are highlights from S&P's report broken down by segment of the nonprofit provider sector:

Health systems

• Operating margins were boosted slightly from 2017 to 2018, but non-operating income slipped and offset those improvements.
• Capital spending exceeded depreciation expenses and M&A activity continued along at healthy pace.
• Systems outpaced stand-alones in ratings distribution from the 'A' rating up.
• Certain market pressures remain ahead, including payer mix deterioration, supply and labor expenses, and legislative uncertainty surrounding federal health policy.
• Systems tend to have more of a financial cushion than other organizations as it relates to weathering a potential recession.

Related: 'Unsustainable Path': Nonprofit Hospital Finances Face Troubling Trend

Stand-alone hospitals 

• Due to ongoing M&A, there were fewer stand-alone hospitals, though one S&P analyst noted that most organizations preferred partnerships over traditional merger agreements.
• Despite operating margins improving, S&P stated that stand-alones face a "growing negative bias in outlooks," due in part to "longer-term expense and reimbursement pressures."
• Additionally, stand-alones must achieve stronger financials to attain the same rating as health systems.
• In general, stand-alones aren't as well-equipped to handle the pressures of a recession as their system counterparts, though some are better situated than others depending on geographic location and financial stability. 

Related: S&P: Not-For-Profit Healthcare Remains Stable

Small and children's hospitals

• Most small hospitals, facilities with total operating revenues below $150 million, were rated BBB or speculative grade due to "limited revenue base and service line offerings."
• Small hospitals are considered more risky compared to stand-alones and health systems, even though their balance sheets are significantly better, operating margins vary wildly.
• Meanwhile, children's hospitals have overwhelmingly stable outlooks, thanks to limited competition and partnership opportunities.
• The largest risk comes from high Medicaid exposure, though strong balance sheets and capital spending help them meet the increasing capacity needs.

Related: Nonprofit Hospital Operating Margins Improve for First Time Since 2016

Other notes

• Analysts expect a boom in telemedicine, though rural hospitals have struggled to manage with the low reimbursement rates.
• In the case of an oncoming recession, providers with credits based primarily on non-operating income are more at risk compared to others.
• The length and severity of a potential recession would play a part in how certain providers fare, though this impact could be more pronounced regionally.