Martin Arrick recently retired from his position as a managing director at S&P Global Ratings and leader of its not-for-profit healthcare group. We asked him to provide a rating agency perspective on the COVID-19 crisis, drawing from experience with past crises and looking forward to what may be a new normal in healthcare. The views expressed in this interview are entirely his own.
Q: We’ve been through a few national crises since 2000, including 9/11 and the credit crisis of 2008-2009. How do rating agencies respond to events like this, which have an industry-wide impact but are generally out of the industry’s control?
A: A fundamental element of rating agencies’ philosophy is that you want to rate through the “noise” over a quarter, or even over a year. In a crisis like this, you need to find a path that feels right for the longer term, weighing noise versus a longer-term change in circumstances.
Unfortunately, the fact that an event is out of any individual provider’s control really can’t be an important consideration for the agencies. If a crisis is of an individual provider’s own making, that might bring the provider’s management into focus, which isn’t the case here. But the lack of control doesn’t change the facts for the sector. If you go from 80 to 20 days cash on hand, it doesn’t matter whose fault it is. It’s a fact that needs to be taken into account. That’s where the sector is now, and it has to be part of the equation.
Q: From a rating agency perspective, are there significant ways in which the COVID-19 crisis differs from what we’ve seen before?
A: One way that it’s different is that hospital and health system providers are central to handling this crisis. We’ve never seen them so much in the middle of things. A fully functioning national healthcare system has been shown to be essential.
Another difference is that the economic impacts are so broad. 2008-2009 was a credit crisis that sharply reduced demand. This is different; it involves things like supply chain and is broader than anything we’ve seen—a real difference in magnitude.
We’re also hearing that unemployment could go as high as 20%, a level not seen since the Great Depression. What does that do to insurance coverage and payer mix over the long term? At the same time, the morality of hospital professionals is that we have to take care of those in need. These two things are colliding to such an extent that it seems very likely that there will be a need for a societal solution.
We’re learning that the healthcare status of every person in this country is important to each of us and to the country as a whole. The Great Depression led to a realization of holes in our society that resulted in Social Security. I think we may see something analogous here.
One similarity: Everybody is now talking about healthcare professionals who are putting their lives on the line. It reminds me of how we looked at fire fighters and other first responders differently after 9/11 and realized that they are actual heroes.
Q: What factors would put a hospital or health system most at risk of a credit downgrade in the current crisis?
A: The short answer is that common sense and credit fundamentals apply here. The weaker your balance sheet cushion, the closer you are to a downgrade. This is why rating agencies have been so balance-sheet focused over many years. If you go from 400 to 300 days cash on hand, it isn’t that significant. But at some point your cash flow goes down to a level that cannot sustain your rating.
The impact on margins is still to be determined but is most likely negative. Supply costs are going up and staffing costs as well. Margins will be narrower. One question is the extent to which a hospital or health system’s outpatient business is up and running. And there’s an interesting question around payer mix. For many hospitals, ICUs will be running at or near capacity, and regulators will be flexible in trying to get as much capacity on line as possible. Intensive care is reimbursed more favorably than non-intensive care, just as surgical is better than medical. If ICU occupancy is elevated, there may be some positive financial impact to the extent that patients have insurance, which could help offset at least some of the rising costs.
The income statement question is fairly complicated. If an organization starts burning through money, where do the lines eventually cross?
There’s an important timing issue around financial reporting as well. For a start, you will need March data; February and earlier won’t be helpful in gauging the impact of the crisis. And no agency is likely to react to just the March results. In reality, it will be summer before you have enough data to tell the story. The only hard number from March that is “actionable” will be the balance sheet. The rating agencies are inclined to be understanding, and it is hard for anyone to predict how long this will last and what the impacts will be.
Q: What organizations are best positioned to mitigate the impacts of the COVID-19 crisis on their credit rating?
A: In many respects, this is the flipside of the previous question. Organizations with a strong balance sheet, strong income statement, and strong demand are in the best position.
I do wonder if regional health systems have a potential advantage here. With multiple hospitals, they can designate some as COVID centers and some as non-COVID centers. They can free up capacity at their main facility by decanting lower acuity (and non-COVID) cases out to other facilities. Arguably, they can manage the burden in more effective ways than a single-site hospital can.
On a side note, it has always been hard to close a hospital and I think it’s going to get harder. Think about a small community hospital in New York City. Would the state of New York let them close today? It might be cold comfort to a bondholder, but it is going to be harder. The healthcare system is expensive and has been responding appropriately in downsizing idle capacity, which is very expensive. And now we have this moment.
Q: If organizations are going through their annual update now, how specific should they be in divulging what they are doing on a minute-by-minute basis to deal with the crisis? Are there any circumstances in which it would make sense for an organization to delay their annual update?
A: The rating agencies want to know everything. The whole model is built on an honest, ongoing, transparent exchange of information. There are a lot of things that could matter, some of them conceptual and non-numeric. For example, 45% of your staff has been infected, or you’re only running half your beds, or your outpatient business has gone from 50% of your revenue to zero.
Rating agencies have to strike a balance. They have a mandate from the SEC and the regulatory apparatus on how often you have to surveil credits, along with internal “thou must” mandates. At the same time, healthcare analysts find they’re trying to talk with people who are getting testing tents set up in their parking lot or have 20 people waiting outside their office door. Senior financial officers want to understand what is the essential information the agency needs without the extras that might normally be requested. And agency analysts are likely to whittle down their requests to only the essentials as well.
Everyone involved needs to strike a balance too. The agencies have mandated responsibilities, hospitals have borrowed money in the public markets, so all involved have responsibilities. The rating agencies are getting calls from investors who have lots of questions and they need information. So maybe the three-hour call can be reduced to an hour and a half or can be divided up into a few shorter calls. But you can’t completely wait for the crisis to pass.
Q: What steps should hospitals and health systems be taking to try to limit damage to their rating?
A: There is only so much they can do right now. Hospitals have always been there to meet community demand and we have always said, “Don’t’ manage to your rating, manage your business.” This is a moment of clarity when you need to take care of your patients.
Balance sheet metrics have come up over the years. There isn’t an infinite range, but rating agencies will want to be flexible to the extent they can. For example, a health system might be strong on coverage, but have a weak balance sheet—say, 120 days cash on hand. If it ran the balance sheet down to 75 days, and other strengths didn’t improve, it would be impossible to maintain an AA- rating. There aren’t precise floors (for example, 76 days versus 75 days), but there are relative floors and the agencies can’t be infinitely flexible.
Q: If the impacts of the pandemic are prolonged (e.g., push the economy into a recession), what factors or indicators of organizational performance will the rating agencies be monitoring most closely?
A: Basically, the same core issues. A key question will be: Are organizations able to reach some homeostasis in terms of performance?
Payer mix may be the ultimate core issue. It incorporates the impact of the recession, including unemployment, the possibility of government intervention, and the impact on Medicaid enrollments. Then, over the medium term, can you stabilize operations? Are electives beginning to come back? You start getting a better sense of payer mix, volume, utilization rates, and the numbers, and then you start getting to a new normal. The agencies have hundreds of ratings, so they have data that helps them begin to understand what the new normal is as they look at the June and September quarterlies.
Finally, there is the political question. Does the government start to approach healthcare in a new way? If we’re in a prolonged crisis, and a year from now we have a new Congress, we’ll have to see what happens.