The COVID-19 crisis is disrupting the health care system like it has never been disrupted before. Hospitals and all other health service providers were hit with this disruption with lightning speed, forcing the industry to learn in real time how to handle a situation for which there was no playbook. With no precedent to look back on, and with so much uncertainty and risk, investors are struggling to assess their holdings. S&P Global Ratings is taking a measured approach to try to distinguish those credits experiencing relatively short-term stress that we expect will ultimately show recovery, from those that may experience higher levels of stress with a less favorable outcome. We expect that our view on which credits will recover and of the pace and extent of their recovery will change as we get a better picture of what the post-pandemic environment will look like.

The approach we are taking incorporates a number of common sense principles.

Many health service providers, most notably hospitals, provide essential services and are not going away.  Yes, there are fewer hospitals than there were years ago, and we do believe the long-term migration to a value and outcome based environment is contributing to a slow migration of patients to lower-cost sites of care, but hospitals, in general, will remain important sites of care for the foreseeable future.

We assume the main cause of disruption is the sudden and total deferral of elective and non-emergent services.  The disruption was in order to ration personal protective equipment, staff, and physical capacity to handle the surge of coronavirus patients as well as the lack of testing capabilities. We view this deferral as temporary until the rate of infection is lowered to a point such that the health system's capacity--including for testing--is adequate to handle the demand. Although we already see some of that deferred volume returning, particularly for procedures that can't be delayed any longer, we expect the ramp-up to take time. The pace may be slow for a while depending on the trajectory of the virus and if there are upticks in COVID-19 patients or if continued fear of the virus leads patients to further defer or forego lower acuity procedures.

We do not necessarily view the period of disruption as a change in the long-term credit story.  We say this notwithstanding the likelihood there will be some lasting alteration in the health care landscape, and considering the possible impact of a recession. Given the extended period of disruption, a recession, and possible lasting changes to communities and the health care marketplace, for nearly all providers, credit metrics in 2020 will be much weaker than what we had expected, and probably somewhat weaker than our expectations for 2021. There will be some credits with more cushion and time to weather stress while they recover to near normal levels, while we may expect others to never recover. For these situations where we don't expect metrics to normalize, or if there is an adverse change in the obligor's long-term credit story, an adverse rating action is likely. As a reminder: a rating is prospective, and not a point-in-time opinion.

Stimulus funds, particularly the grant funds, are supporting existing ratings by providing an immediate injection of cash, offsetting some of the operating performance shortfalls, and easing liquidity declines many hospitals are experiencing with the deferral of non-emergent and elective procedures and should help to support near-term credit quality for many providers. While some weaker, lower rated credits may experience immediate rating pressure, due to any of a number of factors including very weak liquidity, smaller revenue base, or location in smaller markets, credit quality for higher rated credits may be more tied to our view of the recession and recovery, as well as the new normal for hospitals and their financial profile. Our view of management's ability to effectively handle the near-term operating and liquidity stress and adjust to whatever changes might be required over the medium- to long-term will also play a role in our view of credit quality.

Overall, we believe the credit impact on all for-profit and not-for-profit health care service companies will largely be negative, although it's likely that only some will experience a negative rating action. This view incorporates near-term disruption but does heavily weigh our view of the long-term credit picture. We do expect nearly all for-profit and not-for-profit health service companies to be negatively affected in the near term, primarily due to very large declines in revenue from patient volume associated with the deferral of elective and non-emergent procedures. As a result, health service companies will face very significant liquidity pressures for several months, in our view, but are being aided by access to liquidity through many different government programs as well as other external bank and credit support. There are too many uncertainties to estimate with precision when deferred procedures will be restored to near pre-pandemic levels, but we are already beginning to see some return of non-emergent and elective volume in small numbers in many markets. While it's quite possible (depending on the type of business) some business may be permanently lost, and outlooks for some firms may be revised, we believe much of the volume will eventually return. We believe the second quarter of 2020 is the low point and we will see sequential improvement (assuming no second surge causing another total lockdown), though total patient volume for most hospitals, particularly outside of hotspot locations for COVID-19, will remain below historical levels for the balance of the year, and into early 2021.

Acute-Care Providers Begin To Shift Focus To Reactivation And A New Normal

We believe the overall situation regarding the current pandemic and the recession is a negative for all hospitals and health systems, though they may affect the ratings differently for not-for-profit versus for-profit acute care providers. Both not-for-profit and for-profit acute care providers are experiencing the steep decline (30%-50%) in patient volume due to the delay of non-emergent and elective procedures beginning mid-March, resulting in financial challenges. Most of them will receive monies, including stimulus grant funding and perhaps advanced payments from Medicare, to help them overcome financial pressures including near-term liquidity needs, and many of them are beginning to ramp up non-emergent and elective procedures. The major difference in the credit impact between the not-for-profit and for-profit providers lies mostly with the balance sheet. Not-for-profit providers generally have significant cash reserves while for-profit providers do not.

Cash and reserve profile highlights differences between not-for-profit and for-profit providers

Solid levels of reserves (and access to external liquidity support) for many of our rated not-for-profit credits provides some flexibility for short-term stress, but that of course varies by rating and within each rating level. In addition to the cash flow challenges from operating disruption, investment market declines have affected reserves for many of these providers. To the extent that reserves further weaken, either due to cash flow or investment market declines, that could affect broader credit quality for the not-for-profit health care group. We believe our lower rated not-for-profit credits that have light liquidity and particularly those with weak enterprise profiles will be relatively more vulnerable to credit rating changes. The for-profit providers, which are much lower-rated than not-for-profit acute care providers, do not maintain substantial cash reserves, relying instead almost exclusively on cash flow and borrowings (typically revolving credit facilities and asset-based loans) for liquidity. They typically have much more debt leverage than not-for-profit hospitals. Their largest problem during the trough of the pandemic is the sufficiency of their total liquidity, which incorporates possible large cash flow deficits during the business slowdown, near-term refinancing risks, and debt covenant compliance. The currently large cash balance many of the for-profits have recently built up to manage near-term liquidity needs during the pandemic is mostly due to their pre-emptively drawing on the capacity of their revolving credit facilities, to advanced Medicare payments, and in a few cases issuance of new debt. Another rating consideration for not-for-profit hospitals and systemsis that the recent increased use of lines of credit and external liquidity support, which for many credits should be temporary or short-term, could weigh on some credits, particularly if we believe cash flow recovery will be insufficient or much lower than pre-pandemic levels and the short-term lines consequently become more medium- to long-term liabilities.

Non-emergent and elective volumes took a beating but recovery is underway

In addition to the balance sheet impact, the volume decline of non-emergent and elective procedures will have a large adverse impact on profit margins for all acute care providers, as they tend to be the most profitable. Even those hospitals treating a large number of COVID-19 patients will be hurt as these patients are expensive to treat due to higher supply and labor costs. Hospitals will receive a 20% increase in their payment for Medicare COVID-19 patients as part of the CARES Act, which is helpful, particularly to providers in hot spots, but overall we still expect the impact on profitability to be negative. While the return of the delayed procedures and moderation of the COVID-19 cases should help profitability begin to recover, we believe the likely slow ramp-up period due to patient hesitancy could keep margins below historical norms for quite a while. Ramp-up time of volumes could also vary depending on location as facilities in hot spots may be slower to recover. Of course, a second surge or recurring surges of COVID-19 cases may cause delays in procedures that would also hurt margins. Moreover, hospitals may incur new, permanent expenses due to likely changes in protocols to be better prepared for another COVID-19 wave and for the potential of COVID-19 patients becoming a regular occurrence for an extended time--and not to mention, to be better prepared for a future pandemic.

The number of COVID-19 cases has varied significantly across the nation and thus depending on how outbreaks continue to track, location and diversity of a system may influence credit quality. Large regional and multi-state systems, such as the for-profit hospital companies and some of the not-for-profit hospitals we rate, and those not solely located in hot spot markets, may be better able to re-activate their non-emergent and elective procedures more quickly. Even regionally based systems may be able to more efficiently manage their volumes. Single-site hospitals may be at higher risk from a local COVID-19 outbreak. Integrated providers with health plans could be less affected in the near-term as the stream of member premiums helps limit near-term cash flow declines.

Credit fundamentals matter

For all acute care providers notwithstanding tax status, we believe our higher rated credits should better withstand the anticipated revenue pressure from the pandemic crisis. The higher rated not-for-profits have historically had good cash flow, but also have the balance sheets to provide greater credit stability versus their peers, while the higher rated for-profits have superior cash flow and liquidity compared with their peers. While we believe the second quarter will be the most challenged quarter operationally, the pandemic's trajectory could cause ongoing challenges for hospitals. In addition, the recession and increased unemployment will likely shift the payor mix further toward governmental with uninsured also rising. This, in turn, could further pressure margins. Important factors in determining long-term credit quality will include recovery in volumes, cash flow, and balance sheets characteristics (most notably cash reserves for not-for-profits and leverage levels for both not-for-profits and for-profits). If these items remain weaker than pre-COVID-19 levels that could affect how credits can pursue future strategies and initiatives. We expect that many management teams will begin to rethink their strategies using technology and other capital and cost saving initiatives. Given the expected noise, we will continue to turn to credit fundamentals, including enterprise and balance sheet strength, as well as strong and adept management teams to help support our view on credit quality.

Credit actions have been concentrated in outlook changes

Rating actions and outlook revisions for hospitals have been largely negative for both for-profit and not-for-profit hospital companies for those credits that required a rating action or outlook revision. Since the COVID-19 crisis began we have revised the outlooks on two of our nine rated for-profit hospital companies to stable from positive because the likelihood they would meet our expectations for a higher rating over the next year is now far lower, and revised one outlook to negative due to the COVID-19 crisis. In contrast, we have taken a large number of negative actions in our large portfolio of for-profit health care service companies.

In the larger not-for-profit credit portfolio (approximately 420 credits), we continue to triage and review our credits to determine any further outlook or rating considerations. To date, since the beginning of April, we've taken unfavorable outlook actions or placed on CreditWatch Negative about 10% of our credits with only one downgrade related to the pandemic. Most of those outlook actions were taken on what we view as our most vulnerable credits that are speculative grade or have very low levels of liquidity. Given that a large percentage of the not-for-profit credit portfolio ratings are investment grade, we expect many credits can absorb some stress at their current rating level, although we may update that view to the extent our understanding of the pandemic trajectory and economic recession deviate from baseline forecasts by S&P Global Economics. Considering our overall negative sector outlooks for both not-for-profit and for-profit health services, more adverse outlook revisions and rating changes are possible.

Most For-Profit Health Provider Subsectors Feel The Pain

The delay of non-essential elective procedures is dramatically affecting all health providers, not just hospitals and health systems. Severe volume declines, which began during the second half of March, vary depending on the provider type, but overall are substantial. Not surprisingly, the credit impact for these companies as a group is negative, though the degree to which it affects their financial results and credit ratings varies. Moreover, the ratings reflect the risks of an extended slowdown, the timing when patients become less fearful of directly accessing health care, and the ability of these companies to overcome the severe liquidity issues they face. To provide some detail regarding the extent of the business decline at the trough: we hear reports of emergency room visits down 30% to 50%; inpatient and outpatient surgeries down up to 80%; and surgical cases at ambulatory centers down 65% to 75%. All physician services have been affected with physician visits down significantly, though an increase in telehealth has offset some of the decline. Other examples of physician services feeling the pain are anesthesiology and radiology with significant declines of 50% to 70%. Lab companies are experiencing a more than 40% decline in lab tests net of COVID testing. Other subsectors such as dental and physical therapy are nearly closed down except for emergencies.

Credit impact on health service subsectors

Not surprisingly, such an unprecedented decline in business has negatively affected all health services, though the credit impact on specific health service subsectors varies. These typically low-rated companies tend to be highly leveraged, with weak cash flow, and limited liquidity. In many instances, they have upcoming refinancing needs and may struggle to meet debt covenant requirements. They are more susceptible to adverse business conditions, which is exactly the scenario we are currently experiencing. The higher rated of these companies tend to have stronger business positions and superior cash flow and liquidity, giving them greater capacity to withstand the business interruption from the intentional delay in elective surgeries. The sudden and dramatic decline in business with uncertain path to recovery is a key consideration in our credit decisions because these companies can only sustain for so long. Moreover, many lower rated companies with weak or vulnerable businesses are more susceptible to possible lasting, unanticipated changes to their businesses in a post-pandemic world.

Of the many recent rating actions we've taken on our rated health service subsectors (see "Growing Health Care Ratings Contagion From COVID-19," published April 15, 2020, on RatingsDirect), the ones most adversely affected by the pandemic are already very low-rated, have relatively small scale, are narrowly focused, and have little cushion to absorb disruptions in patient volume from unexpected events such as the COVID-19 pandemic. All these subsectors provide services that are to a degree discretionary. They may also struggle with a return of volume if people continue to avoid contact to a lingering fear of exposure at a medical facility.

The rating actions have followed our ranking of for-profit health service subsectors based on our view of risk level from the pandemic disruption

High Risk

Dental companies.  The most affected subsector as the industry has largely shut down. Of the 36 negative actions we've taken in health services, 10 (six outlook changes, four rating downgrades) have been of dental service and dental supply companies

Medical staffing and physician groups.  The large decline in visits to emergency rooms and to physician offices, coupled with the decline in demand for anesthesia and radiology services related to the delay in surgeries has led to two downgrades and four outlook revisions.

Ambulatory surgery centers.  The 70% to 80% decline in surgeries in these facilities at the trough led to outlook changes on both rated ASC companies.

Physical therapy.  Similar to dental, this business has been largely shuttered since mid-March, leading to three outlook revisions and one downgrade.

Moderate/High Risk

Hospitals.  Hospitals saw a sudden loss of their elective business, which is often their most profitable business. However, the degree is not as severe as the high risk companies, and we expect business to recover faster due to the more essential nature of their services.

Home health care.  Although this business is considered to be "essential", we expect staffing disruptions, increased sick leave and absenteeism, and patient deferrals caused by social distancing measures and fear to cause significant volume declines.

Moderate Risk

Laboratories.  Although the large lab companies such as Laboratory Corporation of America and Quest are heavily involved in COVID-19 testing, the net volume of lab testing is significantly reduced related to the decline in surgical procedures, office visits, and social distancing. However we expect their services to become even more important, and for their services to recover reasonably well as testing related to the pandemic continues to grow and as medical procedures and physician visits ramp-up through the rest of the year and into 2021.