The financial state of the not-for-profit hospital sector: key takeaways from the latest medians

The financial condition of the U.S. not-for-profit (NFP) hospital industry can be described as steadily improving but still struggling, according to insights from two of the three main credit-rating agencies.

Fitch Ratings and S&P Global both recently issued reports on sector medians, using audited data from 2023. The companies described an industry that has rebounded operationally from the worst stretches of the pandemic and financially from the intense cost pressures of 2022.

Changes to the outlooks for individual credits have been relatively encouraging during the first half of 2024. For example, S&P has issued 18 favorable revisions, the same number as it distributed for all of 2023. Meanwhile, unfavorable revisions are on pace to total 30 for the year, which would be a decrease of 17 from 2023.

Still, regaining the financial foothold that was in place pre-pandemic will take more time and work and may even be out of reach in the foreseeable future, on an industry level.

The slight margin improvement seen in the newly published medians represents “the beginnings of what Fitch believes will be a slow and sustained recovery for the sector, but making only incremental gains year over year,” Kevin Holloran, sector leader of the Not-for-Profit Healthcare Group, said in the Fitch report (Holloran is a member of HFMA’s Board of Directors).

Here’s a look at a few of the key points from the reports:

1. Margins are still constrained

Fitch’s 2023 data (login required) shows a median operating margin of 0.4%, up from 0.2% the year before. That’s still way down from 3% during the relatively flush year of 2021 and substantially lower than any other year during the past decade (the metric was never lower than 1.5% from 2013 through 2021).

An indication of improving margins is apparent in the subset of rated credits with Dec. 31 year-ends. The median margin among that group in the 2023 data is 0.8%.

That trend gives Fitch’s experts reason to believe 2024 data will show improved margins, roughly in the 1.5% range.

“That’s starting to get back to some level of normalcy,” Holloran said during a webinar. “It really gets down to all the improvement initiatives we [as an industry] put into place. All those initiatives really started to take traction particularly in the third and fourth quarter of 2023.”

S&P reported (login required) a median margin of 0.0%, a tenth of a percentage point lower than in 2022 and a big drop-off from 2.8% in 2021.

Nonetheless, the break-even metric represents “solid underlying operating improvement across the sector, given that [COVID-19] stimulus funding has basically all but dried up,” Blake Fundingsland, associate director, said during a webinar.

For the health system subsector, S&P reported median margins that ranged from 1.4% for AA-rated credits to negative 0.2% for A credits and negative 2.6% for BBB credits. Margins were moderately higher in each category for stand-alone hospitals.

“We do think that margins in general are probably going to be lower for a little while,” said Suzie Desai, managing director and sector leader.

2. Balance sheets provide a boost

Core balance-sheet metrics remain a strength, helping hospitals avoid ratings downgrades that might otherwise accompany shaky margins, Fitch and S&P experts said.

Days cash on hand dropped from 260.3 in 2021 to 211.3 in 2023, according to Fitch, although the metric has been worse as recently as 2016. Cash-to-debt has seesawed from 185.5% in 2021 to 147.1% in 2022 and 163.7% in 2023.

Compared with recent history, “The balance sheets are really, for the sector as a whole, pretty strong,” said Mark Pascaris, senior director with Fitch Ratings.

That helps explain why nearly 90% of Fitch’s 2023 rating actions were affirmations and only 8% were downgrades, he added: “If the balance sheet is there to buy you that time through the stress period, and there’s a viable, believable story to be told about improving operating margins … over where we were in 2022, that can result in pretty stable rating actions.”

S&P reported a similar trend in days cash on hand, which came out to 197 for 2023. That was down from 233, 250 and 210 in the three prior years.

“We believe that lighter cash flow has been the main reason that growth in unrestricted reserves has not been able to keep up with expense growth,” said Marc Arcas, senior analyst, referring to the health system subsector. “We have also seen an increase in capital spending, which of course also contributed to less growth in reserves.”

In recent years, hospital management has sought to match capital spending with cash-flow generation, S&P’s report noted. That approach could change in the short term amid a backlog of projects and deferred maintenance, leading to an increase in debt activity.

3. Expense and revenue trends show promise

The gap between annual growth in expenses and revenue improved considerably from 2022 to 2023, although there was a disparity between the two reports that may reflect the wide variability among individual providers.

In 2022, expense growth outpaced revenue growth by 9.5% to 5.8%, Fitch reported. A year later, the difference was 7.6% to 7%.

“I think we’d all take revenue growth of anywhere from 6% to 7% year over year,” Holloran said. “As long as we keep that expense growth within ‘spitting distance,’ that’s good.”

S&P’s medians showed the operating-expense increase plummeting from 17.2% in 2022 to 5.2% in 2023. Meanwhile, the median operating-revenue increase jumped from 8.8% to 9.9%. And in the health system subsector, the ratio of salaries and benefits to net patient revenue remained generally stable.

Where limited revenue growth was seen, organizations may have been taking steps to manage higher labor costs and labor shortages in ways that affected admissions and utilization, Arcas noted. Simultaneously, pandemic-related funding began to taper off.

Now that clinical operations have stabilized after the pandemic and the labor situation is becoming more manageable, with contract labor usage falling in 2023, organizations are considering additional service lines and other ways to boost revenue, S&P’s experts said.

Labor remains a big expense and is not being matched by reimbursement, however. Tight margins likely will continue “until payers, government or otherwise, begin to raise annual rate increases more in line with the sector’s new-normal expenses,” Fitch’s report states.

Some providers are obtaining rate increases in managed care contracts even as they navigate continuing challenges with denials, S&P reported. Medicaid supplemental payment programs also are “game changers” for providers in some states.

4. Questions about the new normal

Hospital and health system stakeholders should not expect a robust rebound from recent financial pressures, at least in the near term. It’s possible a 1% operating margin will signal a high-performing health system over the next few years.

“I’m starting to maybe not want to use the word recovery because we may be landing just in a different place altogether with our margins and cash flows,” Desai said.

Tailwinds include continuing robust demand and strategic initiatives that support balance-sheet strength and cash-flow improvement, but those factors might not be enough to compensate for systemic concerns around reimbursement and site-of-care shifts.

In a daunting environment, strategic acumen and the willingness to take transformative approaches become paramount for an organization’s viability and, in turn, its credit rating.

Fitch’s report notes that operational strategies are aiming to create additional access points and in-person and virtual capacity “to both deliver high-quality services and to pursue population growth areas, most likely with an improved payer mix.”

Such an effort could help counter foreboding demographic changes that signal a sizable increase in the share of patients with Medicare as opposed to commercial coverage and, simultaneously, a more limited pool of working-age people from which to hire. Concerns about reimbursement will only intensify if policymakers eventually implement cost-cutting steps to tackle the federal deficit and the national debt.

Thus, it will be crucial to seek out efficiencies through technology and new models and modes of care delivery.

“Despite all the headwinds that the industry is facing,” Pascaris said, “the management teams that are in place right now are better equipped than they were a generation ago to deal with external shocks.”