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March 30, 2021

Our take: Moody’s shows hospital margins are 'wholly unsustainable'

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    Moody's Investors Service in a preliminary report released last week said that while nonprofit hospitals saw a notable increase in cash on hand amid the pandemic, their operating margins declined significantly.

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    For the report, Moody's assessed financial data on 130 health systems, the majority of which had fiscal years that ended on June 30, 2020, with the balance ending on September 30, 2020. However, Moody's cautioned that because of "unprecedented effects of the pandemic," the preliminary findings in the report "may significantly differ from full fiscal 2020 results."

    Moody's: Operating margins take a hit, but cash on hand increases

    According to the preliminary report, nonprofit hospitals saw a substantial increase in their median days of cash on hand, from 44 days to 246.9 days, as well as their overall liquidity. That increase was spurred largely by Medicare advance payments, which accounted for roughly 30 to 40 days' worth of that growth, as well as deferred payroll taxes, the suspension of retirement contributions, and deferred capital spending, the report said.

    However, Moody's said that nonprofit hospitals' profits declined significantly amid the pandemic. Specifically, nonprofit hospitals had a median operating margin of 0.5% in fiscal year (FY) 2020, down from 2.4% in FY 2019, and an operating flow margin of 6.7%, down from 8.4% in FY 2019. According to the report, funding from the Coronavirus Aid, Relief, and Economic Security Act "ranged from 14% to over 100% of operating cash flow."

    Moody's also found that nonprofit hospitals' expenses grew in FY2020 at a 4.7% rate—lower than the rate of expense growth in 2019 (5.9%), but still outpacing revenue growth, which was 3%.

    According to Moody's, the pandemic didn't result in a "significant shift in payor mix." Moody's said revenue from Medicaid and commercial payers remained relatively consistent between FY 2020 and FY 2019, while Medicare patient revenue increased slightly, and self-pay patient revenue increased from 5.1% to 5.5%.

    Moody's also found that as patient volumes "declined across all categories"—as patients deferred care and hospitals suspended elective procedures—"acuity rose as hospitals continued to provide essential care." Specifically, the report found that outpatient surgeries declined by a median 8.9% in FY2021, admissions declined by a median 4.9%, ED visits dropped by a median 7.3%, and inpatient and observation stays together declined by a median 4.5%.

    But as a result of suspended elective procedures and deferred nonemergent care, patients in 2020 tended to present with more severe illness and conditions, which contributed to higher reimbursement rates, the report said (Kacik, Modern Healthcare, 3/25; Paavola, Becker's Hospital CFO Report, 3/25; Moody's Investors Service, Sector Profile-Nonprofit and Public Healthcare US, 3/24).


    Advisory Board's take

    Moody's shows 'wholly unsustainable' operating margins—but also a few surprises

    Christopher KernsBy Christopher Kerns, Vice President of Executive Insights

    A few caveats to keep in mind when looking at the Moody's 2020 medians:

    • For 70% of the sample in the preliminary medians, the fiscal year end was in June 2020, not December—so most of the summertime volume recovery would not have been accounted for, nor the fall/winter surge in Covid-19 cases that almost certainly crowded out elective volumes at the end of the year. As a result, the volume numbers are going to look skewed compared to calendar-year performance.
    • Within the sample, 91% of hospitals surveyed carried investment-grade bonds (meaning a credit rating of Baa or better in Moody's, or BBB or higher for Fitch and S&P)—which is another way to say that organizations that hold Moody's credit ratings are, on average, financially healthier than the sector as a whole.

    Those caveats noted, few of the reported metrics in Moody's annual report were terribly surprising. The decline in electives and the rise in medical Covid-19 patients had the predictable result of severely dampening profitability (operating margins declined to a wholly unsustainable 0.5%), even as many providers saw surges in patient volumes. And while the sector was typically nimble in its ability to flex down costs where possible, labor and supply shortages curtailed most organizations' ability to make serious inroads there.

    The most interesting note in the report is around liquidity metrics—showing off the striking success of the CARES Act in preserving hospital cash flow at a critical time. When lockdowns first took effect, we at Advisory Board warned that without external support, a liquidity crunch could morph into a solvency crisis. But access to advance payments and CARES grants—plus support from bank lines of credit—staved off the worst.

    That said, I would be surprised if the final medians for 2020 (with a greater sample of providers with fiscal years ending in September or December) show similar levels of liquidity. As CARES funding wound down in late 2020 and medical volumes surged, hospitals and health systems almost certainly felt some additional cash flow pressures, though evidently not enough to trigger another crunch.

    The last point I should make is that these measures are probably not representative of the sector as a whole. Smaller organizations with less access to credit almost certainly found themselves entirely dependent on CARES funding, and without a robust volume recovery, probably face a difficult 2021 as well. Fortunately, vaccination rates are increasing, and the closer a community gets to herd immunity (or at least to a stage where the virus is endemic), the better positioned providers are for favorable metric comparisons in 2021. 

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