Impact of the COVID-19 pandemic impact could cause more hospitals to breach debt covenants

• An estimate by the American Hospital Association indicates hospitals are expected to lose an estimated $202.6 billion from March 1 to June 30 due to canceled procedures, and the higher cost of labor and supplies during the pandemic, according to a Modern Healthcare article.
• The significant impact on cash flow could cause the number of healthcare organizations that breach their debt covenants to likely tick up in 2020.
• A Moody’s report reiterated this thought, saying hospitals will more likely breach covenants based on their debt service coverage rather than their liquidity.

According to a Modern Healthcare article, an American Hospital Association estimate indicates hospitals are expected to lose an estimated $202.6 billion from March 1 to June 30 due to canceled procedures and the higher cost of labor and supplies during the pandemic. This obviously has a significant impact on cash flow, and the number of organizations that breach their debt covenants is likely to tick up in 2020. The federal funds distributed through the CARES Act as well as the Medicare Advanced Payments have mitigated the risk for some, though the continued impact in regions and areas more affected creates a challenge for providers in those markets.

A Moody’s report reiterated this thought, saying hospitals will more likely breach covenants based on their debt service coverage rather than their liquidity. While legal documents governing bonds often contain force majeure provisions, these are somewhat untested and will require legal review to determine how much flexibility exists currently.

Moody’s said the impact of covenant violations on hospitals’ credit quality depends on the following:

• Whether the breach takes place in conjunction with fundamental operating issues
• What steps management takes to avoid a breach
• What likelihood there is that the violation triggers default and accelerated debt payment

HFMA learned that Greater New York Hospital Association leaders are calling on Congress to require that lenders provide relief from debt covenants on hospital loans to prevent the triggering of financial penalties.

Takeaway

While the financial fire may have died down for many hospitals, the coals are still glowing. Hospitals with a June 30, 2020 measurement date are at a higher risk than others, so we will have a better idea of how this will shake out in July. That said, with the impact of a recurrence of COVID-19 this fall or winter unknown, this should continue to be monitored. Additionally, as Medicare Advanced Payments are short-term loans, and at this point, will become due six months after the cash was received (there is some industry talk about asking Congress to forgive these loans), liquidity could also become an issue this fall.

We reached out to Kevin Holloran, senior director and sector leader for Non-Profit Healthcare at Fitch, and member of HFMA’s Principles and Practice Board, and he provided some calming commentary:

“In regard to bond covenants, we do feel there is a high likelihood  that there will be debt service covenant breaches this year. Some of that depends on the timing of the measurement point, the exact calculation (i.e., do unrealized losses factor in or not), and the flow of stimulus funding, but many issuers will get close or have an actual technical breach of their covenant this year. This is generally not a rating factor. And if you look at the 2008-2009 time frame, most lenders granted waivers or advance waivers.

The basic premise is that this event is not management’s fault; this isn’t poor leadership; this isn’t a structural problem with the providers — it’s a black swan event that happened to all of us — essentially at the same time to the same level of magnitude.  Fitch has not focused on days’ cash on hand, and it’s not a typical bond covenant any longer (it’s been a sellers’ market for the last 10 years and this ratio has generally been removed).  In addition, the pre-payed Medicare funds are making some organizations cash flush for the moment, making days’ cash on hand less of an immediate concern. If this goes on, and figure a good year for a true recovery, then lenders could start to get more worried about bond covenants, but I think for now, they will grant waivers at least this first go around.”

Let us hope Congress listens to the lobbyists and does the right thing to prevent financial penalties for already financially distressed hospitals. Another financial hit could be the final blow for many of these organizations and could have broader consequences considering the need for hospital beds amid a pandemic.