Covenant violations may signal healthcare sector trouble ahead

The not-for-profit healthcare sector continues to face challenges, including a high number of bond covenant violations, which can provide an early warning of payment defaults, said Lisa Washburn, chief credit officer and managing director for Municipal Market Analytics.  

“The hospital sector has definitely seen improvement since the worst of 2022, but I would still classify it as improving, or recovering, versus recovered,” Washburn said. “There are still large and small hospitals having financial pressures resulting in covenant problems.

“There hasn’t been a real uptick in payment defaults,” Washburn said. “It has mainly been covenant-related violations and other challenges.”

San Benito Healthcare District operates Hazel Hawkins Memorial Hospital in Hollister, California, which received a $10 million zero-interest loan from a state program to stablize smaller hospitals.

San Benito Healthcare District

The number of technical defaults in 2023 was the highest MMA has seen since they began tracking them in 2009, and the non-profit hospital sector had 24, Washburn said.

“It’s almost double every year, except two years, in the past decade,” Washburn said. “It is not unreasonable to expect some of those — a percentage would fall into more significant problems, other than a covenant breach. It’s new territory, because we have never seen it before.”

Though analysts say hospitals of all sizes are facing challenges, the hardest hit in California appear to be smaller, independent hospitals that lack the market power and negotiating clout of big hospital chains.

State lawmakers created a zero-interest loan program in an effort to keep some afloat. The two agencies charged with running the program have approved $300 million in loans to 16 hospitals.

The Department of Health Care Access and Information and the California Health Facilities Financing Authority on Monday approved a $57 million loan for Madera Community Hospital.

The California Department of Public Health also approved a Change of Management application from American Advanced Management Inc. to operate the hospital. The Madera facility has been closed since December 2022 and the not-for-profit filed for bankruptcy in March 2023.

The loan and change in management should allow the hospital to reopen, California Gov. Gavin Newsom said in a statement.

The closure left a county of 159,000 residents without a hospital.

MMA had warned in its Jan. 17 default trends report that the sharp year-over-year growth in technical defaults in 2023 could foreshadow an increase in first-time payment defaults from borrowers in six sectors: hospitals, industrial development, land secured, multifamily housing, higher education and charter schools.

Technical defaults occur when a borrower violates loan covenants such as failing to maintain reserve levels versus the missed payments redolent of a straight-up default.

“IDBs, land secureds and local housing (i.e., multifamily housing) all saw sharp year-over-year growth in technical defaults in 2023, while hospitals, higher education institutions, and charter schools all hit or tied their sector’s respective annual record for technical defaults,” according to MMA’s report. “It is precisely these data that argue for an imminent uptick in first-time payment defaults.”

The sector was seeing some improvement in the first few months of the year, but has experienced some backsliding since then.

“The hospital sector has definitely seen improvement since the worst of 2022, but I would still classify it as improving or recovering versus recovered,” said Lisa Washburn, chief credit officer and managing director for Municipal Market Analytics.


At year-end 2023, S&P Global Ratings found that downgrades for hospitals were outpacing upgrades by a 4-to-1 ratio, and unfavorable outlooks outnumbered favorable ones at a 2.6-to-1 ratio, said Suzie Desai, senior director and sector lead of U.S. Not-For-Profit Healthcare. It has a negative outlook for the sector.

“Over the last few months, it was improving, but in March the numbers coming out were showing a bit of a reversion back,” Desai said.

S&P expects to release updated information on the hospital sector within the next several days, she said.

Kaufman Hall’s National Hospital Flash Report released March 27 found that February numbers reflected a strong start to 2024, but Erik Swanson, senior vice president of data and analytics, said in the report “challenges are on the horizon.”

“The aftermath of the Change Healthcare cyberattack and continued competition from industry disrupters may test financial performance in coming months, as disrupters capture more profitable, lower acuity, and lower-capital-intense services from hospitals,” Swanson said.

The cyberattack on Change Healthcare, the largest billing and payment system in the U.S., had a broad impact across all healthcare sectors, according to the U.S. Department of Health and Human Services, interrupting payments to hospitals, physicians, pharmacists, and other providers across the country.

It caused financial harm to thousands of doctors’ practices, with 80% reporting “lost revenue from unpaid claims,” according to a survey conducted by the American Medical Association.

“The disruption caused by this cyberattack is causing tremendous financial strain,” said AMA President Jesse M. Ehrenfeld in a statement. “The one-two punch of compounding Medicare cuts and inability to process claims as a result of this attack is devastating to physician practices that are already struggling to keep their doors open.”

Other challenges facing hospitals, according to analysts, were increased demand from aging Baby Boomers, bringing more claims from Medicare, which reimburses at a lower rate, and increased labor costs as hospitals raised wages to retain or attract employees amid a labor shortage.

The not-for-profit healthcare sector, which was the only one among S&P Global Ratings’ public finance credits to have more downgrades than upgrades in 2023, still has a long way to go toward full recovery, S&P analysts said.

Rating outlook revisions have tended to be revisions from negative to stable, not to positive, said Blake Fundingsland, an S&P associate director.

“The sector seems to be settling into a new normal,” he said.

“There are pockets of improvement,” Desai said. The sector “is just not back to where it was prior to the pandemic. When you look at the ratings, they are just not where you want the margins to land for the long haul.”

Desai placed the hospitals in three buckets: Those that were doing well when other credits were faring well and are still in good shape; the credits that had large losses, but now have fewer losses, but have not recovered back to where they were before the pandemic; and others that are still struggling with higher losses.

“I think the middle bucket is not generating the cash flow they used to, so, as the expense sheet grows, they can’t put as much back on the balance sheet,” Desai said.

It’s unusual for MMA to have this many hospitals in its default and impairment database for any reason, Washburn said. The numbers have also ticked up for retirement centers, charter schools and the housing sector, but those credits tend to be more transactional, and they are less likely to have the financial and oversight teams on staff that hospital systems do, she said.

“With hospitals, in terms of the muni market, particularly the large systems, they have some of the most sophisticated financial management teams out there,” Washburn said. “So there, potentially, would be more opportunities or solutions if it’s truly a technical issue, like they have financial pressures while they implement a turnaround plan.”

Like S&P, Fitch has a negative outlook on the non-profit healthcare sector.

Moody’s revised its sector outlook to stable from negative in November.

“Moody’s returned the ratings to stable, but they still listed a litany of challenges,” Washburn said. “S&P and Fitch Ratings outlooks are not stable. Hospitals are stabilizing, but calling them stable right now seems a bit premature.”

“On balance, the situation still tips more toward addressing challenges, than being completely neutral,” she said.

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