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Pandemic Perseverance Highlights Muni Health Care Sector

Improved cash positions strengthen select health care issuers post-COVID

By Dmitry Feofilaktov
Hospital lobby.

Key Takeaways

Our post-pandemic analysis of the not-for-profit (NFP) health care industry reveals attractive opportunities for municipal bond (muni) investors.

Robust cash positions, primarily accumulated during the pandemic, should insulate many NFP health care organizations from ongoing challenges.

We believe identifying health care providers with proactive management teams that can adapt to ongoing industry challenges and new initiatives is vital to performance.

Select Health Care Systems Offer Opportunities

The essential nature of the NFP health care industry1 should continue to play a critical role in the industry’s stability. Additionally, an aging population, the persistence of chronic diseases and rising nationwide behavioral health needs should ensure strong demand for health care services. We believe these trends bode well for certain health care munis.

Nevertheless, certain indices tracked by passively managed municipal bond portfolios have methodologies that appear to exclude the health care sector. In our view, this leaves many passive investors without exposure to meaningful long-term muni investment opportunities.

The NFP health care sector is a significant component of our actively managed municipal bond portfolios. We believe many operators are well-positioned to weather and overcome current conditions and the ongoing challenges facing the health care industry.

A rigorous security-selection effort underscores our confidence in the sector. We believe security selection remains key to performance, particularly as the divergence between stronger and weaker health care systems widens.

Financial Management, Demand Dynamics Aid Sector Stability

In our view, the U.S. health care system remained steadfast and resilient in the face of substantial operational challenges during the pandemic. Facilities faced precipitous drops in utilization, postponement of elective procedures, overflowing COVID-19 volumes, and staffing and wage pressures. Yet, many health care entities reported adequate profitability and solid liquidity growth over the past two years, important considerations when selecting municipal bonds.

Considerable federal government support, strong investment returns and cost-containment initiatives contributed to the solid results. The industry faces many medium- and long-term challenges, including labor shortages and wage pressures, changing reimbursement models and federal scrutiny over potential consolidations. Nevertheless, for muni investors, the substantial cash positions many organizations accumulated in recent years may cushion those systems against heightened volatility. See Figure 1.

Figure 1 | Cash on Hand Soared During Pandemic

Line chart shows how hospitals' cash on hand (including advance Medicare payments) jumped sharply in 2020 and 2021, climbing from nearly 170 days' worth of cash in 2019 to more than 256 days in 2021. X axis = years; Y axis = days.

Data from 1/1/2015 – 12/31/2021. Source: Investortools/Merritt Research Services.

Ability to Adapt Is a Differentiator

Weaker patient volumes and postponed elective procedures hurt the health care sector’s core profitability at the pandemic’s height in 2020. However, robust federal aid, mainly from CARES Act funding and Paycheck Protection Program loan forgiveness programs, supplemented revenues, resulting in adequate overall performance.

Patient volume trends recovered significantly in 2021, as pandemic restrictions eased, and providers leveraged newly developed expertise to operate in the lingering COVID environment. These efforts resulted in adequate, though slightly weaker, financial results for many systems as federal aid diminished.

Many management teams implemented fruitful revenue-enhancement and cost-reduction initiatives, which should aid the transition to a more stable business environment. See Figure 2.

Over the longer term, we believe systems with these proactive and adaptable management teams will continue to perform better than those with reactive management teams.

Figure 2 | Systems Made Sharp Gains in Debt Service Abilities

Maximum Debt Service Coverage

How facilities' ability to meet annual debt and interest payments has improved since 2020. As of 2021, the average debt service ratio was 4.46x, indicating health care systems may meet upcoming debt obligations. X-axis=years; Y-axis=debt service ratio

Data from 1/1/2015 – 12/31/2021. Source: Investortools/Merritt Research Services.

Systems With Robust Investment Portfolios May Have an Edge

Robust investment performance in 2020 and 2021 significantly helped many NFP health care entities that rely on funding from endowments or other portfolios. Notably, the investment portfolios of larger, more sophisticated systems generally enjoyed higher overall investment returns than their smaller peers. Looking ahead, we believe strong liquidity positions in these portfolios will help providers overcome the financial pressures they likely will face later in 2022 and 2023.

Markets were highly volatile in the first half of 2022. Providers could lose some of the investment gains accrued in recent years unless management teams shift portfolio allocations toward more stable asset classes. So, we believe providers with well-developed investment capabilities should fare better in market downturns than those with less expertise.

Labor Issues Challenge Certain Health Care Organizations

Despite solid performance over the past two years, the health care sector likely faces a bumpy road, mostly due to labor issues. Exhausted frontline workers are fleeing the industry at a record pace, searching for less stressful positions.

With fewer employees, health care providers’ reliance on agency nurses has risen dramatically. Consequently, providers face higher wage and benefit costs to retain employees.

Wage pressures are likely to continue. However, health care systems with proper infrastructure in place, including nursing and medical school relationships and internal training programs, should be able to persevere. Furthermore, we think systems that proactively invest in technology will be better equipped to manage operating costs to offset rising wage pressures.

Looking for Diverse Revenue Sources

Geographic and revenue diversification will play a significant role in the strategic development of many health care providers. We believe payor limitations and other revenue challenges will force systems to explore non-traditional revenue sources, including:

  • Health plan operations.

  • Research and intellectual property capabilities.

  • Peer and affiliate collaborations.

Additionally, as revenue pressures increase, so will the need to adapt and consolidate, leading to further mergers and acquisitions activity. We expect continued combinations of larger systems, the creation of new national mega-systems, and several acquisitions of small single-market entities by larger regional systems. However, federal scrutiny will likely present roadblocks to some combinations.

'Population Health' Is a Trend Worth Watching

Recently, we’ve seen a push for population health initiatives — health outcomes and the distribution and determinants of those outcomes within a defined group. Such groups may include a specific nation, community, ethnicity, gender, a pool of employees or any other defined group of people.

Population health aims to improve the quality of care, outcomes and costs. The reimbursement framework of this value-based concept requires health care systems to take payment risk for the specific patient population. Accordingly, this would force providers to focus on keeping patients healthy, so they don’t need higher (and more expensive) levels of care.

Implementation of population health programs has been incredibly slow, but we believe organizations will continue to prepare for the shift in reimbursement methods. Systems that can successfully transition part of their revenues to capitation contracts should benefit over time as the industry adopts value-based care. The capitation reimbursement model prepays providers a fixed amount of money per patient for a set period, regardless of whether the member seeks care.

Ideally, the payment structure evens out among patients who seek little to no medical services and those needing greater care. We believe larger national systems and scalable regional systems with strong market positions have a greater chance of success with population health and its reimbursement structure.

Security Selection Fuels Our Process

Most segments of the U.S. health care system have successfully emerged from the stresses of the pandemic. This achievement was mostly due to supplemental funding programs and strong investment markets through 2021.

Nevertheless, pre-pandemic challenges have remained intact, and the coronavirus outbreak largely exacerbated those issues. For example, rising costs and wages and sizable revenue pressures will continue to weigh on the industry. Despite these lingering obstacles, we believe the sector still offers significant value via informed security selection.

We seek to invest in health care munis from providers we believe can overcome the sector’s ongoing challenges. We generally favor those showing national or regional scale, revenue diversification, niche service offerings and helpful partnerships. Additionally, we often find good opportunities among smaller providers with robust market share, which positions those businesses as acquisition targets.


Dmitry Feofilaktov

Senior Municipal Credit Analyst

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Not-for-profit health care organizations are exempt from paying taxes. As such, they must invest all profits back into their organizations. In addition to traditional fee-based services, NFPs may generate revenue from foundations, endowments, religious and charitable organizations, research funds and municipal bond issuance.

References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.