The apocalyptic haze over New York City a few weeks ago cast an ominous tone as wildfires in Quebec delivered a thick orange smoke across the area. Masks quickly re-appeared. Mayor Adams advised everyone to stay inside, eerily similar to the early days of the pandemic. The Air Quality Index (AQI) reached the “hazardous” level of 484 compared to the normal range of zero to 50. You don’t need to be a seasoned analyst to conclude that a 484 is very unfavorable to the median.
Like that AQI, Kaufman Hall’s Operating Margin Index shows that hospital financial performance remains challenged. Our National Hospital Flash Report reports a breakeven result (0.0%) through the first four months of 2023, which means that half of the hospitals in the sample remain in the red. For many, volume is slow to return. Others report the payer mix is shifting toward government payers and away from commercial. Despite reductions in expensive contract labor, managing salaries and benefits remains a critical component on the journey back to profitability.
It’s no surprise that rating downgrades are increasing at a pace not seen since the liquidity crisis, with almost as many downgrades through the first five months of 2023 as in all of 2022 by each of the rating agencies. Many of the downgrades reflect anticipated covenant violations (or near misses) in fiscal 2022 and weakened cash positions. Upgrades are few and far between. When excluding upgrades due to a substitution of notes by a higher-rated borrower, upgrades based on improving financial performance are nearly non-existent.
That said, the good news is that the majority of ratings are affirmed as management teams outline a credible plan to create financial durability and have built liquidity to weather the storm. The maintenance of financial reserves—absolute, relative to daily expenses (days cash on hand), and when measured against debt (cash to debt)—are critical metrics in rating committee during difficult times.
The importance of cash cannot be overstated, as our recent report Essential Role of Financial Reserves in Not-for-Profit Healthcare outlined. Reserves are needed to fund the unexpected, like a mandated shutdown of elective services or a government shutdown when Congress can’t agree on a budget package. Reserves are needed to fund capital when debt capacity is limited or the cost of debt is unaffordable. Reserves are needed to fund strategies that may not qualify for tax-exempt financing or be large enough to justify a borrowing. Reserves are needed to fund programs that are core to mission and that payers do not reimburse for, such as teaching costs, research, and community health programs. Reserves are an important metric for assessing credit, which informs the cost to borrow.
In early 2023, my colleague Eric Jordahl eloquently penned in his blog Moving Into and Through 2023 that capital is a hospital’s oxygen and hospitals can no longer afford to hold their breath. If capital is the oxygen, then liquidity is the circulatory system that carries that oxygen. With infinite demands on finite reserves, capital spending decisions must be made deliberately and with urgency. The disruptors are moving with alacrity into the outpatient space with deep pockets, disaggregating the continuum of care that not-for-profit hospitals have built at significant cost over many years.
If there is one lesson learned during the 2008 crisis, the pandemic and its aftermath, a debt ceiling debate, and other events, it’s that the ability to access liquidity is vital to keep breathing, whether the environment is orange, red, or something else.