How the Healthcare Sector is Faring

How is the sector's access to capital? Are there ratings pressures? What about potential Medicaid cuts? As healthcare systems face several challenges, we will spend some time parsing through the sector's current and future plans to adapt.

Transcription:

Mark McIntire (00:10):

Thanks so much Dan, and thanks to Lynne and Bond Buyer for putting on what is yet again another amazing year of conference. So thanks to everyone. I'm here looking at this panel and I keep thinking this should be like a bad joke, two rating analysts and a banker walking into a bar. I won't do that to you and I also won't keep you from those reception drinks, so we will be speedy with this. So anyway, but just to set the stage here, what we're trying to do today is not to talk about what I'll call, and I'm going to reference back to the second session today, the mayhem that has gone on the last seven days or even the last 24 hours or six hours, depending on who you ask. So what we're trying to focus on are the medium and long-term pressures for acute healthcare providers.

(01:04):

So your local hospital health system, basically everyone in this room I presume has a local care provider and they are facing some real existential issues that go above and beyond the current market access issues that people earlier have already discussed. And I think probably maybe beaten into the ground, I promise not to use the L word liquidity. I've counted it no fewer than 18 times in the second session today. So things that we will try to avoid are that. Now for those of you not with the healthcare background, let me just take a step back and sort of give you the lay of the land. As has happened in the federal state here over the last month in March, Congress voted to cut $2 trillion out of the budget. They put Department of Energy interestingly in charge of finding that $2 trillion. And what they've done is they've said, okay, 880 billion is going to come out of healthcare and we've already promised never to touch Medicare.

(02:13):

That's the largest entitlement. So that puts a big bullseye on Medicaid. And for those of you just the mechanics of that, Medicaid obviously supports those that are less fortunate, don't have a lot of excess resources. Let's say a number of states that have expanded their Medicaid, in fact 40 out of 50 states have expanded Medicaid. And what that means, again, for those of you coming into this without healthcare, what it means to have expanded Medicaid is that the federal government pays for 90% of that. And so when you hear things like we're cutting 880 billion out of Medicaid, that has real concerns and that should be a real issue because that money has to come from somewhere where that care goes unmet. And so the question is, and this morning it was quoted, and I should have asked Dan about this, but the Moody's report from a few weeks ago that said, five to 22% of that will likely come from the states. And so the question becomes which states, which providers and how do you just think about all of this coming together at once? And I'll turn it over to whoever wants to,

Richard Park (03:34):

I can take it first background. So from a numbers perspective, you're talking $880 billion. If every non-healthcare related cut is made, there's 600 billion left. That's an enormous percentage of the cuts that need to be made. When it comes to the levers that can be pulled, you're talking about two main levers, one that's already been mentioned, reducing funding for people supported under Medicaid expansion. And the second being also to reduce just funding in general. So what people are calling this in the news called per capita caps, a lot of lawmakers are saying that those two are off the table, but the math just doesn't work out without doing one of the two of those. So if I were to say $600 billion needs to be taken out of the system, so what does that mean for your typical hospital? So our median payer mix from Medicaid out of 200 plus hospitals is 16.7%.

(04:36):

And you might be saying, well, is that a good thing or a bad thing? Well, what I will say is that that median is from 2023 and in 2023, the median operating margin was break even hospitals can just break even with the current lay of the land. Now, we are expecting from our research that that margin will improve when we release our medians in 2024 to right around one and a half percent, maybe towards 2%. But still until now, hospitals have had a major expense problem recently with inflation being challenging with cost of labor going up, especially as well as supplies. So hospitals have been working very hard to manage the expense basis. And now if you're talking Medicaid cuts or less people being covered by Medicaid in general, you're talking less revenue or revenue problem from both number of people who are eligible for Medicaid walking through the door as well as the amount of reimbursement that's coming to the hospitals.

(05:32):

So one more thing that I'll note is that when it comes to children's hospitals, we rate 17 standalone children hospitals, about 55% of their payer mix growth payer mix our median for children's hospitals in 2023. So if you're thinking about pediatric providers, this is an enormous threat to getting payment access healthcare provider in general because there will naturally, if you're at 55% of your gross payer mix is coming from Medicaid, something has to give on the expense side and there definitely is going to be very, very big changes that would have to be taken in order to accommodate that kind of revenue.

Mark McIntire (06:15):

I'm seeing Keith, I think you want to, do you want to say something?

Keith Kleven (06:17):

Because

Mark McIntire (06:18):

I noticed,

Keith Kleven (06:19):

No, I mean the Medicaid program, it's so important because it does serve, and Mark, you talked about this a little bit already, but it serves the least fortunate among us and it's generally poor populations or children that are served by Medicaid. The problem is that those are also some of the lowest margin things that hospitals do as well. So if you're going to cut, if you're all of a sudden not going to be getting Medicaid revenue, if your Medicaid revenue is going to be cut by 20%, the hospital's going to have to respond and do something about that. And unfortunately, the easiest programs to cut are the ones that are getting reimbursed by Medicaid itself. So that then spirals into a problem where now all of a sudden you have people that maybe would have been covered under Medicaid that are coming into the emergency room for higher cost care and those types of things. So it definitely is an issue. And to put some simple numbers on it, if a standard hospital has 20% of their revenue coming in from Medicaid and 20% of that goes away, all of a sudden you can't make that up when you're only making a 2% operating margin.

Mark McIntire (07:40):

And just to make one note, and I think this is great and Rich, Keith, that's terrific. And the one thing though I think we've missed out here on saying, and let me say this clearly, acute care hospitals cannot turn anyone away just because you can't pay. That's sort of a tenant of all not-for-profit hospitals. And so it's not like we can just not do the Medicaid work, we don't run the credit card and then give you care. That's not an option. So that's the other piece of the puzzle here. And I don't know if you want to add onto that, Doug, if you have any.

Doug Kilcommons (08:20):

Yeah, I mean I can't disagree with anything that my fellow panelists have said. It is both a revenue problem and an expense problem. And on the expense side, Richard is right, you have to, as a provider, look for ways if your revenue is not there, what you can do to trim back expenses. The problem is, as we all know, healthcare, since the pandemic has faced rising costs across the board, you can look at drug costs, supply costs and labor. Those three have been big ticket items even before the pandemic. They've continued to go up in the post pandemic environment and there's just a limited ability to really trim back labor, for example. While everybody is very excited and encouraged by the fact that the more expensive traveling nurses in most markets has seemed to abate, you are seeing providers with much higher on staff labor costs because those traveling nurses and hospitalists reset the bar.

(09:14):

When the pandemic receded to keep people on staff, you had to increase salaries, you had to change work rules to be more liberal. So that's a big piece of the expense base that now really can't be touched. And then on the revenue side, you're right, it's we're talking about 20% of your revenue disappearing overnight. What can you practically do? If you are a system or a provider that's going after high acuity cases and you do have a percentage of your payer mix that is in commercial insurance and you have clout in your market such that you can dictate and drive rate reimbursements, you may be able to backfill some of that lost revenue through those means. But the long and short of it is that if you are serving a large Medicaid population and the Medicaid funding is not there, you will face difficult choices as to do you pull back on service lines? Do you target specific cases and move them to an outpatient modality because again, the cost is less. So these are things on both sides that will need to be weighed and factored in terms of trying to manage this.

Mark McIntire (10:19):

And I guess the question though is it's not all doom and gloom, right? Because if you look at Kaufman Hall who does a report, sort of a monthly report, they interview, I don't know, to get numbers from a good number of the US hospitals and health systems. And if you look at that monthly report, you'll see that in fact, Doug, you're absolutely right, labor costs have come down and that is by far and away the largest single cost driver for any hospital that's come down as well. And with that, I should say operating margins have widened that a little bit, but the median, I think you said Rich was just break even

Richard Park (10:58):

Break even at 2023.

Mark McIntire (10:59):

Yeah, I mean you might at the margin do a little bit better on labor costs, but it's not going to make up an $880 billion hole in any way. You do that math

Doug Kilcommons (11:11):

On the other side of the coin, as Keith, I think you said, this is a moral imperative to provide care for this segment of the population. So in some form or fashion, this segment will need to be served. And if you think about even today, hospitals and systems in states where the particular hospital is serving a large indigent care burden or a large percentage of the population that's either Medicaid insured or underinsured in general, you've seen states get creative with how they backfill and provide funding. I'll use New York as a great example of this. There are systems that serve a unique role as both a safety net provider as well as an academic medical center. So they've got the burden of, again, large uninsured or underinsured populations as well as the benefit of being a leader in certain procedures, research, et cetera. And so you're seeing the state, state of New York recognize this and actually provide supplemental funding, supplemental add-on rates to basically take what would otherwise be a very large deficit and shrink it close to break even.

(12:24):

And that dynamic is not about to change because states realize that they need to do these things Now with Medicaid, because most of that Medicaid funding gets directed towards the states, if the federal government is not providing its quote share, states themselves are going to need to figure out how they provide that funding. And if you think about states as a credit in the post pandemic environment, many of those states were left flush and many still are with very large liquidity balances. And I'm sorry to use the word liquidity,

Keith Kleven (12:56):

I knew,

Mark McIntire (12:56):

The L word, right?

Doug Kilcommons (12:59):

But that's the reality. And so that could also be something that the Fed is looking at and thinking about, well, maybe these states that are rated very highly AAA, AA category, what have you, they have the wherewithal to provide more soap,

Mark McIntire (13:12):

To play that out though, Doug, so if you're doing ratings, and this is Rich Doug question, sorry, keep looking back to you in a second. But if this is a ratings question, do you at some point, assuming this all goes through, and there are other hurdles, I'll say that states have put up this requirement of work to qualify for Medicaid. There are other barriers that are up that are going to prevent more and more people from being Medicaid that sort of in addition to the calling of Medicaid roles, and just by way of example, Texas had 20% of the population on Medicaid during COVID, that's now down to 13%, 2 million people have been terminated from the Medicaid program. And so if you have these dynamics and you say there are some rich states and some poor states, do you get a point just sort of make bulk rating changes? Because how are you going to, we know we can't absorb the 880 billion in cost cuts, right?

Richard Park (14:19):

I mean, I think in some ways Fitch, the way the Fitch looks at it is we typically in our ratings incorporate typical, typical variations. So we understand that stress is happening, we understand it. And so our forward-looking scenarios always incorporate some level of operating stress as well as investment portfolio stress. So the question becomes how far do we deviate from what might be a typical cyclical variation? And per state it's going to vary per Medicaid payer mix, it's going to vary. And so we're going to look at those each on an individual basis. And we also have very forward looking ratings. So at the end of the day when we have our conversations with management, we're looking forward to see what your expectations on operating profitability, how does that translate into what you're doing on the capital spending side of things and what does that mean even in a stress scenario, how can you respond and does that translate to some level of rating stability?

Mark McIntire (15:15):

Well, let me ask this though. Do you at some point say these cuts that are so big and that are coming certainly a medium long-term concern, do you change the outlook on the industry?

Richard Park (15:25):

I think they're changing. The outlook on the industry is certainly in the cards. I think that the cuts are so large and so across the board, at a certain point you understand that the margin improvement that we've seen over the past year or two is really going to be completely eroded if these cuts come through. And so the speed of how any management team is able to react to the challenges going to be a big deciding factor on, well, is that liquidity going to be maintained? Sorry, I used the word. And how are operations going to fare in the medium to longer term? And what does that mean for rating stability? And we have to answer those questions on a day-to-day basis.

Mark McIntire (16:05):

Yeah, please.

Doug Kilcommons (16:06):

Yeah. So I would say agree with some of that. And our approach is similar in some respects. However, we've generally shied away as a rating agency from taking broad brush approaches on sectors. It's a strategy that fared well, certainly during the pandemic when many sectors were put on negative outlook. And ultimately that proved to be not the right call. And we've learned from different situations that it's really a credit by credit approach that we take. And again, because exactly to richest point each credit and each management team has unique ways to deal with some of the stressors that these different challenges face. So we've generally shied away from the broad brush approach. With that said, one of the things that we will be looking for in terms of what ratings or which outlooks might change will be financial flexibility and the KBRA rating methodology for not-for-profit healthcare has five determinants covering the usual suspects, everything from market position management, financial performance debt, and then obviously bond security provisions.

(17:13):

But without question of those determinants, management is clearly the most important one because management is in the driver's seat in how they respond to these different industry stressors that show up. That's not to say that management alone can stop again, a 20% fallout in revenue, but there may be plans and strategic ideas that are put forward that can help really mitigate the potential impacts. And you'd be surprised, again, especially for highly rated health systems and hospitals, some of the very strong management teams that are in place, these are corporate style management teams that deal with mergers and acquisitions, they deal with joint ventures, they deal with high level negotiations with commercial payers, they deal with the federal government. So these are things, I think this was mentioned earlier, these are cyclical challenges that the industry faces. And fortunately teams learn from prior crisis. You go back in 20 years and you can see all of the things that healthcare has faced and how the sector has evolved and been able to manage them. So that's why we again, go to this kind of credit by credit approach. And then certainly if there are outliers in situations where it warrants, that's where we take our action.

Mark McIntire (18:26):

Right. So Keith, you're talking to hospitals, CFOs every day about all of a uncertainty. I think you said you had five calls lined up for of clients want to talk about

Keith Kleven (18:39):

Talking about the market.

Mark McIntire (18:40):

Yeah, the market, right. So what do you say to a hospital CFO to deal with all this uncertainty? They want to, or they need to raise capital for one reason or another, or there's a refunding for savings, which probably could be out of the money this hour, last hour, it could have been in the money, but what do you say to them about capital structure and financing vehicles at this point?

Keith Kleven (19:03):

Yeah, I mean to try and eliminate the last four days of our memory before we answer this question would probably be helpful. But I would say that the larger systems, not small community hospitals, but the larger systems, we're in an interest rate environment now that we would call elevated based on recent experience. So what that has meant for a lot of our health system clients is they have started to look to other financing vehicles other than just the straightforward tax exempt, long-term fixed rate financing. Now you introduce operational things in like this, and it does make it more challenging for them to think about and compartmentalize how they want their capital structure to look when they have all these operational risks that they're facing as well. But I think you set it well in that hospitals are facing this every year. You're in this business long enough, their payment mechanisms are constantly changing, whether it's the balanced budget Act, whether it's the Affordable Care Act, they're always going to be reacting to something and the good management teams will be able to react to it.

(20:18):

So now we get into a little bit more of an elevated interest rate environment and they start to think about, well, maybe we should have shorter structures on the balance sheet. We're not just going to do a 30 year fixed rate long-term deal anymore. Maybe we want to add one serial bullet maturity or one mandatory tender bond or put bond in five years and seven years to diversify the optionality in their capital structure. So they're starting to do a lot more of that, and it's based on the fact that they believe that there might be a better time to come into the market and refinance 'em. So they'll line up financing events in 3, 5, 7 years, whatever part of the yield curve that they want to pick and know that they're just going to have to refinance when the time comes.

Mark McIntire (21:09):

Are you seeing bank loans, well, I guess are commercial banks even, do they have the capacity right now? Do they have the willingness to do that?

Keith Kleven (21:18):

I think they have public, yeah, I think they have the capacity. The mechanism has changed slightly when we were in a declining interest rate environment and the federal funds rate was at zero, banks had relatively cheap funding compared to today. So bank transactions were really popular and then they kind of slowed down here over the last year to two years as the public markets have become price competitive again with what the banks can do. So I don't think that there's a lack of appetite from the banks. They're just pricing off of a different mechanism than the public markets do, and therefore the pricing just isn't as aggressive as it used to be.

Mark McIntire (22:03):

Well, so to that point, I guess you're talking about some contingent risks, right? Some renewal risk in the capital structure, rollover risk, whatever you want to call it, put risk. So I guess how do you, Rich and Doug, your respective agencies, how do you think about that type of risk? Do you quantify it? Does it impact the rating? If so, how?

Keith Kleven (22:28):

Try doing this without saying liquidity.

Doug Kilcommons (22:30):

I'll try. I can't promise, but I will try.

Mark McIntire (22:32):

There you go.

Doug Kilcommons (22:33):

No, so it's a great question and honestly, we expect if you're a large system, and again, I'm going to have to use the words, so my apologies with lots of cash and liquidity

(22:44):

On the balance sheet, you'll likely be taking advantage of debt structures that are not your typical 30 year amortizing fixed rate issuances. And you'll see variable rate instruments of some type. You may see backloaded debt structures, you may see put bonds, you may see a number of different types of instruments. And again, if you are a highly rated system with the financial flexibility to manage the instrument and have the knowledge and expertise on staff, meaning you don't have to rely on your financial advisor for all the answers, we do not have an issue with that. And again, that's why the rating speaks to is as high as it is, and it speaks to the ability to manage that as you go down the credit spectrum, the ability to manage some of these things becomes more challenge, especially without external assistance in most cases. And that's really where it may make a difference in the rating.

(23:40):

But I will say that even as you go down the credit spectrum, we're looking to see the why behind the debt strategy among other strategies that the organization may have. Why is it that you chose after doing fixed rate 30 year bonds for the last decade plus all of a sudden you've pivoted to a direct placement with a commercial bank or you're doing a five year put or a seven year put? And again, we don't get nervous just because it's different. We're going to ask questions around what's in place to support this? What's in place to deal with the risks? And if for a five year put, when that put date comes, what are you as an institution going to be doing to prepare for that put date? Do you have policies in place to manage that? What's the plan? And so again, going back to management, if you as a management team have planned for it, have a good well articulated strategy for dealing with it, it's likely not going to have an impact in the rating.

Mark McIntire (24:36):

And I can't help but go back to something that was said earlier and draw a parallel to balanced budget act or covid or whatever the uncertainty of the moment is. And just in our business, it assured guarantee what we do bond insurance. And it has a way of sort of, I don't say immunizing to some extent the impact of that. And I'm just curious if you see bond insurance use more, Keith, this is probably a you question or are you seeing that more frequently or?

Keith Kleven (25:09):

Yeah, I think anytime that there's credit uncertainty in the sector, it's going to be a time where you start to open up and look for ways to get your bonds in the hands of more folks. And the way to do that is to put insurance on it. So especially as we go into a market environment like we're likely going into here where there's a lot of uncertainty around what's going on in the market. So you may have certain buyers that are not there anymore, and you really do need to widen out that net bond insurance is one way to commoditize issues so that more buyers can enter the space. And that I think is going to be key in the coming months here.

Mark McIntire (25:56):

Yeah, it's interesting. I remember back before 2020 when taxable deals were a lot more common. If you all remember right before that election, all the kind of volume pulled up a few months. And I remember crossover buyers, European crossover buyers, they wanted to buy healthcare bonds. It's got the yield, but they wanted it wrapped because they didn't really understand healthcare. American healthcare is like, I mean, you can't possibly get across how that works in an hour long zoom session or whatever, but there are utilities like that. So change topics and pivot here to everyone's favorite topic of the day tax exemption and how that could play out for acute hospitals and specifically, I mean, going back to that earlier comment, the idea is you give charity care, you give free care, indigent care, whatever you want to call it in exchange for tax exemption to some extent, there's a quid pro quo understanding you're getting this cheap money, relatively cheap money, and you provide this charity care and don't turn people away. Does that change if tax exemption goes away? Do the hospitals just sort of say, thanks for stopping, but the credit card didn't work and keep moving?

Richard Park (27:22):

Well, I think that if your tax exempt 5 0 1 C3, you have that obligation to provide services. So as long as that's in place, I think that hospitals will have to keep their doors open. You're going to start to ask questions about whether the supply of capacity will be decreased in order to respond to the challenges. On the reimbursement side of things, you're going to just have to ask the questions of where do you place inpatient outpatient facilities? And we're already seeing that facilities are very highly interested in outpatient lower labor cost environments. And so that's going to continue to be a focus for hospitals. How do you generate the return on investment without investing in inpatient beds? I think I heard a statistic that said one inpatient bed in California costs $2 million a piece.

Mark McIntire (28:15):

Yeah,

Richard Park (28:16):

As you can imagine, how much that cost would escalate if you start to build a hundred bed facility, 200 bed facility. It just goes up and up and up and up. So the concept of where does inpatient care belong in the spectrum of care is a big, big question to be answered. You reduce outpatient, if outpatient care or access gets reduced for any reason, including Medicaid cuts, you might see acuity of patients go up in the inpatient facility. There's going to be capacity questions there. Capacity questions. On the outpatient side of things, I think one thing I wanted to add to the interest rate thing that people we've been talking about is philanthropic giving. It's a very, very big part of the puzzle right now. Hospitals are challenged with managing liquidity, managing operation, trying to find how to support the community with its needs, but on a relatively manageable cost of capital if they find that communities have certain services that will be supported by philanthropic giving and that has that strong demand as well as you can get that support, naming rights, all that kind of stuff, that's very helpful in this current environment.

Mark McIntire (29:26):

And I can't help but think that quality has to, I mean, it's healthcare, right? We all want quality healthcare, and if you come to the emergency department and say, take two aspirin, call us in the morning, what happens to quality? It seems like those are inversely, right?

Richard Park (29:45):

And I don't think we like answering this question, but in COVID, we were almost getting to that point where people, when they're triaging patients, you have to make life-threatening calls and it's an unfortunate reality. But if in the event that funding cuts happen and capacity constraints begin to arise, you begin to have force clinicians to make decisions like that that are very, very challenging to make. And on top of all the stresses that have been on hospital systems, just talk about culture, talk about maintaining morale, that's very, very hard to do.

Mark McIntire (30:17):

Doug, what do you think?

Doug Kilcommons (30:18):

I agree with much of what Rich said. I would just add that in the sectors that we worry about with tax exemption, healthcare would not be at the top of the list. I'm going to leave the name of the sector name list, but I'll just say it's a sector where the word endowment spends a lot of time circulating through the press, and there's been focus since pre great financial crisis on the growth in investment returns and the growth intuition. That's a harder argument to make as to why you should be tax exempt versus as we're talking about not-for-profit healthcare, which again, you are truly providing a societal benefit, especially for a facility that is so important to a large Medicaid population. So I worry less about healthcare as far as tax exemption. Again, if it's applied across the board from Munis, that's a different argument.

(31:13):

But I think for this sector and fully agree with what Rich said, this is going to be a trade-off if you are now left with the lack of tax exemption, there will have to be difficult choices made in other places and whether or not you can serve as large of an indigent care population, whether or not you can offer inpatient services across a full gamut of different types of care, maybe not. So it'll be this balance to figure out, okay, if we are saddled with additional costs, additional regulation, additional requirements, other things will have to give in order to accommodate that.

Mark McIntire (31:52):

Keith, are there other Well, yeah, please.

Keith Kleven (31:55):

Well, I was just going to comment on there's the obvious capital cost issue here too, right? So if not-for-profit, hospitals lose tax exemption and they need to borrow in the taxable market. I agree with you. One thing, the healthcare industry probably is better set up to do that than the rest of munis as well, because we've done it before you referenced it already, back in the early Covid days from 2020 to 2023, a lot of hospitals were out there doing taxable deals when they could just assume go ahead and do a tax exempt deal. But they did taxable deals because the rates were right on top of each other. So that mechanism already exists for them. Now the interest rate environment isn't the same as it was then. So you would see an increase in borrowing costs in the current market of 20% or something like that, but the mechanism would be there and I think the investors would be there.

Mark McIntire (33:00):

Okay, yeah, that's interesting. Let's take that to its logical extent. I want to come back to another point here related to, we had talked about differing levels of tax exempt revocation, right? But what about industry by industry? So maybe that unnamed sector,

Doug Kilcommons (33:22):

What I basically named.

Mark McIntire (33:25):

Does have tax exempt status revoked, but others churches, I mean maybe or it seems interesting because we're talking about it as if you could gradate it across all sectors, and I'm not sure that's how they're planning the legislation.

Doug Kilcommons (33:48):

We just don't know. And Keith raised a very, very important point on capital, which I think bears, especially for healthcare bears some focus. One of the strategies that was put in place by I would say less credit worthy issuers during the pandemic was the deferral of capital investment into facilities to conserve cash. It was something that we saw certainly at the lower credit levels, but even large systems put in place temporary pauses on inpatient towers, on expanding their outpatient ambulatory clinics. There was a whole host of just pauses on the capital front to conserve cash. In recent years, particularly the last year, maybe two years, some of those investments have restarted. So there's a deployment of cash now back into the physical plant. There's just, I would argue, a limited ability now to say, okay, if all of these things change, we're going to go back to that strategy of hoarding cash and not investing in our physical assets that not only is problematic from a strategic standpoint because your brand as a service provider of high acuity care may be tarnished. And we hear from especially the most prestigious systems that they're conscious of, if they don't keep their hospital inpatient care comparable to a provider down the road, there's a potential loss of doctors and a loss of patients. So they've got to keep that investment going. And the window to pause that really is only for periods of extreme stress. We just had one with the pandemic. So I would argue that it will be challenging now, especially if multiple things are coming at the sector to use the capital deferral as a potential strategy.

Mark McIntire (35:39):

And what about, again, taking this to a fully, let's just assume a hundred percent tax exempt gone. What happens do these not-for-profits that are using only taxable financing vehicles now all of a sudden become like their corporate brethren and m and a spikes? And we have, I mean, we've had consolidation in healthcare, but what happens then and is that good or is that bad? Because maybe that's more efficient.

Richard Park (36:07):

I mean, I think to some level, you're already seeing it happen. They're forced to act in this way. When your margins get compressed, you have to make those choices. You need to see your dollar go a lot further. Now, given the expense space has been permanently reset, so you do see non-for-profits acting a little bit more like for-profits in some ways, consolidation results in more overhead being allocated to a larger set of dollars coming in the door. So that's already happening. You see also providers who are struggling in certain markets, they're being forced to exit because it's not as easy to do business in every market anymore. So you're looking at people focusing on density, you're focusing on market share, focusing on service lines and being very precise now instead of very looser in historical years about what do we want to focus on and where and why, and are we good at those things? And if not, maybe we should exit. Maybe we should partner JVs. All those things are being up for consideration, but hospitals have to be very careful Now, in today's day and age to not say we are good at everything. We're going to be a provider of everything. Who can we partner with? Who can we work with to make sure that we are providing the best level of services? We don't have to do everything ourselves,

Mark McIntire (37:23):

Keith.

Keith Kleven (37:24):

Yeah, I mean, one point that I was just going to make too is every hospital, every health system on the planet has service lines that are not profitable.

(37:35):

And so all of a sudden you take and you add 20% to their cost of capital, and that's where you're going to start to see contractions. And so it's going to be very unpopular, particularly for community health systems that might be the only hospital within 45 miles or a hundred miles or whatever it happens to be. If all of a sudden their cost of capital goes up by 20%, you're going to lose the, you're going to lose the mother baby unit in a hospital, in a town in the middle of the state of Texas, right? And that's where people are really going to see the impact of that.

Mark McIntire (38:11):

Yeah, yeah. Let's pivot here a little bit specifically with regard to cyber events. Obviously if anyone's looked at news related to hospitals in the last year or two, you've seen the change healthcare attack, you've seen single source providers. Well, it's been dangerous to say the least. And I'm curious if the whole tariff conversation in terms of supply chain around physical equipment, if not services, I mean, does that give you a pause? I mean, what do you ask when you're meeting with clients? I guess Doug and Rich, you're talking about risks as it relates to tariffs and whatnot?

Richard Park (38:57):

I think that if anything, the past few years have shown that the supply chain is very fragile and changing. It takes time and it's very challenging. So healthcare is an industry full of regulatory approvals. So it's not very easy to just say, I'm going to stop shipping out of one country. I'm going to resource from another country. It's not that easy. And so tariffs are just one of many, many challenges that hospitals have to face. If tariffs come through and are permanent, that's going to increase the expenses that hospitals have to pay for equipment and things like that. And it's a challenge because it's like where do you go to go and increase that revenue that you need to offset that? You've already been asking commercial payers to pay above average rates. You've been already doing that negotiation. Can you continue down that road year over year over year?

(39:50):

And those commercial contracts are staggered over multi years, so you kind of have to wait until your time is due to make that change. So in some ways, we are very focused on focusing on the issuers that have strong balance sheets because those have proven both from a cyber perspective as well as from an industry headwinds perspective, to fair best, they can make quick decisions because they have the liquidity to do so. That's both on the supplies and the cybersecurity side of things. What we've seen from a cyber attack is that the providers that can act quickly, make decisions quickly are the ones that come out quicker and are able to get their operations back online when you don't have the dollars to pay ransom or you don't have updated equipment, you have equipment that you're not able to keep inventory of the assets that you have. Sometimes things updates are not happening or things are really out of date. So in those situations, when you look at facilities that have had challenges on spending over the past few years, you have to begin to ask the question, well, are they a larger risk from a tariff as well as a cybersecurity point of view.

Mark McIntire (40:59):

Doug, do you have any?

Doug Kilcommons (41:00):

Yeah, it's an interesting question. I still would argue it's too early to determine what exactly is going to be the fallout of this. I think obviously it has the potential to not only increase costs of supplies and capital, which will then have pressure on or yield pressure on wages. It has the potential to destroy fundraising because it's right now as we've been seeing it's destroying consumer confidence and when that goes, fundraising tends to be more difficult. But I think we're still too early to make a definitive statement as to what we expect. I will say, and again agree with Rich a hundred percent on this, that it's one of a whole host of things that need to be managed and looked at. I would say that what we focus on with regards to cyber, our plans that are in place and personnel who are in place that are monitoring this, that are dealing with this, and again, if there is an incident of any type, what the response has been, I would say that one of the things we do ask a lot about, whether it comes to IT infrastructure, and again related to cyber revenue cycle management and what you have in your system in your hospital in terms of IT infrastructure to make sure that whatever money you are due for reimbursement of a service you are collecting.

(42:25):

And you would be surprised at the answers that you get to this topic, especially as systems have grown, and we've just talked about the need for potential consolidation, joint ventures or full on mergers, the ability to combine EMR electronic medical records, the systems across a disparate number of newly added or newly acquired facilities is very costly. It's very time consuming, and that is a piece of it that I would argue while cyber is certainly front and center because there's real large costs to that, the integration of it more broadly and especially as it relates to revenue collection and revenue cycle management is especially in this environment top of mind.

Mark McIntire (43:12):

That's a good point. So other side of the same coin, because we've been asking rating Alice here, how you look at things from the other side of the same coin, Keith, when you talk to a CFO about putting together a rating presentation, what in this environment, given all of the uncertainty, what do you want to see them put together that you think, well, because you're not going to, we don't know if the tariffs are going to hit, we don't know if the Medicaid, we don't, don't know the extent. We don't know any of that, but we just know there's uncertainty. What do you want to see advise a client when you're talking to 'em about this?

Keith Kleven (43:50):

At some point the numbers are going to be the numbers where they stack up on the medians, I think. And when I'm advising a client about what to put into a rating agency, what I think is most important that they get across is the process and the planning that goes into what they do every day. We talked a little bit about hospitals. Health systems are in a very dynamic industry with things changing all the time. Great. So what kind of a system do you have in place? What kind of strategic planning process do you have in place in order to adapt to those changes as they go along? And then it's also how specific can you be? How robust is your strategic planning process so that when you come to the end of the year and you've got a hole of $50 million that you have to fill, what are the line items that are going to get you there? Pharmacy revenue increase, decrease in labor here, what are the specific things and what are the dollar amounts tied to those that will get you to where you need to be on a performance improvement plan?

Mark McIntire (44:56):

Doug, Rich agree? Anything you'd want to see?

Richard Park (45:02):

Definitely can advise on what to put in. But what I can say is that we do seriously,

Mark McIntire (45:08):

Don't quote me,

Richard Park (45:09):

No, don't quote me, do not,

Mark McIntire (45:10):

which someone else did earlier.

(45:12):

I love that.

Richard Park (45:12):

But I think what everything that Keith said is accurate in the sense that we are in a dynamically changing environment, and I think the planning process to some level is dynamic right now. And I think we're always asking what the assumptions that you've built in are and how quickly you can pull the lever on different things. And in some ways, if you are not being transparent about the challenges that you're facing, I don't think it's very hard for us to see that you missed your budget by $50 million and that you don't have a plan to gap solve for that. And so in a way, if you come to the meeting and you don't have a gap solve for that $50 million problem, whether it's from a revenue expense or supplemental funding, fema, whatever you call it standpoint, it will just begin to raise questions and ones that we have to work as a rating agency to solve and manage from a risk point of view, how we manage that through the rating cycle and through the management talks that we have. I think we incorporate all of that into the ultimate rating that we get to.

Mark McIntire (46:16):

We've got time for one more topic, and I just want to pivot to this. I think so many people are impacted by this, wildfires, hurricanes, whatever the case might be, but just environmental. And I know rating reports, both of you have sections that deal with that, but my question is, do these things really impact the long-term rating? In other words, if you're 50 feet away from the ocean and you're 10 feet above water instead of an A, should you be a BBB? How do you think about that? There's no real and present danger, but at some point over the 30 years of the life of the bond, there's probably going to be some risk.

Doug Kilcommons (46:56):

It's a fair question mark. And I'll say it's really an extension of the management conversation that we've talked about a number of times today. And it's ESG, which is what this is really boiling down to, again, is a natural extension of management and it's just now kind of carved out on its own for good reason. With that said, the KBRA approach has been to look at ESG factors and make rating decisions and changes only when those specific factors are impacting credit. So we are not in the business of deciding which issuers governance is good, bad, or otherwise. We're not in the business of determining which environmental strategy works in one market versus another. That's not our bread and butter business, which is ratings which speak to full and timely repayment. So we don't go too far flip from that core. That said, if you are an issuer that is exposed to wildfires or you're an issuer that's trying to meet some type of statewide mandate to move towards clean energy and you're putting out there very large necessary investments to get there, that may have an impact on your debt profile.

(48:09):

Now we may be in a situation where that rises to a sensitivity and a rating report or in some cases a move in outlook, but that's really how we address that. But certainly part of the general planning and again, management strategy conversation, if you've gone through two hurricane seasons and have dealt with damage, you can rest assured we'll be asking, well, what are you doing to keep assets hardened and what strategies are you employing? I think for us, the biggest wild card that we saw this year and looking and asking issuer inland issuers more now has to do with flooding from storms that instead of going up the coast and flooding the coast, they're making inland turns going up the mountains and causing incredible amounts of rainfall. And the places I'm thinking of this past year in North Carolina, Tennessee, places that you would never would think would be impacted by hurricane type rainfall actually work catastrophic rain and it led to severe flooding and damage and loss of life. That's something now that we have to kind of expand our thought process around because it was not a factor, let's say 5, 10 years ago.

Mark McIntire (49:21):

Richard.

Richard Park (49:22):

And I think from a Fitch point of view, we are always and continually exploring the data sets that are available to us to better look at ESG and to stay on top of the risks. So we're actively looking into that. I think one of the things that I'll say interesting about healthcare is that a lot of the challenges from a climate point of view is not often that you see a hospital get burned down or flooded out because often they're very prepared for that. It's the challenge is can the patient end up getting to the facility? Are the roads blocked off? It's all kinds of issues that can make it so that, okay, the hospital might be online, there's backup generator power and all kinds of reasons. But if the patient can't get there, if you have to cancel all kinds of surgical procedures, then the revenue's not coming through the door.

Keith Kleven (50:09):

The ESG thing was a hot topic, I would say maybe 18 months ago to two years ago. It has kind of died down a little bit. And just from the investing side, I think part of the reason that it has died down is we still haven't had anybody pay us extra for a bond because of ESG factors. Right, fair point. Yeah, so we don't think about it all that much because the moment has passed a little bit.

Mark McIntire (50:40):

So let me thank you by the way. That was great. Let me open it to questions. We've got a little time. You've got a question, someone out there's got a question. Yeah, right over there. You touched on

Audience Member 1 (50:57):

It a few times and that is the financial, medical services, those types of services. It seems like it always comes out out a few times this conference and that is whether it's tax exemption issue, whether it's access to capital issues, sorry, the smaller communities is the smaller towns that don't have the profit margin, they're much more difficult to serve, they're much more costly to serve per patient. How do you address that? What are your thoughts about that? Because it seems like that's, they will be the people really left behind. I mean, you're trying to solve the problem. The circumstances seem to be really putting pressure on that part.

Keith Kleven (51:51):

Well, one way that the industry has tried to address it, and if you come from a small community and you have a small town hospital, one way the industry has tried to address it is through consolidation. But the problem that always comes up when you talk about consolidation, you have a smaller hospital that gets absorbed into the bigger hospital, what's the first service to go? And that can only be fixed through reimbursement mechanisms. Smaller towns have different demographics, they're often served by higher Medicaid populations, they're often served by higher Medicare populations and every hospital on the planet tries their best to try and break even from Medicare from a reimbursement perspective. So it's a huge challenge and there are differing reimbursement mechanisms for smaller hospitals and rural hospitals and disproportionate share and those types of things, but it has to come through the payment mechanism or cutting services.

Richard Park (53:01):

I think the one thing to add because we are in Texas, is that we have a lot of hospital districts in this state. And so one question that's probably going to be answered is whether hospitals want to become districts and begin to tax the local area to be able to make up that funding gap. So we already have that with many hospital districts in Texas. There's many, there's both rural and urban hospital districts that we have. And quite frankly right now already those safety net hospitals would struggle without those taxing dollars. And so go take that a lot further. How many more rural challenging reimbursement situations will be made up by taxing a question to be answered? But there's going to be a cost shift that's going to have to happen if you want to keep services open.

Doug Kilcommons (53:53):

I mean, the other thing I'll just mention is that this does argue in some respects for more consolidation because if you can provide better quality care and serve that needy population with a facility that may be a little bit more or a little bit of a distance away from where the previous one was, but you're getting a better, more consistent quality of care standard and that the facility is financially much stronger, that may argue for a little bit more of a drive to that provider or have that system that comes in, put an ambulatory clinic there and then have again, the highest acuity situations go to the main hospital. That's a little bit further afoot from where again, that small struggling community provider once stood. So it's not an ideal situation, but what you ultimately want is for the industry to be stronger because the stronger the industry is and all of the things that we've talked about today with what it has faced, a stronger industry can deal with those challenges more adeptly than if you have all of these providers that still are out there on their own that are really just one reimbursement cut away from closing edge doors and after a while you just can't cut so many services that you become irrelevant to the community that you're trying to serve.

(55:08):

So that's really, it's a difficult balancing act, but that's really what is needed in a lot of cases.

Mark McIntire (55:17):

Anything else? Alright, I think it's time to declare reception, drink time. So thanks for coming. Thanks.