Fitch Ratings Lowers Outlook on Hospitals to Negative From Stable

CHICAGO - Fitch Ratings yesterday revised to negative from stable its outlook on the U.S. not-for-profit hospital sector, citing a slew of capital and operational challenges.

Among the factors expected to weaken profits is the increased cost of capital as hospitals issue fixed-rate debt in lieu of variable-rate bonds - sacrificing the possibility of lower interest rates in the interest of stability, according to Fitch analyst Jeff Schaub.

The fiscal challenges facing nonprofit hospitals prompted Moody's Investors Service to revise its outlook to negative from stable last month, and Standard & Poor's to warn last February that credit quality is deteriorating across the sector. Downgrades in the sector have generally outpaced upgrades for all three rating agencies so far this year.

Many hospitals have suffered significant investment losses due to declines in the equity markets during the year, with 20% to 30% declines in liquidity not uncommon, according to Fitch. Broader economic pressures, meanwhile, have sparked an increase in uncompensated care and a decline in volume as well as likely reimbursement constraints in the future.

To blunt the impact, hospitals are postponing capital spending in an effort to maintain liquidity.

"Everyone is scaling back," Schaub said. "If there's any kind of discretionary spending out there that's not patient-safety related, it's being put on hold."

Those hospitals that are moving forward with borrowing plans are finding that capital is significantly more expensive than it was six to 12 months ago, he said.

"We've seen fixed-rate bonds starting to hit the market again [after the recent credit freeze], but interest rates are higher than three months ago," Schaub said. "Double-A and A credits are able to sell bonds, but the interest rates they're faced with for long-term debt are a couple hundred basis points or more higher than they had been when project plans were being devised. Hospitals that were counting on financing debt at 4.5% are now paying 6.5% or higher, and that's going to depress profitability."

Despite higher interest rates, many hospitals are now issuing fixed-rate bonds instead of the variable-rate demand bonds long favored by the sector. The move stems in part from the collapse of the auction-rate debt market last February as well as from the increasing difficulty and expense in obtaining liquidity to support debt issuances.

Some providers, particularly larger, higher-rate ones, have issued variable-rate debt backed by their own liquidity, though that move is not without risk, according to Schaub. To maintain sufficient liquidity, some providers may need to curtail other investments. And the fine print attached to providing self-liquidity could end up being a headache.

"Hospitals are not banks, but providing self-liquidity requires hospitals to act like banks. They need to set up policies and procedures they may be unfamiliar with," the Fitch analyst said. "Six months ago it was pretty unlikely those policies and procedures would be tested, but they have been tested in the last six weeks or so, with some hospitals having to buy back their own self-liquidity backed bonds."

In addition to more expensive and less accessible capital markets, major investment losses are also prompting some hospitals to scale back capital plans, according to Fitch. This year's downturn in the equity market has eaten away at the "liquidity cushion that many hospitals amassed from 2004 to 2007," the agency said in a release on the outlook revision.

The direct consequence of investment losses is a drop in the number of days' cash on hand, an important measure for credit quality.

"The losses in investments are a big driver of the desire to hoard cash," Schaub said.

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Healthcare industry
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