The latest on hospital finances: Signs of improvement, but margins remain tight

Industry-level hospital financial insights reflect the mixed results of a recovery that’s in progress but is expected to be a long slog.

In a 2023 midyear report (login required), Moody’s Investors Service noted that margins are below 3% for a third of the company’s rated hospitals. Before the pandemic, only about 6% had margins in that range.

“While acute COVID-driven labor stress has abated, the budgetary aftershocks will reverberate for years to come, suppressing operating results through at least 2024,” Moody’s wrote.

Fitch Ratings this week released its annual report (login required) on not-for-profit hospital medians, illustrating the degree to which margins and balance sheet metrics deteriorated in 2022 due to “labor shortages, generationally elevated inflation and the depletion of prior pandemic-era relief funding.”

For example, median operating margin fell from 3% in 2021 to 0.2% in 2022, while median EBITDA margin dropped from 8.9% to 5.8%. About half of Fitch’s rated hospitals recorded a negative operating margin for the year.

There have been indicators of a rebound this year. In its latest National Hospital Flash Report, showing May 2023 data, Kaufman Hall reported a positive median industrywide operating margin (0.3%) for the third consecutive month.

That’s not a sign of a robust comeback, however. Break-even might be the best some organizations can expect to do by the end of this year, Fitch says.

“Longer-term industry dynamics continue to suggest protracted margin compression compared to historical trends as additional expenses, primarily labor, remain elevated,” Kevin Holloran, senior director with Fitch, said in the report.

Labor costs remain a drag

“Hospitals are benefiting from some expense relief as staffing has become easier and the need to use pricey contract labor has decreased,” according to the Moody’s report. “But it will take time for improved margins to follow and labor issues will remain an underlying sector challenge.”

The labor crunch will ease in upcoming quarters as hospitals fill staffing gaps and further reduce their reliance on contract labor, Moody’s wrote. But with an ongoing need to increase compensation in response to the market, wages rose by 11% in 2022 and 7% in Q1 2023.

While an improvement, the Q1 increase is “high compared with historical levels,” and such a jump “significantly restricts financial performance.”

The wage scale is unlikely to return to pre-pandemic levels in the foreseeable future, especially with respect to nursing, which is facing a long-term shortage.

“Until the hikes in compensation for permanent staff are absorbed into ongoing expenses, operating margins won’t return to historical levels,” Moody’s wrote.

On the for-profit side, hospital chains HCA and Tenet benefited from a drop of about 1 percentage point in salaries and benefits as a proportion of revenue in Q1, Moody’s reported. In turn, HCA’s reported EBITDA rose by about 8%, to $3.2 billion.

But Community Health Systems, with a larger share of operations in rural areas, has faced greater challenges in finding nurses and also in negotiating favorable terms with payers. The company’s salaries and benefits as a share of revenue rose by 1.3%, with EBITDA falling by 18.1%, to $335 million.

Delving into the metrics

Lower-rated hospitals (those categorized as below investment grade) had a 0.3% operating EBITDA margin in 2022, compared with 6.9% in 2021, Fitch reported. For mid-investment-grade hospitals (those with an A rating), operating EBITDA margin fell from 8.8% to 4.8%, while higher-rated hospitals experienced a decrease from 9.6% to 6.8% (Fitch’s median rating for 2022 remained A+, while the most common rating remained AA).

Below-investment-grade hospitals also saw a decline of 37.5% in cash to adjusted debt. Even hospitals with AA ratings struggled to a degree in that metric, with a 16.8% decrease. Days cash on hand dropped from 260 in 2021 to 216 in 2022, including from 320 to 273 for AA hospitals, 241 to 204 for A hospitals, 176 to 149 for BBB hospitals and 90 to 75 for below-investment-grade hospitals.

For most of the sector, days cash on hand nonetheless was near or above pre-pandemic levels.

“Despite the precipitous decline, which comes after a rapid strengthening in 2021, liquidity metrics remain strong for the sector, and while no longer at all-time highs, still compare favorably to pre-pandemic levels,” Fitch reported. “The metrics continue to provide some cushion against equity market volatility, inflationary pressures and added expenses due to labor scarcity.”

The industry outlook

After the downturn that was evident in 2022 medians, Fitch wrote, “It remains to be seen if, as 2023 progresses and operations gradually improve, this step back will become a sidestep along a very complicated sector journey, or the new normal.”

Ratings in 2022 largely were stable, with Fitch affirming 91% of its rated credits. But there were slightly more downgrades (5%) than upgrades (4%), and more negative outlooks (6%) issued than positive forecasts (2%). And through the first half of 2023, Fitch issued 12 downgrades and four upgrades, Holloran reported during a July 27 webinar.

“Even as macro-wide operating margins slowly rebound in 2023, Fitch expects the trend of downgrades and negative rating outlooks to outpace upgrades and positive rating outlooks, particularly for systems whose operating margins in 2023 are no better, or worse, than in 2022,” the report states.

Fitch also forecasts a widening credit gap between stronger and weaker providers, including a growing split among higher-rated credits, “with some providers easing through 2022 and 2023 with very little difficulty compared to others.”