Health care industry facing swift reversal of fortune, downgraded by

Colorado Springs Business Journal, Dec 12, 2008 by Amy Gillentine

Moody's Investor Services has downgraded the health care system, mere months after giving it a stable rating.

The New York-based bond rating company cited "operation, economic and political challenges that will lower margins and hamper growth" for the change -- which could mean higher costs for hospitals trying to borrow money for expansion or other capital projects.

"Interest rates are going to go up, at least a couple of percentage points," said Steve Berkshire, professor of health administration at Central Michigan University. "So that could affect how many hospitals get new equipment or new buildings. But generally, it's not the case that hospitals systemwide are going to fail."

But a few hospitals could have more trouble during the next year - - particularly those in places where unemployment is high or nonprofit hospitals that might have trouble obtaining tax-free bonds.

"Individual hospitals, particularly those operating on tight margins, could fail because of this," Berkshire said. "If they have floating interest rates -- the bond market's answer to adjustable rate mortgages -- those rates will go up overnight."

Memorial Health System has about $170 million in auction rate debt with floating interest rates. Those rates -- as market liquidity dries up -- can change rapidly. During the past two months, Memorial has seen its interest rates increase from 4 percent to 12 percent.

"It's about $1 million in additional interest payments," said Mike Scialdone, chief financial officer at Memorial. "It's one reason we're looking to change our debt structure, and try to get into more stable debt structures."

The news from Moody's isn't a surprise to anyone in the industry, he said. The American Hospital Association has been tracking debt and credit liquidity for months.

"It's not anything new," Scialdone said. "We've been tracking this problem. The price is going to be higher interest payments because of auction rate bonds."

Memorial is focusing on refinancing its debt, keeping its operation efficient to offer a strong balance sheet to lenders and scrutinizing its capital expenses.

"Salaries are about 50 cents of the cost of every dollar we expect to receive, so that's the biggest expense," Scialdone said. "Avoiding layoffs is going to depend on our ability to effectively provide flex time, productive management."

And hospitals' problems could cause a domino effect -- changing the bottom line for medical device companies and insurers. Higher interest rates to buy certain types of medical products could cause hospitals to put off major equipment purchases.

"The challenges facing the hospital sector lead us to expect softening demand for certain medical products," said Diana Lee, Moody's vice president and senior credit officer.

And construction projects will slow, or be put off completely because it will be more difficult to borrow money, Berkshire said.

Penrose-St. Francis Health System is relieved its $250 million construction project, St. Francis Hospital, is finished.

"I wouldn't want to try to find financing for that today," said interim Chief Financial Officer Danny Reeves. "We're lucky we started -- and finished -- when we did."

Penrose has added leverage in today's economic environment. It is part of a nationwide network, Catholic Health Initiatives. Its corporate office is responsible for issuing bonds and getting loans.

"They might be having some trouble now that Moody's downgraded the industry," Reeves said. "But thankfully, it's not something we have to worry about here. They handle all the financing for new projects."

Until this downgrade by Moody's, health care was deemed recession- proof. But recent economic changes show that the industry isn't immune to the downturn. And the company said that the forecast looks gloomy for health insurers as well -- thanks to growing unemployment and fewer patients opting for elective procedures.

Economic trends lead people to delay medical treatment and avoid going to the doctor, Moody's said when it released the outlook.

"The current uncertainty surrounding political solutions with respect to health care at both the state and federal levels hinders insurers' ability to develop focused strategic plans," said Moody's Vice President Stephen Zaharuk.