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Performance Ratios Stabilized In 2023 With Some Mixed Balance-Sheet Trends

U.S. not-for-profit acute health care medians for 2023 are broadly stable compared with those for 2022, which we view as mixed news, particularly for performance metrics (see table 1). Although performance ratios didn't weaken further from 2022, the lack of any meaningful improvement closer to historical levels highlights the ongoing sector challenges and underscores our view that improvement of those ratios will likely continue to take time and those performance ratios could remain lower for the next several years. The absence of significant debt issuances and some investment market rebound kept most balance sheets sound, although we observed a decline in one of our key measures of liquidity; days' cash on hand was below the important 200-day threshold for the first time in the last decade primarily due to a growing expense base and limited strengthening of reserves.

There remains greater dispersion of S&P Global Ratings' medians among the upper half of organizations we rate and the lower half, indicating an uneven recovery across organizations (see table 2). Medians among the upper half of entities trended lower in the past couple of years, indicating higher-rated organizations have not been immune from sector difficulties and have exhibited weakening credit quality. The typical credit quality gap of earlier years is still present, but not as pronounced, and is shifting slightly as some of the stronger entities are weakening or remaining in place, at best, while weaker organizations remain pressured. Amid this backdrop, we expect lower-rated providers could further weaken, while those on stronger or sounder footing with more financial cushion often can make the changes necessary to improve cash flow enough and reinvest in their enterprise.

Key balance-sheet ratios still provide sufficient cushion for many and, along with enterprise profiles, play a role in maintaining most ratings. That said, we've also observed capital spending rise with increased debt activity, particularly in 2024, while days' cash on hand is still pressured and cash flow remains below historical levels for many providers. Given these factors, combined with the higher percentage of negative outlooks, we expect some ratings will still be negatively affected but this will hinge in large part on the pace of general recovery trends in the next year or two.

Table 1

Table 2

Improvement in performance-related medians likely will continue on a slow trend

Fiscal 2023 medians reinforced our view that the sector's cash flow has reached a trough, with profitability and cash flow stabilizing from historically pressured 2022 (see chart 1). Our preliminary median report, "Preliminary 2023 Medians For U.S. Acute Health Care Providers Indicate Continued Operating Pressures For Many," published April 30, 2024, with a partial sample, pointed to very similar results, though there are some nuances based on fiscal year-ends. When analyzed through this lens, we noticed modest improvement for those with fiscal year periods ending later in the calendar year.

Uneven performance trend continued into 2023.   There is still a substantial divergence of performance both across the rating spectrum and within specific rating categories as well as between systems and stand-alone hospitals. The diversity of operating results is apparent in our acute health care median operating margin of 0.0% in 2023, indicating the sector was equally split across those with operating gains and losses. We believe that, relative to the median operating margin of 0.1% the previous year, underlying progress on performance in 2023 is masked by the tapering of stimulus funding from 2022, with providers broadly making up the lost one-time revenue as part of their performance improvement initiatives, although some organizations continued to benefit from nonrecurring revenue such as Federal Emergency Management Agency (FEMA) and 340B settlement funds.

Operational initiatives contribute to stabilizing performance.   With significant management initiatives and lessening inflationary pressures, there was more structural balance between the rate of expense growth and revenues and reimbursement. Rightsizing of nonclinical staffing, concerted efforts to reduce average length of stay, renegotiated commercial contracts and revenue cycle initiatives, and enhanced Medicaid supplemental funding programs have produced some benefit to providers, albeit to varying degrees. In addition, contract labor spending, both in terms of hourly rates and personnel count, has fallen across the sector, bolstering confidence in labor expense forecasts. Although this is a positive credit factor, management focus has now shifted to full-time salary and benefit initiatives, including a reduction of premium pay and internal labor pools, common levers used to stem contract labor exposure. However, median salary and benefit expenses as a percentage of net patient revenue remains higher than in pre-pandemic years and slightly higher than in 2022 as higher pay rates implemented during the pandemic are now part of the permanent expense structure.

Median performance and cash flow remain below management's targets.   Broadly, S&P Global Ratings views 2023 performance medians as indicative of incremental progress among providers, as the chasm between expenses and revenue narrowed. Nevertheless, cash flow did not improve meaningfully and is still below many organizations' long-range margin target that yields sufficient resources for capital investment and maintains desired balance-sheet cushion. After a decade of maximum annual debt service coverage at or above 4.0x, this measure of cash flow fell in 2022 and then further in 2023 to just 3.1x.

Chart 1

Balance-sheet ratios are still sound, but the gap is widening slightly between weaker and stronger providers

In our view, despite being down from the peak of 2021 and generally flat with 2022, sector balance sheets are still a principal credit strength of the sector. And despite the lighter cash flow, modest investment returns contributed to a slight increase in median unrestricted reserves. An absence of debt issuance supported unrestricted reserves to long-term debt and leverage medians, with both metrics remaining favorable compared with historical levels of the past decade. Key risks include a forecast weaker U.S. economy and any related investment market volatility (see "Economic Outlook U.S. Q3 2024: Milder Growth Ahead," published June 24, 2024), partially offset by any interest rate cuts, which could have a favorable impact on borrowing costs, especially at a time when debt issuance is on the rise.

Decrease in days' cash on hand stands out among other stable-to-improving balance-sheet ratios.   Increases in daily cash operating expenses have made days' cash on hand an outlier in this respect, with the measure below 200 days and down more than 50 days from 2021 (see chart 2), although we recognize 2021 was a high point for this metric. Medians for days' cash on hand vary considerably across rating categories, and with about a 160-day difference across medians between the lower and upper halves of the metric. Although days' cash on hand fell for both cohorts in 2023, the decline was slightly larger for the lower half.

Capital spending is increasing and could begin to influence debt-related ratios.   Providers are starting to make progress on deferred and strategic projects and capital spending to depreciation expense held at 1.2x in 2023, consistent with the sector's historical rate of reinvestment following drops at the pandemic's onset. With this, debt activity has risen in 2024 and we expect that will continue for many providers. Given minimal debt issuance during most of the pandemic, there's likely some debt capacity at many organizations, perhaps with the offset of providing greater stability in reserves; however, depending on cash flow trends, increases to debt service could pressure debt service coverage.

Chart 2

Outlook revisions are beginning to stabilize, but with a negative bias on rating actions

Downgrades continue to outpace upgrades, although the rate is slowing.   We continue to affirm the vast majority of our ratings; however, a negative bias on rating actions remains. These actions are generally due to persistent strained cash flow with balance-sheet metrics that no longer provide adequate cushion, although there are other reasons and various nuances. Midway through 2024, the ratio of downgrades to upgrades slowed slightly to 3.0 to 1 from 3.8 to 1 for calendar year 2023, with most of this year's downgrades (88%) in the 'A' category or lower (see chart 3). Four of the seven upgrades in 2024 were based on credit quality improvement, with the remainder tied to mergers and acquisitions (M&A) and the credit strength of the affiliated entity.

Outlook revisions are beginning to even out, with most ratings carrying a stable outlook.   We may be seeing emerging signs of stability on the horizon, as the ratio of unfavorable to favorable outlook revisions is 0.8 to 1 midway through 2024, compared with 2.6 to 1 for calendar year 2023 and an even higher 4.8 to 1 midway through 2023 (see chart 4). A favorable outlook change constitutes a 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. Most of our unfavorable outlook changes in 2024 were a revision to negative while favorable outlooks were more mixed between revisions to stable and positive, which is another encouraging sign. Although negative outlook revisions are slowing, the slowdown has had only a modest effect on our percentage of negative outlooks for the sector, which was 22% as of June 30, 2024, compared with 24% at the end of 2023, as it may take up to two years for unfavorable outlooks to be resolved via rating actions or revisions to stable as new data becomes available and actual results are analyzed relative to expectations (see chart 5).

Chart 3

Chart 4

Rating distribution is stable but with a slight deterioration at the higher end of rating scale.   Although the number of rating changes, new issuers, and provider consolidation through M&A can change the rating distribution from year to year, significant movement between rating categories is unusual, and our rating distribution remains fairly similar to that of previous years (see chart 6). That said, the number of ratings in the 'AA' category fell slightly by 1%, and the number of ratings in the 'A' category rose 2% from June 2023 to June 2024, indicating some slight credit quality weakening at the higher end of the rated universe. In addition, there was also a slight increase to the 'A' category from 'BBB', although this could be partially related to M&A activity. Our most common rating remains 'A', which is consistent with previous years.

Chart 5

Chart 6

Sector Update: Sector View Remains Negative, But Signs Of Stability Are Emerging

We maintained our negative sector view at the start of calendar 2024 for the not-for-profit acute health care sector, given our uncharacteristically high percentage of negative outlooks, the unfavorable trend of rating and outlook actions, and limited improvement or uneven performance trends for many organizations (see "U.S. Not-For-Profit Acute Health Care Providers 2024 Outlook: Historical Peak Of Negative Outlooks Signals Ongoing Challenges," published Dec. 6, 2023). However, significant management actions, easing of labor cost growth, and some reimbursement improvements are showing positive effects on margins and cash flow, albeit at levels that are still low relative to historical trends and often with some one-time revenues related to the 340B settlement that many providers accrued for at the end of calendar 2023 or early calendar 2024. A preliminary view of interim 2024 operating margin medians on a very limited sample size (about 25% of our rated issuers) is near 1.8%, which would be a sound improvement from 2023 if that trend continues through the remainder of 2024 and into 2025.

Sector headwinds persist, but a broad array of both near- and long-term initiatives and opportunities for efficiencies and financial improvement are also in play. Our view of individual hospital or health system rating trends, which influence our sector view, along with consideration to revise our sector view, could be informed by:

• Underlying financial performance trends, including expense and revenue drivers as well as key assumptions in forward-looking forecasts;
• Magnitude of capital spending needs and funding sources, and ability to service debt;
• M&A and partnership trends that could support capital needs and broader enterprise investments; and
• Outlook revision trends and the pace and resolution of ratings that already carry a negative outlook.

There will likely continue to be a negative bias on our rating actions, given the higher percentage of negative outlooks, and it could take multiple years for the percentage of outlooks to return closer to historical levels as we still expect an extended performance recovery. That said, the favorable trends noted above, along with greater visibility and confidence from management on near-term financial performance and balance-sheet trends, could inform a return to a stable sector view.

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 issuers 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 audited financial statements used for medians and in our analysis include both obligated and nonobligated group members. For the medians, unrestricted reserves exclude Medicare advance payments, and total operating revenue includes all recognized stimulus funding, FEMA reimbursement, and 340B settlement funding.

Related Research

• U.S. Not-For-Profit Health Care Stand-Alone Hospital Median Financial Ratios--2023, Aug. 7, 2024
• U.S. Not-For-Profit Health Care System Median Financial Ratios--2023, Aug. 7, 2024
• U.S. Not-For-Profit Health Care Children’s Hospital Median Financial Ratios--2023, Aug. 7, 2024
• U.S. Not-For-Profit Acute Health Care Speculative-Grade Median Financial Ratios--2023, Aug. 7, 2024
• U.S. Not-For-Profit Health Care Small Stand-Alone Hospital Median Financial Ratios--2023, Aug. 7, 2024
• U.S. Not-For-Profit Health Care Outstanding Ratings And Outlooks As Of June 30, 2024, July 18, 2024
• Economic Outlook U.S. Q3 2024: Milder Growth Ahead, June 24, 2024
• Preliminary 2023 Medians For U.S. Acute Health Care Providers Indicate Continued Operating Pressures For Many, April 30, 2024
• U.S. Not-For-Profit Acute Health Care Rating Actions, 2023 Year-End Review, Feb. 8, 2024
• U.S. Not-For-Profit Acute Health Care Providers 2024 Outlook: Historical Peak Of Negative Outlooks Signals Ongoing Challenges, Dec. 6, 2023

Glossary

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

Quarterly rating actions

• U.S. Not-For-Profit Health Care Rating Actions, June And Second Quarter 2024, July 12, 2024
• U.S. Not-For-Profit Health Care Rating Actions, March 2024, April 15, 2024