MuniLand – Healthcare Credit Review Update

As we wrote a few weeks back, the Patient Protection and Affordable Care Act (ACA) could have a material impact on non-profit hospital operators’ uncompensated care revenue and patient volumes.  We now see data supporting this thesis, as uncompensated care has declined and patient volumes have increased, according to second quarter earnings releases from for-profit hospitals.  Hospital operators in states that expanded Medicaid saw material quarter over quarter increases in revenue and profits.  The Wall Street Journal reports Universal Health Service’s revenue rose 10%, for example, and LifePoint Hospital’s profit rose 44% on increased patient volume and reduced uncompensated care.  Increased patient volumes can be partially attributed to better economic activity and more workers being employed, but a large part of the increase is due to more people having access to healthcare services.  We believe that these trends are also showing up in the muni non-profit hospital space.  So far this year, the Bank of America Merrill Lynch Municipal Master Benchmark shows the hospital sector as one of the best performing sectors, outperforming the broad muni market by 186 bps on total return basis and 101 bps on an excess return basis.  Our credit review of FY13 non-profit hospital operators’ annual financial reports do not yet show the same trend of increased patient volume and reduced uncompensated care because much of the activity related to the ACA changes occurred in the first half of 2014.  Nonetheless, the timing of the ACA implementation and release of annual financials is opportune because it highlights one of the material ancillary risks associated with the ACA.  That risk is industry consolidation.  For example, many of our large multi-state hospital systems are actively acquiring smaller players.  These same credits suffered reduced operating performance as they assimilated the smaller entities, but continued to maintain strong debt service coverage ratios.  In California, the hospital names that we follow that were less active in acquiring market share saw improved operating margins and positive credit metrics due to more robust economic activity in the state.  In all, we are overweight to the hospital sector in our accounts, and that decision has been a positive contributor to performance.