Demand Plus Resiliency Yield Significant Improvement

The 2021 U.S. not-for-profit acute health care medians saw remarkable improvement from 2020 despite the continued turmoil last year as providers managed through multiple surges of COVID-19 and significant labor pressure (see table). This highlights demand for services as well as the resiliency of management teams that continued to focus on financial performance and balance sheet preservation while also managing through an exceptionally challenging clinical environment. While financial performance improved over the fiscal 2020 median levels, provider relief funding provided material support, as illustrated in the calculation of operating income excluding nonrecurring operating income. Notably, operating income adjusted for nonrecurring operating income is improved and positive as compared to the same figure in 2020, but COVID-19 stimulus funds still accounted for a material amount of support.

Last year may be a peak year for acute health care medians as we expect ratios to moderate significantly in fiscal 2022 in light of recent industry and macroeconomic headwinds, coupled with limited, if any, remaining COVID-19 stimulus funds. The improvements in recent years, in particular on balance sheets, provide some (albeit limited) cushion for managing through the potentially strained cash flow environment that began in the second half of calendar 2021 and has persisted through 2022. The nursing shortages and rising labor costs continue to affect the sector as we saw through the first calendar quarter and were exacerbated by Omicron, and will continue through 2022 and likely early 2023. Preliminary second calendar quarter results are showing variability, with modest quarter-over-quarter improvement for some but ongoing challenges for others. Demand for services remains sound with health care remaining an essential service; however, if organizations cannot maintain staff to service demand, and as other shifts in care continue (e.g., inpatient to outpatient) cash flow may be further challenged. The structural imbalance related to staffing should ease eventually, but it will test cash flow and performance, particularly if investment markets--a key support for cash flow and the balance sheet in recent years--also remain soft. While 2021 medians are a retrospective view, they provide a perspective into the level of flexibility which an organization may have entering into this challenging time. Of course, this is always reviewed along with an organization's broader enterprise and institutional strength along with its operating culture relative to others in its peer group.

For additional information on the current sector view and expectations for the remainder of 2022, please see "U.S. Not-For-Profit Acute Health Care Midyear 2022 Update: Providers Face Mounting Pressures From Inflation And Labor Costs," published June 27, 2022, on RatingsDirect.

Financial performance saw solid rebound, supported by stimulus funding and realized investment returns

Following compression in 2020, every financial performance median saw improvement in fiscal 2021 (see chart 1). As volumes began to normalize, net patient revenue median increased by nearly 11%, with total operating revenue median seeing continued growth year over year as well. The increased revenue, supported by demand, higher acuity of services, and some COVID-19 related stimulus, contributed to a solid increase in the median operating margin that is now higher than pre-pandemic levels.

However, with the exclusion of nonrecurring revenue consisting mostly of provider relief funding, the median operating margin would have been significantly lower at near breakeven levels. Median cash flow (EBIDA margin) also improved, though we note that this figure was supported by a larger level of nonoperating income and realized investment returns than in prior years given solid investment market performance. The increased median operating income in combination with stronger than typical median nonoperating income also contributed to a sharp uptick in median maximum annual debt service coverage in 2021 after years of stability near 4x.

Chart 1

Balance sheet metrics continue multi-year trend of strengthening

With robust investment returns, provider relief funding, and lower capital spending, balance sheets strengthened in fiscal 2021 with materially higher days' cash on hand and unrestricted reserves relative to debt, as well as lower long-term debt-to-capitalization (see chart 2). Leverage saw continued moderation despite significant long-term debt issuance for liquidity and interest rate savings, largely due to the increase in capitalization fueled by unrestricted reserve growth. In addition, many organizations continued to de-risk their debt portfolios by eliminating bank and variable rate debt given the favorable interest rate environment, which resulted in contingent liabilities accounting for a lower amount of the debt portfolio and exceptional unrestricted reserves-to-contingent liabilities.

Many organizations also slowed capital spending further into fiscal 2021, as seen by the decline in capital expenditures and commensurate rise in average age of plant, suggesting increased needs in the coming years. While certain projects were unavoidably slowed because of the pandemic and social distancing requirements, many teams also reduced capital spending to preserve liquidity and to consider whether shifting priorities and operating strategies might change capital funding needs. Finally, median defined benefit pension plan funded status improved significantly due to substantial growth in plan assets and rising discount rates which could potentially provide some short-term relief for funding needs.

Chart 2

Rating actions and outlook distribution indicate stability for now

Our rating and outlook actions in fiscal 2021 support stabilization after the challenging 2020, as upgrades and downgrades were nearly equal. Despite the financial challenges that emerged in late 2021 and through 2022, the rating actions through the first half of 2022 remain largely equal and are occurring at a similar pace relative to the prior year. However, eliminating the five upgrades this year that are related to merger activity suggests a slowdown in favorable rating actions while the strong balance sheets and enterprise stability could help prevent a material increase in downgrades.

Outlook revisions appear to be trending more favorably with favorable outlook revisions outpacing unfavorable outlook revisions; however, almost 70% of the unfavorable outlook revisions are outlooks that went to negative whereas only about 40% of the favorable outlook revisions moved to positive. We consider a favorable outlook change to include revision to positive from stable, to stable from negative, or the less common occurrence to positive from negative, and vice versa for unfavorable outlook changes, where the rating itself doesn't change. Further, our 2021 rating distribution remains largely in line with 2020 with minimal movement between rating levels. These trends as well as a high number of organizations maintaining stable outlooks factor into our current stable sector view. That said, there could be an increase in downgrades and unfavorable outlook revisions during the remainder of fiscal 2022 and into fiscal 2023 if labor, expense, and macroeconomic pressures continue at the current rate and there are not meaningful signs of financial offsets.

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Ratio Analysis

We view ratio analysis as an important tool in our assessment of the credit quality of not-for-profit health care organizations in addition to other key considerations including our analysis of enterprise profile factors and forward-looking views relative to both the business and financial positions. The median ratios offer a snapshot of the financial profile and help in the comparison of credits across rating categories. Tracking median ratios over time also presents a clearer understanding of industrywide trends and provides a tool to better assess the sector's future credit quality.

The financial statements used for medians and in our analysis include both obligated and nonobligated group members. For the 2020 and 2021 medians, unrestricted reserves exclude Medicare advance payments. All recognized CARES Act funding and other pandemic related relief is included in total operating revenue.

Related Research

• U.S. Not-For-Profit Health Care Stand-Alone Hospital Median Financial Ratios--2021, Aug. 24, 2022
• U.S. Not-For-Profit Health Care System Median Financial Ratios--2021, Aug. 24, 2022
• U.S. Not-For-Profit Health Care Children’s Hospital Median Financial Ratios--2021, Aug. 24, 2022
• U.S. Not-For-Profit Acute Health Care Speculative Grade Median Financial Ratios--2021, Aug. 24, 2022
• U.S. Not-For-Profit Health Care Small Stand-Alone Hospital Median Financial Ratios--2021, Aug. 24, 2022
• U.S. Not-For-Profit Health Care Ratings And Outlooks As of June 30, 2021, July 21, 2022
• Outlook For U.S. Not-For-Profit Acute Health Care: Navigating The Bumps While Getting Back On Track, Jan. 12, 2021
• U.S. Not-For-Profit Acute Health Care Midyear 2022 Update: Providers Face Mounting Pressures From Inflation And Labor Costs, June 27, 2022
• Outlook For U.S. Not-For-Profit Acute Health Care: A Booster May Be Needed, Jan. 6, 2022

Glossary of our ratios

• Glossary: Not-For-Profit Health Care Organization Ratios, March 19, 2018

Quarterly rating actions

• U.S. Not-For-Profit Health Care Rating Actions, June 2022 And Second-Quarter 2022, July 25, 2022
• U.S. Not-For-Profit Health Care Rating Actions, March And First-Quarter 2022, April 27, 2022