S&P Global Ratings believes the rapid deterioration in financial performance that it saw through most of 2022 is likely behind us and representative of a low point. However, challenges remain for the U.S. not-for-profit health care sector. We expect a longer tail to recovery of a couple more years. Early 2023 financial results indicate mixed performance as revenues and demand are generally healthy but expenses, both labor and non-labor, remain elevated for many health care providers. Our sector view remains negative (see "Outlook For U.S. Not-For-Profit Acute Health Care: A Long Road Ahead," published Dec. 1, 2022, on RatingsDirect) and we expect that rating and outlook actions on balance will be more negative, though the pace of changes could begin to slow in the second half of the calendar year as we monitor performance recovery.

For most providers, we expect improvement from 2022's operating losses over the remainder of 2023 and into 2024; for many that could be reduced losses or breakeven-to-just slightly positive margins. The ability of providers to demonstrate improved performance, despite the broad sector pressures, will be key to credit stability. Other critical areas for determining credit rating stability will be:

• Pace and sustainability of performance recovery;
• Post pandemic run rate for performance; and
• Broader credit characteristics including financial flexibility and enterprise strength.

Whether an organization can operate at a "new normal" performance level and maintain the rating will depend on our view of the provider's operating flexibility at a specific rating, as well as a holistic analysis of an organization, including such areas as balance-sheet flexibility, strengths of the business position, and capital needs, among other factors.

The broader sector environment is improving from 2022 primarily due to better staffing trends, reduced use of agency and related costs and some easing of inflationary pressures. That said, we expect that most providers will continue to underperform financially relative to pre-pandemic through the remainder of this year and going into 2024 (see chart below). Certain offsets could contribute to near-term credit stability.

Current Challenges And Stabilizers To Credit Stability

Rating Action Trends Through The First Five Months Of 2023

Rating and outlook actions are likely to slow, but we expect ongoing negative bias.   The first five months of 2023 can be characterized by increased downgrades, including some multinotch actions mostly for ratings in the 'BBB' category and lower, along with a higher number of unfavorable outlook revisions. Almost 25% and just over 15% of our rated hospitals and health systems, respectively, have negative outlooks demonstrating that pressures persist. We expect the negative bias on rating actions will likely continue through the remainder of the year, including unfavorable outlooks. However, absolute rating actions could begin to slow because we have already taken actions on some of the more hard-pressed providers, and as performance pressures lessen and we monitor the pace and level of recovery as previously indicated. That said, some organizations have limited financial flexibility and could continue to experience credit profile weakening resulting in additional rating actions.

Chart 1

Key Credit Considerations For The Remainder Of 2023

Agency use and costs are abating, but higher salary and premium pay costs will remain a pressure point.   Agency costs are abating as most providers have reduced their use of agency labor substantially from 2022, but higher salary costs and premium pay are likely to remain a pressure point. A combination of better retention and recruitment, and temporary closure of beds to minimize the costs of staffing those beds has reduced, but not eliminated, reliance on agency staff. In addition, we continue to watch net hire trends, which are positive for many providers in 2023, despite turnover remaining above pre-pandemic levels. Given the significant staff turnover in the past few years coupled with increased demand from baby boomers, we expect it will take several years to get staffing to levels that adequately meet demand in a cost-effective way. Labor union negotiations could also continue to complicate performance. Many organizations are piloting care for patients using technology with lower headcount, virtual nursing, or different staffing mixes, but we believe a meaningful impact to overall costs and earnings could take time. Providers in states with minimum staffing requirements, or that maintain collective bargaining agreements with similar language, might find it more difficult to benefit from these strategies.

Chart 2

Commercial payor rates and continued revenue and demand trends will be important for performance recovery.   We understand that for most organizations, demand and volume growth remain healthy, contributing to generally good revenue trends despite some normalization of acuity. At the same time, the ongoing transition to outpatient care and payor mix shifts to governmental will continue to require health systems to consider different ways to ensure healthy cash flow. There are examples of health care organizations, in part based on services provided or importance to a region, obtaining higher-than-typical rate increases, albeit still below expense growth over the past year and a half. We expect that this will play out to varying degrees for the overall sector over a few years given different lengths of existing contracts and differences in the expense structure and, along with other revenue initiatives, could be a key factor to support earnings. While payors have not necessarily reopened multiyear contracts, we understand conversations have begun early with some willingness to consider higher-than-typical rate increases. That said, a potential recession, broader views to maintain affordability, and ongoing pushback by employers for premium increases could be downward offsets.

Reserves have stabilized, providing credit stability for many, but that could ease as days' cash on hand has weakened given expense growth.   Following investment market declines in 2022, unrestricted reserves have begun to stabilize with limited capital spending and rising discount rates to minimize pension funding, as well as with investment market improvement through early 2023. As a result, we view some providers as still maintaining sufficient cushion and headroom at the current rating to work through ongoing performance improvement initiatives. This balance-sheet flexibility, coupled with a favorable enterprise profile, could provide tolerance for a slightly slower earnings recovery but would also be dependent on the rating. However, absent investment-market improvement and over the next year, balance-sheet flexibility could be limited as we expect cash flow will be pressured and capital expenditures will continue to ramp up as teams refocus on strategic projects. As a result, reserve growth could slow, and days' cash on hand would have limited improvement (and could decline) given the rising expense base.

The extent of enterprise strength plays a role in maintaining credit stability, but outlook changes could still be a consideration.   Enterprise strength serves as a core component of the overall rating, which could also factor into how much runway an issuer has to generate sustained earnings that are more appropriate for the rating. Key components of the enterprise profile, including consistent demand and expanded patient draw, significant depth of clinical services and research, and importance to a particular service area, would also be key factors for our view of performance recovery timeline.

The threat of covenant violations is lessening but could cause challenges for certain credits.   Risks for covenant violations are beginning to ease for many organizations, but we continue to monitor covenant compliance and ongoing remedies in the event of a covenant violation, including ability to obtain waivers or forbearance agreements. To date, we've seen banks and bondholders willing to provide appropriate approvals and agreements, but there could be greater risk for the lower-rated and more challenged provider. Violation of covenants doesn't necessarily result in a rating change, but is dependent on the issuer's business position, overall balance sheet, particularly unrestricted reserve strength, and view of the viability of management's plan to address underlying performance issues.

Medium-Term Credit Considerations

Geographic regions may exhibit different paces and extent of operating performance improvement.   Certain parts of the U.S. may have differing recovery rates due to demographic trends, labor dynamics, and the broader regulatory environment. Certain providers in regions such as the Pacific Northwest, upper Midwest, and parts of the Northeast showed, in some cases, significant losses in 2022, which, over time and depending on level of recovery could cause rating pressure. Opposite that are parts of the country where population growth and certain payor and reimbursement dynamics could lead to quicker and sustained performance recovery, though a tight labor market creates offsetting nuances with sustained strong patient demand.

Many providers are considering strategic realignment with challenges and transitions of the sector.   Given the operating challenges, discussions to improve care delivery, limit health care cost growth, and maintain affordability many health care systems are rethinking how to best position themselves. Some larger organizations are making difficult decisions to divest and refocus resources. Merger announcements have also been steady through late 2022 and 2023 with many large and generally healthy systems looking to partner with other similar organizations, and often in noncontiguous states. The impetus for some of these mergers appear to be strategic as organizations consider how to maintain organizational strength amid the complex dynamics of the sector, using size and scale to implement cost-management initiatives and increase value-based reimbursement. Whether these mergers help maintain long-term credit stability and are successful in achieving providers' goals will likely play out over several years.

Table 1

Related Research

• Outlook For U.S. Not-For-Profit Acute Health Care: A Long Road Ahead, published Dec. 1, 2022 on RatingsDirect
• U.S. Not-For-Profit Health Care Rating Actions, January 2023, published Feb. 17, 2023, on RatingsDirect
• U.S. Not-For-Profit Health Care Rating Actions, February 2023, published March 17, 2023 on RatingsDirect
• U.S. Not-For-Profit Health Care Outstanding Ratings And Outlooks As Of March 31, 2023, published April 19, 2023, on RatingsDirect
• U.S. Not-For-Profit Health Care Rating Actions, March and First-Quarter 2023, published April 25, 2023, on RatingsDirect
• U.S. Not-For-Profit Health Care Rating Actions, April 2023, published May 4, 2023, on RatingsDirect
• U.S. Not-For-Profit Health Care Rating Actions, May 2023, published June 13, 2023, on RatingsDirect