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Rating Agency Update: Supplemental Funding Programs, Cybersecurity, and Industry Outlooks

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This year’s Therese L. Wareham Rating Agency Panel at the 2024 Kaufman Hall Healthcare Leadership Conference featured panelists Suzie Desai, Senior Director, S&P Global Ratings; Kevin Holloran, Senior Director, Fitch Ratings; and Dan Steingart, Associate Managing Director, Moody’s Ratings. A summary of our discussion with them follows.

Supplemental funding programs

A growing number of states have been supporting supplemental funding programs. For hospitals and health systems, this support can have a significant impact on both cashflow and the balance sheet. Among the most common of these programs are state-directed payment programs, which raise payment rates for Medicaid beneficiaries to average commercial rates and are seen as an important tool in increasing beneficiaries’ access to healthcare services. Many organizations also saw a one-time payment this year under the 340B Drug Pricing Program to settle a lawsuit that ultimately went to the U.S. Supreme Court, which found that the Department of Health and Human Services had underpaid 340B hospitals over a five-year period.

These payments are a positive from the rating agency perspective; as a general rule, anything that strengthens an organization’s balance sheet makes it a stronger credit. The rating agencies look at the quality of earnings; where there is a lot of money coming from a supplemental funding program, they are interested in the permanence of the program. The longer the program has been in place, the higher the comfort level that is a reliable source of income.

Ideally, organizations will break out the amount they are receiving under these programs in their rating presentations and provide information on the approval cycle for the programs (e.g., program renewals are approved by the state legislature every two years). For organizations that benefitted from a one-time 340B settlement payment, the agencies will be interested in seeing what the next year’s financials will look like without the payment and how the organization plans to address any resulting gap in financial performance.

Organizations in states that have not implemented a supplemental funding program may ultimately be disadvantaged vis-à-vis their peers in other states.

Cybersecurity

Cybersecurity is receiving more scrutiny from the rating agencies, as cyberattacks against hospitals and health systems—as well as vendors on which they rely for services—become more common. To date, a cyber event has not directly caused a rating action. Although some organizations have had to temporarily shut down or restrict services as they recover from an event, the agencies have seen that much of the deferred business gradually comes back, making the event less damaging over the long term. They also see a mitigating impact from good reserves and cyber insurance.

The agencies do monitor how organizations manage their response to a cyberattack; the response offers insights into the effectiveness of the organization’s operations and management skills. The panelists also stressed that organizations not only need to have a response plan in place, but also practice and drill that plan—similar to the mass casualty and ER drills that already occur at many hospitals and health systems.

The agencies increasingly see the Chief Information Officer involved in rating presentations, and are interested in hearing about cyber hygiene protocols, staff training protocols, and response plans for possible longer downtime and recovery in the event of an attack. Cybersecurity has become one of several possible events—others include major lawsuits or natural disasters—that the agencies now stress test for their rated credits.

Industry outlooks

All three rating agencies are seeing continued improvement in performance. Fitch’s ratio of downgrades to upgrades is now at approximately 2:1, down from 3:1 last year, with about 90% of rating actions resulting in affirmations. The ratio at Moody’s and S&P Global is closer to 3.5:1, but both agencies are seeing an increased number of favorable outlook revisions for their rated credits. In most cases, this is a negative outlook moving to stable but sometimes a stable outlook moving to positive.

At the same time, many organizations have not yet fully recovered from the Covid “hangover,” and restoring operations and financial performance remains a significant concern. There is also a sense that some of the forward momentum seen over the last year has slowed. Balance sheets are still fairly strong, but the investment markets will eventually turn and areas that operators can control are not yet back to truly healthy numbers. The panelists predicted that median operating margins for 2024 will end up around 1%, still short of the 3% margin that they typically hear is required for long-term sustainability.

Capital spending is starting to move after a period in which the age of plant has been creeping up, as organizations withheld capital spending to save money in the short term. Ambulatory and technology spending is a significant focus, but an aging population will mean that inpatient volumes will remain solid, and that is where much of capital spending is tied up.

Staffing shortages and access remain a concern. If patients have a few good choices for a service, they will go where they can get in first. Organizations need to rationalize services in a smart way, focusing on services that can help them differentiate themselves in the market.

The impact of the 2024 election is still uncertain for healthcare, but one question is how extension of the 2017 tax cuts—a likely priority for the Trump administration and Congress—will be paid for. Ballooning deficits would also likely restrict the government’s ability to help bail out organizations if another emergency like the Covid pandemic appears.

The session ended with advice for organizations to pursue a “mind the gap” mentality. This means staying on top of matters including payer reimbursement and negotiations, clinical quality, and credit to avoid a situation where a gap in any of these areas becomes too big to close.

A thank you to our panelists

We are grateful for the time our panelists contribute to make the Therese L. Wareham Rating Agency Panel a highlight of our Healthcare Leadership Conference, and we look forward to continuing our conversation with them over the months and years to come.

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