CHICAGO — Fundamental changes in the way non-profit hospitals do business — chief among them the way they are paid — are driving the consolidation trend that has marked the sector over the past year, Fitch Ratings says in a new special report.

One of the biggest changes tied to the new federal health care law, which takes effect in 2014, is a shift from a volume-based fee-for-service payment model to a performance or value-based model that is tied to outcome, Fitch says in the report, "Nonprofit Hospital Consolidation, Integration and Alignment."

A decline in inpatient volume as well as reimbursement reductions from the government and commercial insurers and a need to focus on outpatient care will challenge hospitals over the near term, analysts said.

"A few weeks ago, one CEO of a hospital mentioned that in her 20 to 30 years of hospital management, what's going on right now is, for the first time in her career, truly changing the fabric of the operating environment," said Fitch analyst Adam Kates, who wrote the report. "This is a transition in the way that they're actually paid."

The new payment model is already being implemented in the Medicare program as well as by some commercial insurers. To prepare for the full-scale shift with the new law, hospitals are turning to each other as well as commercial insurers and physicians to adapt — and that's led to an increasingly blurred line between hospitals, physicians and insurers, Fitch said.

It remains uncertain how the new trends will affect health care bond issuance over the near term, Kates said. But when it comes to borrowing, more issuers are expected to invest in information technology, outpatient facilities, and building support for physicians instead of the traditional investment in large inpatient towers.

"We are expecting a lot of future capital expenditure to be focused on outpatient facilities as opposed to the investment in inpatient facilities that we've seen over the last decade," said Kates.

The changes in the sector's operating environment will aggravate the credit gap that has long existed between the large, higher-rated systems and smaller, lower-rated stand-alone facilities.

Hospitals with less liquidity, reserves, and market access will have a harder time adjusting to the shifts in the landscape, Fitch said.

Smaller, lower-rated facilities also tend to lack the managerial expertise that the new law will require as hospitals start to take on more risk, rewards and penalties associated with value-based reimbursements, Kates said.

"New and untested strategies and alignments are being created to prepare for a value-based payment environment," Kates wrote in the report. "The credit implications of these evolving strategies will vary on a credit by credit basis. However, large operating footprints and financial strength including size, scale, robust cash flows, and strong liquidity can provide cushion to mitigate against downside scenarios."

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