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Health Care Sees Progress

CHICAGO — There is cautious optimism for the nonprofit health care sector as operating performance and debt-market access show improvement after two years of financial turmoil.

Standard & Poor’s and Fitch Ratings recently released median ratio reports that show slight upticks in several metrics across the ratings spectrum.

“If you think back to where we were a year ago, there was a sense that the sector was in some type of free fall,” Standard & Poor’s analyst Martin Arrick said on a recent conference call held after the agency released its 2009 median ratios report.

“Numbers were falling all over the place and balance sheets were dropping left and right,” he said. “Now when we’re looking at it, it does feel and seem much more stable than a couple years ago.”

Fitch and Moody’s Investors Service — which recently reported a jump in sector downgrades — continue to maintain a negative outlook on the industry, predicting downgrades are likely to continue to outpace upgrades for the next 12 to 18 months.

The industry’s health is a key question as it prepares to implement sweeping changes tied to the new federal health care law.

On the debt side, many nonprofit health care issuers have spent the last two years slashing expenses — and capital budgets — to offset falling revenue.

Investment-grade issuers have returned to the debt markets, though new-money issuance is expected to remain lower than pre-2008 levels. Hospitals rely on capital spending to maintain a competitive edge, but a pause in capital spending isn’t necessarily a bad thing, according to Fitch analyst Jeff Schaub.

“The sector went through a tremendous building boom throughout the first decade of this century, so a momentary abatement in capital spending is not a horrible thing,” he said. “It will take some time before the sector really suffers from a downturn in capital spending. But some hospitals that were late getting to that capital-spend party may be at a competitive disadvantage.”

After the borrowing freeze of late 2008 and early 2009, investment-grade credits, even on the low end of the scale, again have access to the market, said a long-time health care investment banker.

But junk-level credits are increasingly exploring alternatives to borrowing, including some type of consolidation, said Arlan Dohrmann, managing director at Stern Brothers & Co.’s Chicago office.

“There’s been a recovery in the bond market for lower-rated, investment-grade rated hospitals,” he  said.

“If the credit is triple-B or better, there is a capital market there that wasn’t a year ago. Where before there was nobody, now investors are willing to accept that quality,” Dohrmann said. “If you’re rated below investment grade, then it’s tougher.”

In response, junk-rated health care credits are increasingly entering into relationships with larger nonprofit systems or for-profit entities to meet their capital and operating needs.

“Hospitals systems and community hospitals in some parts of the country are looking at more joint-operating type agreements, not necessarily full mergers,” Dohrmann said. “At the same time, you’ve got for-profit entities that are flush looking for opportunity. The trend is there.”

Cutting back on capital spending and other expenses has improved bottom lines across most of the rating spectrums, credit analysts said.

“One of the key improvements we saw was the operating margin increases between 2009 and 2008,” said Standard & Poor’s analyst Suzie Desai. “This reverses three years of operating performance declines. The improvement appears to be an expense story.”

Desai and Arrick noted that expense cuts are good for the bottom line but not sustainable, and that ultimately revenue will have to pick up for the industry to recover stability.

“Given the capital intensive nature of the industry, when will we see that spending ramp up again?” Desai asked.

The future is particularly uncertain as hospitals prepare for the impact of the new health care law coupled with the prospect of reimbursement cutbacks from Medicaid, Medicare, and even commercial insurers, analysts said.

“Hospitals are facing pressures, and the implementation of reform will cause more pressures,” Schaub said. “But many hospitals are really doing okay, especially considering the headwinds and uncertainties that they’ve been facing.”

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