Many of our rated credits weathered the COVID-19 storm reasonably well in 2020 and we expect many to continue to do so in 2021 given underlying credit fundamentals and proactive management teams as well as funding support from the Coronavirus Aid, Relief, and Economic Security (CARES) Act (see charts 1 and 2). Demand for health care services helps support some resiliency of the sector and is reflected by the number of ratings that were maintained in 2020. However, the number of downgrades relative to upgrades in 2020 coupled with the higher percentage of negative outlooks compared to prior years, particularly within the stand-alone hospital group, highlights our view of increasing pressures in the sector with some credits in a tighter position relative to their rating. Credit quality could be tested, particularly for organizations that have a relatively light balance sheet or have already been struggling operationally as we believe some of these credits, given the headwinds, may not be able to generate enough operating cash flow to continue needed investments, further widening the existing credit quality gap. Below, we've highlighted questions that we believe will be the main drivers for credit quality over the next year.

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Questions That Matter

1. What will volumes look like over the next year?

We will continue to see uneven volumes as COVID-19 cases remain higher this winter, with likely smaller ebbs and flows of cases as vaccine rollout occurs through 2021.

How this will shape 2021

Early part of year may have more volume fluctuations.  Volume trends for non-COVID-19 care may differ across regions, types of hospitals, and service lines, and the number of individuals obtaining non-COVID-19 care will depend in part on the level of COVID-19 cases and community spread, particularly early in the year. While there could be pockets of COVID-19 flareups throughout the year, we expect the intensity to decrease as weather improves, if adherence to public health guideline rises, and eventually as more individuals are vaccinated.

Second half of year could lead to more normalized volume trends.  If the vaccination rollout is effective and the number of vaccinated individuals reaches adequate levels, we could see volumes return closer to pre-pandemic levels for many providers during the latter part of the year. However, certain volumes, such as lower acuity emergency room volumes, may not return for a while, if ever. Additionally, fatigue from the pandemic could limit the ability to staff for higher volumes and there may be a potentially slower return of elective care as individuals ease back into more normal life post-pandemic.

Volume trends may be affected by economic conditions.  While certain emergent health care needs may be recession-resistant, elective and preventative care could be exposed to the broader economic conditions given the increasing shift to high deductible plans with greater out of pocket costs and an ongoing uninsured population.

What we think and why

Sustained volume recovery will depend largely on COVID-19 containment.  We expect fewer, and better-managed, COVID-19 cases in the community will facilitate the ramp-up of non-COVID-19 volumes at clinics and hospitals, which should help minimize financial stress as demonstrated this past summer and early fall in many areas, but that return remains dependent on the willingness of individuals to seek care. (See chart 3 for early revenue trends during the pandemic relative to prior periods.) Certain preventative care and elective procedures which can be delayed could be slower to return while those hospitals providing a greater percentage of high acuity services may recover faster. Certain volumes may not return (like lower acuity emergency room volumes) which could have a mixed effect on financials. For many providers the acuity of care has risen when individuals delayed care; we are likely to see this continue into 2021, resulting in higher net patient revenues. For those credits with payment at risk or providers who bear some of the burden of those higher costs of care, that could result in incremental challenges to margins.

CARES Act and other provider relief funds may provide some aid in 2021.  CARES Act funding helped hospitals manage volume declines in 2020. While there is still available funding from the CARES Act that could support COVID-19 volume challenges, as well as other federal funding from additional stimulus bills, there is some uncertainty as to how and when the remaining funds will be distributed.

Successful vaccine rollout will be helpful.  With a more widespread vaccine rollout we expect increasing willingness by the population to seek care, and more care will likely be required as the public resumes normal activities. S&P Global Economics is forecasting that the vaccine will reach the broader public by the second half of 2021. However, if there are problems in vaccine distribution or vaccination rates, we could see prolonged volume softness and continued expense pressure as capacity and staffing needs rise.

Economic trends may matter, particularly for elective and preventative care.  We believe individuals could forgo certain care depending on their economic situations and the extent of their out-of-pocket costs. To the extent that federal stimulus to states and to businesses affects economic recovery, we could see less volume impact. We believe regions with potentially slower economic recovery--such as those that rely on tourism--could also experience slower recovery in volume due to unemployment or underemployment. A sluggish economic recovery that yields to S&P Global Economics' downside scenario could also potentially further stress volumes. While a better-than-expected economic recovery could aid volumes, the industry has been grappling with volume shifts for several years as individuals bear more out-of pocket-costs, and we expect that trend to continue to be a downward pressure.

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2. What additional factors are likely to affect margins and cash flow?

In addition to uneven volumes, hospital margins and cash flow are likely to be pressured this year given potential shifts in payor mix, increased COVID-19 expenses, and headwinds that have weighed on the sector for several years.

How this will shape 2021

Increased expenses related to COVID-19 may exacerbate existing industry challenges.  Staffing expenses are the biggest portion of provider expenses and could increase due to COVID-19 surges, use of temporary staff, and ongoing wage and labor dynamics. Health care organizations could also continue to experience higher expenses for COVID-19 related personal protective equipment, supplies, and pharmaceuticals.

Payor mix shifts are likely to continue in 2021.  States have indicated higher Medicaid enrollment over the past year. At the same time, providers have already been experiencing an increasing shift to Medicare payors from commercial over the last several years.

Shifting industry dynamics and evolving technology continue to require operating investments.  In addition to managing the day-to-day operating expenses for clinical care, health care providers require ongoing investments to enhance their competitive position and maintain the operating and strategic health of their institutions. While this is a broad category of expenses it includes areas such as information technology, physician investments, and expanded clinical service lines.

What we think and why

Ongoing industry pressures compounded by COVID-19.  At the start of 2020, we noted that there were increasing operating pressures for providers including payor mix shifts to Medicare, shifts in treatment patterns to outpatient from inpatient services, higher labor and pharmaceutical expenses, and continued operating investments to position providers for changes to health care delivery. These trends have been compounded by COVID-19 related volume challenges and expenses. Labor expense growth is likely to be a prolonged stress as clinical and other hospital staff may need to be compensated or relieved given the immense pressure they've experienced during the pandemic. Additionally, certain COVID-19 revenue enhancements (telehealth reimbursement, delays in Medicare sequestration cuts, and add-ons for COVID-19 care) are likely to expire at the end of the public health emergency unless extended or revised. There is still some CARES Act funding available, as well as an additional $3 billion from the recent COVID-19 relief bill, that could help support cash flow should COVID-19 continue to cause volume and expense challenges, but support will depend on how the remaining funds are distributed. In addition, the recent COVID-19 relief bill permits more flexibility in recognizing previously distributed CARES Act funds, which will be helpful to providers through the first half of 2021.

Payor mix shifts to Medicare/Medicaid create downward pressure on margins.  Payor mix shifts to Medicare coupled with increasing Medicaid enrollees could negatively affect operating margins and cash flow in 2021 as both are traditionally weaker payors. Many Medicare patients have limited their health care visits during COVID-19 and the combination of those patients returning for care along with higher Medicaid utilization without the benefit of the enhanced federal medical assistance percentage when that authorization period expires, and potential Medicaid cuts, could further negatively affect margins. Higher bad debt expense could increase as uninsured patients and those with high deductible plans are affected by the economic pressures.

Operating controls imperative to support margin recovery.  These operating challenges continue to demand management attention, especially innovative ways to contain expenses and find broader efficiencies in clinical care. Experienced management teams with operating controls and a performance improvement infrastructure will be key to managing through 2021. Implementing lessons learned from the pandemic will be key as well. That said, struggles to gain efficiencies or grow cash flow back to pre-COVID-19 levels could slow investments for the clinical enterprise and possibly weaken balance sheets if reserves are drawn down. M&A may accelerate for credits that are challenged or can't make the needed investments given their current situation.

3. Will balance sheets continue to provide adequate cushion for credits?

Balance sheets, which include healthy reserves, access to external liquidity sources, and manageable debt levels, have supported credit quality for many providers thus far, but the need for strategic investments against the backdrop of potentially lighter cash flow may test this stabilizing force for certain credits.

How this will shape 2021

Renewed focus on capital and strategic investments after a pause in 2020.  There was a pause on some strategic and capital investments in 2020 by many of our rated providers. The industry is faced with traditional and non-traditional competition which requires health care providers to consider investments to compete effectively. At the same time, health care providers must continue routine expenditures to ensure that facilities and related equipment and technologies are updated.

Low interest rates could facilitate both tax exempt and taxable debt issuance.  Many providers issued taxable and tax-exempt debt in recent months and that trend may continue for other providers.

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What we think and why

For most providers, balance sheets remain supportive to credit allowing some flexibility in 2021.  Many providers' balance sheets are still poised to support uneven and lower cash flow for a period of time but that flexibility isn't unlimited. Many of our rated providers built up reserves since the last economic recession and generally used debt in a measured manner (see chart 4). For some providers, the recent months' taxable and tax-exempt bond issuances provides additional flexibility for spending going into 2021. Additionally, receipt of CARES Act funds, deliberate easing of capital expenditures and investment markets that largely recovered from the March downturn further supported reserves over this past year. Many providers accessed or have access to lines of credit and received Medicare advanced and accelerated payments (MAP) that are scheduled for repayment beginning April 2021. (Our analysis of unrestricted reserves typically excludes MAPs and line-of-credit draws so payback of these sources are largely incorporated and shouldn't materially affect our view of credit quality.) However, we also believe that some providers are in a more tenuous position, relative to their rating, given the challenges in 2020 and from earlier years and may have more limited cushion.

Future strength will depend on cash flow recovery and pace of capital spending and investments.  Ongoing balance sheet flexibility will depend on how quickly capital and strategic investment resume, coupled with our view of cash flow recovery and margins as well as investment market performance. If the low-interest-rate market continues, some providers may be able generate additional flexibility by using debt for needed spending, provided debt related metrics don't become too pressured. However, to the extent that cash flow remains sluggish and capital spending resumes, or investment markets undergo a correction, we could see a tightening of balance sheet flexibility that could affect credit quality for some providers, particularly those with already limited reserves or high debt metrics for their rating. And for those providers that continue to defer or slow capital spend due to a longer cash flow recovery, that could also create medium-term risks with increased capital needs and competitive pressures over time.

4. How will the new administration and legislation affect health care providers?

With different leadership in the White House and a new legislative session, we expect some changes in health care policy in 2021. We anticipate changes will initially be limited in scope, with the immediate focus on controlling the pandemic.

How this will shape 2021

The first months in office will likely focus on COVID-19.  Under the Biden administration, we may see a more cohesive national approach to COVID-19, including testing and contact tracing protocols, as well as a coordinated vaccination campaign though specific plans for such a strategy have not yet been provided. Until the pandemic is under control, we do not expect significant movement on other health policy issues.

Seismic administrative and policy shifts are unlikely but expanded coverage could be at play .  While there is likely to be a Democratic controlled Congress, it is still a slim majority formed by a delicate coalition of Democrats, which will likely limit major policy shifts that require legislative approval. President-elect Biden has supported the ACA and has desires to expand coverage through a public option and by lowering the Medicare eligibility age, but we don't believe that is likely this year. However, there could still be a broader set of health care policies implemented, particularly to support expanded insurance within the framework of the ACA and other incentives. President-elect Biden has also expressed support for policies addressing the cost of health care, including increased oversight of hospital mergers and acquisitions, elimination of surprise billing, and regulated drug pricing.

The ACA appears to be safe, for now.  Based on the Supreme Court's approach in California v. Texas, we believe full repeal of the ACA is unlikely. Still, this will remain uncertain until the decision is handed down later in 2021. However, we also note that with Democrats in control of the White House and Congress, a legislative intervention could mitigate a court ruling that dismantles the ACA.

What we think and why

A more coordinated federal response could help recovery.  A coordinated pandemic response and vaccine rollout could be beneficial to credit quality as it may reduce future surges of COVID-19, and may also support an accelerated economic recovery, both of which would in turn result in higher volumes and less payor mix pressure.

Expanded insurance coverage through the ACA supports providers.  We also view maintenance of and support of the ACA positively. Hospitals and health systems have seen the benefits of the ACA over the last several years, and any further expansion of insurance coverage (such as what is expected in Missouri and Oklahoma) or removal of administrative roadblocks to coverage would incrementally benefit revenues and patient demand. Full repeal of the ACA, though not expected, would result in a substantial and immediate increase in uninsured and underinsured individuals, forcing hospitals to bear more of the cost for their care and would be a meaningful credit negative to the sector.

Limits to M&A activity could be credit-negative.  Tighter regulation of mergers and acquisitions may limit some organizations from establishing strategic partnerships or seeking acquisitions in cases of financial distress. We generally view increased size and scale as a credit positive, and increased oversight may limit further growth for some systems.

Cost control initiatives will likely remain a federal focus.  While it is less clear how other potential legislative or administrative action could affect near-term credit quality, regulations that target the cost of care could create further revenue pressure for many hospitals, but this would depend on the specific nature of these policies. Recent actions such as 340b cuts, elimination of Medicare's inpatient-only list, price transparency beginning Jan. 1, and ban on surprise billing, are likely to be incremental over the near term. Longer term, we expect the federal government (and states and employers) to continue trying to limit health care cost growth while improving quality which could be more difficult to absorb depending on longer-term impacts from the pandemic and other industry headwinds.

5. What are the strategic implications of the pandemic on health care providers?

Disruption in the industry continues and ongoing delay in implementation of strategic initiatives and investments could put providers in catch-up mode to compete with both traditional and non-traditional competitors. Still, COVID-19 spurred rapid innovation and adaptation which may serve providers well as they adjust to the post-pandemic world.

How this will shape 2021

Telehealth and care at home are here to stay.  The COVID-19 pandemic rapidly accelerated utilization of telehealth and other means of non-hospital-based care. We expect this trend will continue even after widespread vaccination but will also depend on reimbursement.

Non-traditional competitors will remain active.  While hospitals were at the forefront dealing with the pandemic during 2020, non-traditional competitors have been and will remain active in the sector, particularly as COVID-19 is more controlled. With the growth in telemedicine and digital care, coupled with consumer-friendly organizations entering the health care space, patients may become more comfortable seeking care outside of traditional settings and geographic boundaries.

Mergers and acquisitions will continue.  Despite possible increased federal scrutiny, we expect that M&A will remain a strategic tool to enhance business positions as well as support hospitals that may be in a more challenged situation.

Social determinants of health (SDOH) are more relevant than ever.  The pandemic highlighted disparities in health care and outcomes for different sectors of the population. Providers will continue to invest in strategies that address SDOH in their communities.

What we think and why

Competition continues to expand beyond health care providers.  For most hospitals and health systems, competition is not only coming from peers, but from well-capitalized start-ups and large companies moving into the health care space, many of which are focused on offering customer-centric care at potentially lower price points. We view this as a credit risk, particularly as these competitors gain access to patients early on and may target high-margin business while directing patients to low cost providers. While the pandemic was disruptive, it also forced management to quickly make decisions and adapt immediately to changing circumstances, both of which are skills that could be used to better compete in the market.

Technology investments will be critical.  Ongoing technology investments are necessary for clinical care advances, as payor models shift towards risk, and as hospitals make efforts to improve the patient experience. Investments in telehealth, care at home models, and digital health are likely to be important and delays in investments could put providers steps behind others and be less competitive. Providers are likely to look to M&A and partnerships given that certain strategies may need scale and specific skillsets to be successful.

Innovation will make a difference.  Organizations will need to continue to diversify, innovate, and adapt, particularly if volumes remain depressed, patients seek care outside of traditional settings, or there are more payments tied to cost and quality, and as all payors focus on curbing the growth of health care costs. Many organizations are also working to address the foundational health and wellness issues at the community level, including addressing the SDOH outside the walls of the hospital, which we believe should help to improve the costs of care and improve quality, but likely will take a long time to adequately address.

Rating Distribution And Activity

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