Sifting Through the Data: 5 Things to Decipher From S&P's 2011 Hospital Medians

In August, Standard & Poor's Ratings Services released its two major healthcare medians reports: one for non-profit health systems and one for non-profit standalone hospitals. S&P's healthcare credit analysts doled out several figures across 40 pages of research and came away with some interesting conclusions — not surprisingly, many of which were related to healthcare reform.

Standard & Poor's Ratings ServicesS&P compiled data for 143 health systems and 550 standalone hospitals. Martin Arrick, managing director at Standard & Poor's Ratings Services and one of the analysts who compiled S&P's reports, shares five major takeaways from his rating agency's data.

1. Health systems have a firmer foundation to face industry pressures. Within the titles of the two reports stands one of the most prominent observations: Health systems will face challenges during healthcare reform, but they have a solid foundation to face those changes, while standalone hospitals may have a more difficult road.

Overall, the 2011 medians of non-profit hospitals and health systems were stable, with some variability at certain rating levels. There were far more health systems rated AA+, AA, AA-, A+ or A than standalone hospitals, and this was mostly due to the health systems' increasing economies of scale, growth in revenue and acquisition strategies.

"One of the things we are trying to say is look at where healthcare is going," Mr. Arrick says. "The systems have some real strengths that will help them with the challenges coming up ahead. This is not to say they will be immune to challenges or their financial medians won't decline over time, but they are probably better positioned to handle what's coming."

Mr. Arrick says there are certainly some larger standalone hospitals that are faring as well or better than small health systems, but health systems generally have better financial health on paper because they are able to devote more time and resources to standardization and streamlining.

"For example, think about a 50-hospital system that owns X million square feet of space across all locations," Mr. Arrick says. "They can say, 'Let's try to put best practice property management skills in place.' They believe they can save 15 to 20 percent in property management costs, and when they roll that out, they will save $10 million in the next year. If you're a small hospital, you have a facilities manager spending maybe 5 percent of time on that. Systems have these kinds of strengths."

Health systems are more likely to have higher credit ratings than standalone hospitals.2. Capital projects are not a major focal point. Slowly but surely, the average age of plant for standalone hospitals and health systems is rising, while debt burden and capital expenditures are coming down. Health systems had an average age of plant of 10.2 years and a debt burden of 2.6 percent in 2011 compared with 9.7 years and 2.8 percent, respectively, in 2008. Standalone hospitals had an average age of plant of 10.4 years and a debt burden of 2.9 percent in 2011 compared with 9.6 years and 3.2 percent in 2007.

Essentially, hospitals are holding off on major capital projects as new healthcare reform measures unfold. For instance, hospitals and health systems would rather postpone building a new inpatient bed tower to see if that type of project is necessary in an environment that discourages inpatient stays.

"The average age of plant has gone up, but it's not the end of the world," Mr. Arrick says. "Volume pressure has relieved some of the need for plant updates, at least for inpatient beds. Everybody is waiting to see where volume goes, and people are being cautious with big capital projects right now."

3. Revenue is on the rise, but profitability is not necessarily following. Net patient revenue increased heavily among hospitals and health systems between 2010 and 2011. Median net patient revenue for standalone hospitals jumped 10.8 percent, from $393.9 million in 2010 to $436.3 million last year. The gain was even bigger for health systems. Revenue spiked 11.7 percent, from a median of $1.34 billion in 2010 to $1.5 billion in 2011.

Despite the large gains in net patient revenue, hospitals and health systems did not see a tangential rise in profits. The median operating margin actually fell for health systems, from 3 percent in 2010 to 2.7 percent last year, and standalones witnessed a slight uptick in operating margin, from 2.4 percent to 2.6 percent.

Mr. Arrick says there are a couple reasons for this trend, and both revolve around the growing merger and acquisition market. First, the very nature of the M&A market will lead to larger revenues, but profits may not necessarily follow.

"If an A-rated credit and BBB-rated credit merge, the A rating probably survives," Mr. Arrick says. "Revenues go up, but maybe profitability hasn't gone up."

More specifically, hospitals and health systems are acquiring more physician practices, which lead to more revenue. "Initially, there were weaker annual updates from payors, volume was flat and the revenue environment was constrained [going into 2011]," Mr. Arrick says. "Then all of a sudden, there is a real robust revenue growth. [Hospitals and health systems] went and purchased many physicians, and revenue flows through them."

4. Hospitals are at the top of a cycle.
The two reports overwhelmingly show that all things considered, 2011 was a mildly productive year for many hospitals. In the face of new healthcare reform measures and declining reimbursement all around, hospitals and health systems could have fared worse. However, Mr. Arrick believes the industry may be peaking in terms of growing financial metrics. The next three years will incorporate major changes, namely sequestration and other big cuts to Medicare and Medicaid, and he says 2014, in particular, will be a closely watched year by all.

"In prior years, the majority of the ratios improved. Everything was going up, and finances were recovering," Mr. Arrick says. "This year was somewhat choppy with some ratios going up, some down and some flat. We believe that this means we're at the top of the credit cycle."

Mr. Arrick adds that all medians — and averages, in general — need to be taken with a grain of salt. While they give a snapshot of the entire hospital industry, not all hospitals are going through the same ups and downs. Both medians and means are susceptible to fluctuations due to outliers, and astute hospital CFOs understand the core behind medians — to serve as a quick benchmark that requires further digging and analysis.

5. Hospital CFOs are focusing on the balance sheet and liquidity. Like many other industries, hospitals and health systems took a major hit to their balance sheets during the economic collapse in 2008. Many healthcare organizations had assets in the stock market, and the market was pummeled.

Since then, hospital CFOs have generally made a concerted effort to improve their cash balance and liquidity, Mr. Arrick says. For example, the average days cash on hand for standalone hospitals have increased from 145.9 in 2008 to 172.7 last year. For health systems, average days cash on hand went from 154.3 in 2008 to 175.7 last year. Operating cash flow has also increased for standalones and health systems.

Mr. Arrick says this renewed focus on managing debt and building up cash reserves has resulted in more stabilized balance sheets. "A lot of CFOs are spending time on rebuilding the balance sheet, and they've been successful," Mr. Arrick says. "The market has helped them, but they've actually been managing it as well. People have become more conservative in asset allocation and are actively trying to protect the balance sheet."

More Articles on Hospital Financial Metrics:

Credit Downgrades: How Could They Impact a Hospital's Capital Structure?

Moody's: 118 Statistics on Non-Profit Hospital Medians

S&P: New Pressures Could Upend Hospitals' Stable FY 2011 Median Ratios

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