Ahead of expected turmoil, the hospital sector is on solid footing

With uncertainty on the horizon for healthcare operations, hospitals and health systems appear to have established a stable foundation from which to respond to challenges.

Recently reported financial data offers further indication that the not-for-profit (NFP) hospital sector has attained a measure of equilibrium several years after the pandemic and the ensuing turbulence in labor costs. In its latest report on sector medians, Fitch Ratings noted that the “negative tilt” in its credit-rating trend has turned mildly positive.

Having updated its outlook for the sector from Deteriorating to Neutral going into 2025, Fitch has seen continued steadiness during the first half of the year. Most ratings updates have been affirmations, with nine upgrades and eight downgrades. Among outlooks that have been issued for rated hospitals, 80% have been stable, although negative outlooks (12.5%) have exceeded positive outlooks (7.4%).

“Despite a lot of noise and challenges in the industry, we’re still in a period where most of our credits have stable outlooks,” Mark Pascaris, senior director with Fitch Ratings, said during a webinar.

Among the eight downgrades, Fitch reported that five hospitals had operating revenue of less than $750 million. Downgrades generally resulted from underperformance on margin, including because of changes in Medicaid state-directed payments (SDPs) — illustrating the impact that recently legislated reductions in those payments could have on hospital finances.

Other factors in margin-related downgrades included revenues that did not meet expectations, such as because of depressed volumes or a change in payer mix, along with costs stemming from continued reliance on contract labor or other expense pressures.

Reason for optimism

For 2023-24, Fitch’s newly reported data shows year-over-year revenue growth (9.17%) exceeding expense growth (7.88%) among NFP hospitals. That’s a change from two years earlier, when expenses climbed 9.06% and the revenue increase was only 5.49%.

Between 2022 and 2024, median operating margin for Fitch’s rated credits increased from 0.2% to 1.1%, while EBITDA margin rose from 7.3% to 8.6%. The improvement is notable but not as fast as the industry might have wanted, perhaps indicating constrained margins are here for the foreseeable future.

But days’ cash on hand, at 215.1 for 2024, remains favorable compared with historical medians. Ratios of cash to debt (169.2%) and cash to adjusted debt (164.5%) are trending significantly upward, providing operational flexibility for organizations unless they experience a drastic change in circumstances.

Improvement in those metrics stems from sustained equity gains that have outpaced new debt issuance, Pascaris said.

Continued steadiness

In the latest version of its monthly report on hospital financials, Strata Decision Technology found that year-to-date median operating margin ticked up from 1.1% in May to 1.2% in June. Year-over-year, the increase was 2.4%.

The year-over-year gain was driven by revenue increases of 12.3% in hospital outpatient settings and 7% for inpatient care. Strata did, however, note month-over-month decreases of 2.1% on the outpatient side and 3.4% for inpatient operations.

Current trends appear promising for bad debt and charity care deductions, which fell by 3% year over year, while net patient service revenue (NPSR) was up by 3.3% per adjusted discharge and 2% per adjusted patient day.

Fitch’s numbers suggest efforts to tamp down premium labor costs and the use of contract labor since 2022 have “directly resulted in bottom-line improvement,” Pascaris said.

Expenses nonetheless remain a significant issue, Strata reported, with drug costs increasing by 9.8% year over year. Other areas that continue to get more expensive include supplies (8.7%) and purchased services (6.9%), and although labor costs are relatively under control, they are rising (3.8%). These trends mostly do not reflect the anticipated impact of the Trump administration’s still-evolving tariff policy.

A tenuous future

“The tone, but not the outlook, for the remainder of 2025 and beyond has turned decidedly negative,” Fitch wrote in its report.

“While providers’ expense bases, primarily labor costs, will undoubtedly remain elevated over the near term, significant structural changes to federal healthcare spending, particularly Medicaid under OBBBA [the One Big Beautiful Bill Act], represent the greatest threat to not-for-profit hospital operations and cash flow,” the agency also stated

Although most of the new law’s headlining provisions will not take effect until the end of 2026 or later, some attrition in healthcare coverage may be felt imminently, seeing as the legislation canceled certain aspects of 2024 regulations that were drafted to improve enrollment and renewal processes for Medicaid and Medicare Savings Programs.

States and hospitals also no longer can count on new revenue from Medicaid provider taxes, with an immediate prohibition placed on new and increased taxes and then, in FY28, a phased-in 2.5-percentage-point reduction in maximum current tax rates (as a share of net patient revenue). A similar dynamic applies to SDPs, with newly implemented payments already capped at the Medicare rate in expansion states and 110% of the rate in non-expansion states before a gradual decline in current payments begins in CY28.

“Liquidity and leverage metrics remain largely unchanged and are still at the high end of the range for the past 10-plus years,” Fitch wrote. “Combined with OBBBA provisions that will not be implemented until 2027, this should provide a brief window of time to prepare for the cuts to operating income that are inevitably coming.”

In fact, the agency stated in a slide deck, “We anticipate an additional uptick in operating results in 2025, especially as hospital management teams accelerate cost savings efforts in advance of federal Medicaid funding cuts.”