The US hospital sector saw a substantial direct impact from COVID-19, primarily via the sharp decline in elective medical procedures, but also received significant aid from the Coronavirus Aid, Relief, and Economic Security (CARES) Act. So what now?
Ultimately, the performance of hospitals — and the municipal bonds (munis) they issue — will depend on the severity and duration of the current health crisis. We expect diminished revenues for the remainder of 2020, although many hospitals are cutting costs and deferring capital spending to help offset this. We believe hospitals with strong balance streets and fundamentally viable operations are best positioned to weather the crisis; for weaker hospitals, ratings downgrades are likely.
The current condition of hospitals
Coming into the pandemic, financial performance across the US hospital sector was largely stable. Most health care providers were managing through various sector headwinds, thanks to healthy cash flows and strong balance sheets. However, patient volumes and revenues declined dramatically in the wake of COVID-19, mainly from sharp reductions in elective and emergency room procedures, forcing health systems to draw on liquidity to sustain their operations.
Much of the US is now in various stages of economic reopening, leading to a recovery in elective procedures, with overall volumes rebounding to about 80% – 90% of their pre-COVID levels. Still, we believe capital spending across the sector will be squeezed at least through 2021. Large projects will likely be postponed or canceled, as will purchases of new state-of-the-art equipment in the absence of clear, strong demand. We think it will take at least a year for this type of spending to reemerge. Most hospitals will need this time to rebuild their cash balances, rethink their capital plans, and then justify any new spending. In the meantime, reduced spending seems prudent.
What to watch going forward
- The US will likely experience resurgences of COVID-19, to varying degrees by region, until a vaccination and/or viable treatment options are widely available.
- Hospitals and other health care providers should be better prepared to manage COVID case volumes going forward, while remaining largely open for business as this unfolds.
- CARES Act stimulus funds cover roughly 20% – 30% of revenue shortfalls across the provider sector, with more funding expected to come. A combination of recouped patient volumes and cost-reduction measures may help fill the gap.
- Environmental, social, and governance (ESG) criteria evaluation will be key going forward, as we assess the effectiveness (or lack thereof) of management tactics in mitigating pandemic risk and optimizing the post-COVID return to business.
- Longer term, we will continue to evaluate the potentially profound implications of telehealth and virtual platforms for the hospital sector. (i.e., How will hospitals be part of these types of solutions? Will they be reimbursed fairly?)
Credit research is paramount
When it comes to investing in hospital munis, credit research will be critical to both: 1) identifying hospitals that are well positioned to navigate the ongoing public-health crisis; and 2) avoiding weaker hospital names that are likely to face ratings downgrades.
We favor large, integrated, and geographically diversified health systems with solid underlying fundamentals, including:
- Clear pre-COVID demand;
- Competitive market share;
- Socioeconomic health across a growing population;
- A diverse employer base;
- Ample cash reserves; and
- Easy access to liquidity.
Meanwhile, we are more cautious on smaller hospitals with prior operational strains and lower credit qualities (i.e., light cash reserves and elevated debt). ESG considerations will also remain essential to our philosophy and process.
This crisis has brought a renewed awareness of the importance of hospitals, which we believe will continue to play a vital role in society. That said, health care delivery across the US has fundamentally changed. The shift from hospital-based to same-day outpatient services, and from outpatient/office-based to telehealth “visits,” will likely accelerate over the next few years. Notably, however, hospitals and health care systems will be part of this evolution, since they already own most of the components of the care continuum.