Breakout 4: Healthcare Sector Update

Transcription:

Karen Pierog (00:08):

All right, last panel before the break. Alright, we're going to start. So hospitals nationwide and here in Texas are trying to put the COVID-19 pandemic and its lingering effects in the rear view mirror as they move ahead in addressing pent up healthcare needs in the communities that they serve. Meanwhile, other risks are out there including crippling cyber attacks, labor pressures, and high interest rates and inflation. On today's panel are Michele Vobach, a Senior Managing Director and Head of Healthcare investment banking at Hilltop Securities based in Dallas. Richard Park, a Director at Fitch Ratings, and Doug Kilcommons, a Managing Director at Kroll Bond Rating Agency. So Kaufman Hall's National Monthly Operating Margin Index stood at 3.96% in February, continuing a strong start to the year after January's 4.7%, which followed December's 5%. Kaufman Hall noted outpatient revenue is outpacing patient revenue. So what are you guys seeing on the margin front for Texas hospitals?



Michele Vobach (01:27):

So what I would say is it's always a tale of what part of the market you're in. Texas has been incredibly resilient part of the country and we have more AA hospitals, both hospital systems and also governmental hospitals than almost anywhere else in the country except maybe North Carolina or Virginia. So we really have seen quite a bit of resilience in our margins here in Texas, particularly in some of the big metro areas. And I'll just point out because this is public information, hospitals like Methodist Health System in Dallas, Baylor Scott and White have really continued to be very, very strong despite some of the headwinds with labor costs, et cetera, where we have seen more challenges in margins, have really been in some of the rural hospitals and also some of the smaller community hospitals outside the large metro areas. But again, I think the margin story has been a pretty strong one here in Texas.



Karen Pierog (02:24):

How about you guys?



Richard Park (02:27):

I'll agree. I'll agree with what Michelle just said. What we're seeing is that volume is very strong and that's a good problem to have for hospitals when more bodies are worth walking through the door. You're seeing more revenue growth of course. But it's an interesting story because we have a lot of hospitals that are centered in a lot of metropolitan areas, Houston, Dallas, San Antonio, and Austin of course. And so volume growth in those cities have been very strong through the pandemic, which is supporting margin generation. Then you have some district hospitals, a lot of them are supported by real estate values from minerals and oil and gas. And so those hospitals have been supported by very strong growth in real estate values that have really provided top line revenues from those sources. And then we have some struggles with rural hospitals that might not have the demand or the taxing support you could say, to be able to generate the margins. And some recent acquisitions of course have happened with struggling hospitals with large organizations and there's been a lot of consolidation happening in the industry and that's a result of some hospitals being in some ways unsustainable in the current environment with labor costs, really outpacing revenue generation.



Doug Kilcommons (03:50):

So I would say from the KBRA point of view, we are in agreement with what the Kaufman Hall Index has shown in terms of margin improvement, certainly from the low points of 2021 and 2022 when negative operating margins in some cases double digit margins were the norm for most providers. Since that time, there has been significant improvement with most providers approaching the breakeven level, if not above that. But as my fellow panelists indicated, that has been an inconsistent uneven story with more rural providers, providers outside of large systems really still struggling to get back to that breakeven level. The other thing I would mention specifically to Texas that does benefit providers in this state is the growth. And obviously we heard in a number of panels today the in migration to the state and that's obviously been helpful in a lot of metropolitan areas, especially in situations where those hospitals and systems are serving a payer base or I should say a patient base rather that is heavily in commercial or supported by commercial payers. Obviously on the other side of the coin, in situations where you've seen lots of growth but it is being supported or partially supported by governmental payers, it's been more of a mixed story. So in general, we're seeing the improvement as well. And again, definitely we are turning the corner from where we were in 2021 when many, many providers were really in trouble.



Karen Pierog (05:23):

Okay. Well another thing we want to talk about was a labor. It emerged as a huge and expensive issue for hospitals in an effort to boost the pipeline of nurses. The Texas legislature passed a bill last year that revamped a scholarship program, created a new grant program for clinical training and expanded a loan repayment assistance assistance program. Another measure requires healthcare facilities to have violence prevention policies and plans and enhances the penalty for assaults on hospital personnel. Has a labor situation in Texas stabilized and if so, at what cost to hospitals? Bottom line?



Michele Vobach (06:03):

I think definitely our labor market has been stronger in Texas. I think we all appreciate that one of the challenges in the healthcare sector has been that there are other strong sectors that compete with healthcare for labor. I'll give you an example. In some of the western part of the state where there's a lot of oil industry, there are a lot of jobs that can be gotten in those other industries that are more attractive than healthcare. And so you talk about the nursing shortage, but also there's just the level of critical hospital staff and workers that are needed. And so again, because we've had kind of a hot market, whether it's Amazon, Tesla, sort of other sectors, just getting a lot of the staff that you need in healthcare to be attracted to healthcare has been a challenge. And I've actually seen that even more in other parts of the country. But it's certainly a factor here. I think from a nursing perspective, a lot of the larger academic systems have been very strategic, to your point, Karen, about coming up with academic and other collaborative programs to really develop collaborations with smaller universities and colleges to really create a pipeline of nursing and medical staff. So again, I think we're starting to see a better future and more strategy around filling those positions.



Karen Pierog (07:27):

And you guys, what about the effect on the bottom lines because it just got so expensive for hospitals from the pandemic?



Michele Vobach (07:36):

Well, I think the higher costs are here to stay, and I think most of the systems have actually built that in. Nurses were really being underpaid. So I think hospitals have had to make that adjustment in their margins to keep the staffing. That being said, healthcare systems have historically been able to become more and more efficient to take costs out of the expense base. And so I think they're literally shifting to make up for some of those more built-in expenses.



Karen Pierog (08:05):

Yeah how about you guys, Richard?



Richard Park (08:07):

Yeah, I would agree. I think the labor situation, when you say stabilized, it's more of a new normal that I would say where hospital systems understand that the permanent wage base has permanently gone up and that goes up against the fixed cost that you've received per service that you're given. And so unfortunately when that situation happens, you have to find cost savings elsewhere. So you see people developing AI technology better throughput. Unfortunately there's been some length of stay issues with discharging to skilled nursing, which has been problematic as the expenses has have to go up to have additional personnel to deal with that additional length of stay. So from a margin standpoint though, a lot of this expense growth has been offset by revenue growth. And then at the same time as the providers with a lot of strong market presence are renegotiating their rates, they're able to come to their payers and say, Hey, our expense space, our cost of care has gone up.



(09:06):

We need to do something to try to be able to mitigate that situation on our bottom line. And it's become somewhat of a, do you have the balance sheet to be able to withstand these pressures and to be able to get through this to be able to get those throughput things to help on the bottom line side of things. And I think a lot of systems have leaned in to their balance sheet for a period of time to allow those expense pressures to alleviate and are now getting to more stabilized in terms of margin generation. But I wouldn't say the labor situation is necessarily stabilized. Turnover is still higher than it's pre pandemic. That's very problematic for hospitals because at a hospital training a nurse takes a lot of time, a nurse to get used to your systems, to get used to your processes takes time, cohorting takes time.



(09:53):

And unfortunately you can't just bring in new people and assume that they're going to be able to work right away. That's a challenge that takes time to alleviate as that turnover rate starts to come down, as the wage rates help on that, as the benefits as well as just the traveling nurse wages come down and now the rise in permanent wages are meeting there, you're seeing this dynamic shift where not as many people are seeing it as attractive to go and travel, but now it's more attractive to maybe stay and get a permanent job and be a nurse in that kind of way.



Doug Kilcommons (10:27):

So I would fully agree with my panelists here. A couple of things I would just point out, Richard raised this point of turnover or this issue of turnover. That is something that we are actively asking management teams about when we sit down because now we're beyond the point of what percentage of your nursing staff is traveling. Most hospitals will tell you that that number is at its low point since the start of the pandemic. So that's a good starting point. But then the question is, okay, well how are you retaining who you have? And then how, to Richard's point, how expensive is it to retain these employees and to again grow them professionally to give them opportunities in your system or your hospital? So questions around that because there's a cost associated with those things. We definitely see more globally the situation stabilizing. If you look across the continuum of care, where you do still see pressure points is on the long-term care side of rehabilitation hospitals.



(11:29):

It is very difficult still to attract and retain nurses. That's an area that we continue to watch. And you see the use of agency staffing, you see lots of turnover. So that's a pressure point for that sub-sector of this market. The one other item I will just mention, obviously, and Michele mentioned this in her comments, there are a lot of different things that hospitals and systems are doing to partner with local colleges. Community colleges provide pathways to careers. That is so important because those are the pipelines where you will find the next generation of hospital staffs that are needed for any system to function. And as systems grow, they add different parts of the continuum to an already large and established platform. You need people to staff those models. So we also ask lots of questions around what investment have you made in working with your community? And especially if you're expanding over state lines and you're really looking to grow your volumes, what have you done to build up that infrastructure to support that because you just can't see an increase in patients and not have the network, the support to adequately meet their needs.



Karen Pierog (12:43):

Thank you. So hospitals face an array of risks at the same time they may be poised to invest in new construction or deferred maintenance. So let's look at how hospital administrators are navigating these risks. And let's start with the recent cyber attack on change healthcare, which impacted its ability to process payments to providers. The American Hospital Association called the situation the most significant and consequential cyber attack on the US healthcare system in American history. What do you guys say about that?



Michele Vobach (13:20):

Well, one thing I would ask this group, I think this is a huge issue in healthcare and yet I don't think it's all that well known. I don't even think it's been articulated very well in the media and the fact that we think about healthcare and we think about risks and one of the biggest risks we have in healthcare is that there are so few payment processors on the technology side and on the payment side and on the payer side, you talk about hospital consolidation and how many hospital systems there are, but if you look at how few payers there are in the market and how few technology platforms there are in healthcare, that really does create a pretty big risk for cyber attacks and just other systemic risks to occur. So I think this caught a lot of people by surprise the idea that you would only have two providers of these payment systems and also if that gets impacted how much liquidity that can drain out of healthcare systems. And that's I think what we've all seen is that a number of our large healthcare systems have said, oh gosh, we've got to increase our lines of credit, we've got to increase our liquidity reserves, we've got to change our investment portfolios to make sure that we can cover that risk. And I do think that caught people quite a bit by surprise. So again, sometimes there are the risks, we think about the labor market, but then there are other risks we don't think about as much and I think it got people's attention.



Karen Pierog (14:56):

Yeah. Is it causing any credit issues you guys?



Richard Park (14:59):

So I think for the most part we put out a pressure release this week I believe, or early in the last week actually talking about this. I think the main impact to credit is for small providers that particularly have low liquidity levels because I think there has been some time to figure out pathways out drawing on liquidating some of your investments, trying to get a Medicare advance drawing on your lines of credit. So there are pathways to be able to shore up your liquidity in the short term to be able to navigate these challenges. So we haven't seen any rating impacts to date and we don't expect any widespread rating impact because I think most of the providers are now actively working through how to shore up your liquidity or to maybe even change out of a different provider, didn't mean to use the word there, but change healthcare chain.



(15:45):

But I think the interesting thing that's come up is that the change healthcare problem has highlighted that systemic risk can come outside of cyber risk that's within your organization. There's now this single organization risk and how are their cyber practices and their connectivity to you going to impact your potential ability to be able to provide services over the longer term. So I think hospitals are now in a situation where they have to assess their mission critical risks and be able to have contingency plans for things like that, not just address the cyber attacks and the problems with security within their own organizations.



Doug Kilcommons (16:28):

Two things I will add. I would say first and foremost, one of the things as a credit analyst that's increasingly challenging is actually assessing what is an effective cyber risk policy or cyber risk strategy versus one that is not. And one of the reasons for that, this is an area where we typically get very limited disclosure and for good reason, you don't want to show your hand as an organization as to what exactly you're doing to manage a cyber attack because that's again, not really protecting critical data. So there's very limited information or insight we'll typically get from management when we ask this question, although you'll get a good sense of at least the framework that's in place. So we listen for that and ask questions around exactly what it's designed to protect and again, what would be if something was breached, what the plan would be to get things back on track, the recovery, that sort of thing.



(17:21):

So just an interesting nuance with cyber in general, but I would say from a credit perspective, we are looking for levers that you could press to Richard's comment would agree with that, that if you are an organization that has very limited liquidity, no access to an external provider for liquidity, you again are managing different pressure points and along comes a cyber attack that would likely be a situation that could result in a rating change or an outlook change at a minimum. However, if you're a larger system, which it seems that these cyber attacks go after organizations that are larger because they have more to lose, meanwhile they also have better protections in general, there typically is not a rating impact. However, it might create organizational stress for a period of time and that certainly would be something we would be discussing in a rating committee when looking at a potential for a credit action. So I would say most organizations have been focused on this, but unfortunately cyber criminals are creative and just because you've surrounded the attacks that we've seen to date and have planned for those, none of us know what they could be planning. And then again, as an organization we look for nimbleness. Are you thinking about that potential next issue and what you're doing to potentially protect against it?



Karen Pierog (18:42):

Okay, Doug, let's stay with you. What are hospitals doing in terms of liquidity management as they deal with the current high interest rate environment and high inflation? What are some of the things you're seeing them do?



Doug Kilcommons (18:55):

Sure. So I'll start with the latter part of that question. The inflationary environment has been challenging for every industry. Healthcare not-for-profit healthcare is not immune. When we look at income statements now, and you can look at the year over year growth in expense categories, supplies, drug costs, just the overall procurement process itself. You can see up to double digit year over year increases. And if you look over a five-year period, you're talking about eight to 9% cagr, which are just exceptionally high. We've already talked about labor. That's also a pressure point. And so all of these things basically land on, okay, can you generate sufficient revenue through your volumes and through your payer payer mix to compensate for the increased costs? Certainly the margins, we've talked about compression already. They're not at the level where they were certainly pre pandemic and they're struggling to get back to a break even position at this point.



(19:51):

So what do you do? You have to rely on your liquidity. The liquidity situation is one that for hospitals that entered the pandemic from a position of strength, those tended to be the ones that are exiting the pandemic also from a position of strength and their liquidity pool is largely intact. But what we actually ask for and look for is the strategy around liquidity. Do you look at external liquidity different from your internal reserves? Do those two things actually, is there a matrix that you look to in managing how many external banks you might bring on to provide liquidity facilities? Are you looking to measure an internal days cash on hand or some other metric that you look to and then backfill with external providers really trying to get a handle on exactly what the strategy is, what you're benchmarking to. And I would say for most a combination of both internally generated funds as well as some access to external liquidity is where most land and we've seen more and more, especially larger systems, really look to have not all of their eggs in one basket in terms of external providers.



(21:09):

So you see a mix of facilities with different maturity dates. And one of the things we ask as a rating agency is around how are you managing some of those relationships in terms of covenants because each of these facilities potentially come with a different covenant package and you never want to be in a situation where you accidentally trip a covenant and that causes some downstream issue that further crunches your liquidity. So really looking at the whole liquidity management and where the sources are coming from. Last but not least, when we do look at balance sheets and we do look at covenant packages, we start to get concerned when we are looking at balance sheet tests that are what I would say loosely defined in terms of what actually goes into the numerator in terms of what is being counted as liquidity. You may be thinking to yourself, well shouldn't this be very clear in transaction documents? It should be, but it not always is. So we like to press a little bit on that, especially when the definitions seem a little bit more vague because again, when you're in situations like the pandemic, like the financial crisis, the details really matter.



Karen Pierog (22:20):

Richard,



Richard Park (22:23):

I think it's been interesting because the industry as a whole I think has to be much more selective on what they're deciding to move forward on projects. There's a lot of what I would call asset light investment, not so much bricks and mortar inpatient, but you would see a lot more outpatient on the specialty side of things. We're seeing a lot of new issuance come in for those types of activities. And interestingly enough with Texas the growth here, you need services to provide services for that growth. You're seeing growth in both the urban settings as well as West Texas. So whether you're talking about some providers out there that are now building outpatient centers trying to be able to expand their inpatient facilities, that's a cost effective way of doing it. Move some departments from the current tower to an outpatient facility and then backfill.



(23:13):

So that's some routes that are being taken. And then beyond that, you have very, very large projects that are being announced that are going to be very, very top line and creative. You'll have University of Texas and MD Anderson having announced a very large project here locally. You have Bexar County Hospital District doing two community-based hospitals to relieve some of the pressures that they're experiencing at their main tower. They're also opening a women's and children's facility. You also have Dallas, their children's health UTSW collaboration over there building a multi-billion dollar facility. So we do have a high interest rate environment, but we also have a high growth environment that is very supportive of capital investment. And that capital investment is coming in a time when the industry, especially on the healthcare side of things, is anticipating growth on the overall population side of things. But don't forget that we have a very large aging population as well.



(24:06):

So over the next 10, 20 years, there's going to be an increase in utilization as well as a slight shift towards Medicare. In terms of the payer mix, how are hospitals dealing with that? That's a question that needs to be answered as well. And then I think just in terms of the current environment and inflationary environment, you'll see some issuers be really creative with how they structure deals. Where is it in the yield curve that you can take advantage of in terms of placing your maturity dates to be able to get the best rate of return and given what you know about the return you're expecting on the asset that you're building. So we see a lot of creative solutions that are not just going out long with their bonds but going medium long, but to be able to be nimble and selective with what they're paying on the interest rate side of things.



Karen Pierog (24:54):

So Michele, can you talk about what they might be doing in terms of refinancing or restructuring or addressing swaps, tenders, things like that?



Michele Vobach (25:04):

There's all sorts of interesting stuff going on. So during the pandemic, as we know rates were at historic lows, there was a lot of liquidity and many of our healthcare clients restructured their balance sheets. They used that opportunity to refinance debt to really position themselves very favorably. So we come out of the pandemic and all of a sudden we're looking at huge pent up demand, particularly in this state, there's so much growth and a lot of our clients had really forgotten how to build projects and how to figure out what they should hurdle, what kind of returns they should have, how they should be configured. Because again, so much of the work in financing had been refinancing debt or growth through acquisitions. So now we've got new projects coming online. And the one thing I would say is that yes, interest rates are higher by a couple of hundred basis points and that is a material fact.



(26:03):

However, from an historic perspective, interest rates are very, very low. And I would argue if a hospital system can't hurdle a four point a half percent cost of capital on a project, maybe the project needs to be reevaluated to some degree. And I think a lot of our clients are really doing that. So I think yes, we're in a higher interest rate environment, but growth is a big part of the story and figuring out the right types of projects, the right types of collaborations. As my colleagues here, we're talking about collaborating around high-end services, really seeing big academic medical centers team up with governmental hospital districts, also teaming up with some of the other not-for-profit systems. We're seeing a lot of really interesting collaborations, particularly for growth in areas like oncology, which is a huge area of need and also a lot of the pediatric services.



(26:57):

So again, seeing a lot of activity there and I think systems are figuring it out. The other thing we're seeing is even though rates are a bit higher, it does create some other refinancing opportunities. For example, a lot of our healthcare clients had interest rate swaps that go back to the 2007, 2008 timeframe. These fixed payers now we're finally in a high enough interest rate environment that those swaps in many cases can be actually unwound at a net break even level and refinanced the underlying debt on a tax exempt fixed rate basis. So that really allows you to take more risk off of your balance sheet to really de-risk your portfolio to not have all the requirement for all this underlying variable and underlying liquidity tied into the bond portfolio. And again, as we talked about, maybe having more liquidity reserved for potential black swan risk events might be a wiser thing than having it all tied up into your bond issue.



(28:03):

So I think that's an opportunity. We're also seeing even some ability to restructure taxable bonds. A lot of our clients issue taxable bonds back anywhere from 2009 and 10 around the Build America bonds phase and started issuing much more aggressively in the early 2000 teens. Now there are a lot of ways to refinance some of those bonds into tax exempt structures. So again, the market is, rates are higher, but the market is also giving us some other opportunities with the shape of the yield curve. And the last thing I will say is investors want this market. We are seeing the high yield market is opening up again, we're seeing a huge demand for healthcare bonds. It's coming from institutional investors, it's also coming from the SMAs. So you're seeing a lot of the high net worth individuals that really want to buy bonds, want tax exempt bonds.



(29:06):

And we're also seeing that now we have had such a dearth of supply over the last few years, particularly in healthcare. I mean again, all Munis have been down, but where somewhere down 30% healthcare was down 50 to 75%. So again, we're starting to see pent up demand, we're starting to see some projects come back into the market and we're seeing investors really going after those deals. We were advisor on a deal for the Midland Hospital Authority about a week ago. That deal was extremely well received in the market and again, that client probably could have issued more bonds and sold them very successfully. So just a lot of demand out there.



Karen Pierog (29:49):

Great. So they're projecting a really kind of really bad hurricane season and we went through last summer in the southwest in Texas where it was darn hot. So what about a climate risk for hospitals? What do you see, Doug?



Doug Kilcommons (30:11):

I would say every geography faces some climate risk and some potential significant or severe climate event. So we are typically asking as part of our analysis of a capital improvement plan projects that may or may not specifically be addressing some of those risks. Obviously if you have a situation where an institution has gone through a climate event where they have taken steps to shore up their assets, where they've seen what could happen if flooding takes place, severe flooding, if they're in a place where that gets lots of tornado activity like the region we're in now, what they do to prepare for that and potentially manage a very severe event and really asking questions around management's understanding of these potential risks and their planning for it. In a capital improvement plan, especially one that is multi-year, you typically will find projects that address some of these risks, especially for systems that are very sophisticated with teams that have been in place for long periods of time.



(31:22):

And we ask questions around again how they've arrived at some of their projects, particularly if they're expensive and lasting over multiple years. So I guess the short answer to the question, Karen, is we do a lot of investigatory work and I would say we will ask questions when we don't hear. There are projects that are addressing some of the things that are out there and you'd be surprised. There are definitely situations where these climate risks because they might not have led to an event in the last several years and people forget. So we ask questions around that and try to get a better understanding of, okay, if we know you haven't seen this in the last several years, what happens if it does develop? What are you doing to prepare?



Karen Pierog (32:07):

Hi, Richard.



Richard Park (32:11):

Yeah, I think I agree with Doug. We make sure we cover our bases, especially when it comes to ESG on all sides of it in terms of energies and with climate, it's really interesting because there's a lot of different ways of tackling and you have places like Florida that deal with hurricanes, you have places like the west coast that also deal with coastal type issues and Texas has its own slew of issues with tornado, with energy grid types of things. So you do see a lot of Texas issuers who are making sure the doors in the hospital cannot just close for days because of hurricane happen. So you'll see places like Houston that have a lot of preparedness for things like that. And so we do ask those questions. We make sure that there are always plans in place, that there are things that the hospital can do in the event that some kind of event happens. And often hospitals are looked at as being safe havens for people, and so they need to be able to handle situations like that. And so we make sure that the hospitals well prepared that they're building appropriately for those types of risks and try to make sure that those bases are covered and that we're not looking at other kinds of potential risks in terms of utilization and volumes when it comes to climate and things like that.



Karen Pierog (33:25):

Go ahead.



Michele Vobach (33:26):

Yeah, a lot of our clients are also really upgrading their central utility plants. So whether it's a new project or just upgrading your whole system, we're seeing very significant investments in what I call energy as a service. So really looking at central utility plants and looking at making investments over time, usually with engineering firms and other stakeholders to build the resilience of these systems and to increase just their ability to withstand different changes in climate. We're seeing this particularly in brand new systems, but also large scale systems that may be building onto one facility and they'll improve and enhance the overall facility. Hospitals have not yet been fully pressured to measure their carbon footprint and to be forced into metrics by CMS to be reimbursed accordingly, however that has been talked about and I think a lot of systems have responded proactively to that. The other thing we're seeing is the whole focus on microgrids, and I know we've seen this quite a bit in the airport space, but again, a number of large healthcare systems are looking at microgrids, particularly ones that are tied into universities or other different users where they're all on a common platform.



(34:51):

But again, there's a lot of sensitivity around making sure there's resilience around climate considerations, and then obviously a new construction. We're seeing a lot more focus on resiliency around just hurricane risks, high wind risks, et cetera.



Karen Pierog (35:08):

Okay. Here's a toss up question. So what's the situation in Texas with uncompensated care and is the migrant situation making it worse for hospitals? Anybody?



Richard Park (35:26):

I would say that the question in Texas really I think the biggest credit question would be what's going on with the Medicaid disinvolvement? I think that there's been a lot of press about how that's not going so well to put it lightly. And so the unfortunate part of that is that people lose coverage because natural churn happens often because of administrative reasons, not necessarily because you're ineligible, but for some reason whether it's right or wrong, you become ineligible for Medicaid and as a result the uncompensated care level goes up. So that's a situation there's to be seen on that specific one because we're obviously in the midst of that process right now and the hospitals we're going to be seeing those patients as we speak. And so there are question marks about how that's going to be handled. Obviously, Texas isn't from a supplemental funding side of things, has uncompensated care as a part of the supplemental funding that hospitals often receive? Unfortunately, those funds are received with data that was done years ago, so it'll take some time for that to catch up. But I think that there's question marks there. The migraine care, I wouldn't say has come up as being a significant credit issue for Texas hospitals, but I do believe that something that the hospitals are taking very much hard line and look at is what's going on with the Medicaid dis-enrollment and how that's going to affect their bottom line and payer mix.



Karen Pierog (36:57):

Okay. Anybody else?



Doug Kilcommons (36:58):

Yeah, I would just add to that, excuse me. We are asking across the board at KBRA for all of our city, city, state, local government credits, this impact of the migrant issue because it does have costs that you might not necessarily see right now, but there are costs that are building hospitals are going to face those costs, especially in places where you are seeing an influx of migrants. However, I would fully agree with Richard on this that the question for us is that when you do look at that uncompensated care number and you see that go up over time, the question that we're asking is how is this going to be addressed? And often there is no immediate answer to that question and it's going to take potentially state action, federal action for that to be dealt with, but it is something that we are asking about.



(37:52):

And also just in terms of the physical footprint of a hospital, if that hospital is becoming overrun with migrants that need primary care, the emergency room then takes on that role as the primary care facility. What is that doing to the ed? What is that doing to the staffing levels? How is that going to impact from an operational standpoint what it is you're going to do day in and day out? So that is a question that we're asking and clearly in places where we've all heard where the migrant situation seems to be at worse levels than others, that's a place where we're spending more time in terms of our questions regarding the issue. But it is something that we expect will have some cost pressures across the board.



Karen Pierog (38:41):

So in Texas, are we seeing greenfield developments for hospitals and things like that? What do you see, Michele?



Michele Vobach (38:50):

We're seeing a lot of greenfield development because again, communities want hospitals. What's been fascinating to me, just the development story you see around Texas, particularly with home builders and communities that really start to grow 50 miles out, let's say from a metro area, they all need a hospital. What tends to happen is those governments will go to one of the big systems and sort of argue, Hey, can you plant a flag out in our town, our community? And it's tough, right? It's tough to negotiate those kind of deals because not everybody has a hospital district and smaller communities, they know they need a healthcare presence. So we're starting to see a bit of this void being filled by certain developers and it is a interesting strategy. We've seen several of these. They've not all gone well, but some have gone better than others. I think that, as we talked about earlier, some of the big hospital systems are very careful in terms of how they go into markets. But if you get a strong developer team that can come in, start to plan a flag, maybe collaborate with a larger system or collaborate with a group of physicians, there are ways to get some of these greenfield projects off the ground, particularly where the growth is significant. But you definitely need to proceed with caution, have full-blown feasibility studies, really have a good sense for the physician climate and know that there's still some significant risk even in a good economic setting.



Karen Pierog (40:30):

Okay. So why don't you each kind of give your outlook for Texas hospitals like overall, Doug?



Doug Kilcommons (40:43):

So I would say to kind of close where we started, it's basically mixed where you are going to see the large systems, the systems that serve very large acute care, high acuity type cases do and fair better versus standalone providers, rural hospitals. You're going to see that divide continue and in fact potentially widen. I would say that we are definitely past the worst of the pandemic and in the post pandemic environment, we're actually on a bit of an upswing versus where we were just a year ago. But again, there's lots of unknowns in the not-for-profit healthcare space. And so we would see those providers that have liquidity access to liquidity, those that understand where their particular market, the patient base is moving, your ability to pivot from historically a largely inpatient type modality to one where outpatient plays a lot larger role. Your ability to do those things and be nimble and flexible in this environment, which is continuing to evolve really positions you best for whatever is to come. And so I would say, again, a mixed outlook, but certainly the largest systems, the systems that are serving the case mixes that are getting reimbursed at higher rates, those are probably you're stronger credits. Those will continue to be the strongest. And again, if you're a standalone provider in a market that is very competitive, that's a difficult place to be and it was a difficult place to be in pre pandemic and it will continue to be in the environment we're in today.



Richard Park (42:24):

I would agree with what Doug said. I think that Texas is a state that is ready for continual investment. And I think that that continued investment has to come along with an understanding of can you build it and can you also staff it? And that's a question mark that I think every provider has to ask. There's so many projects that are happening not just in the city centers, but on the outside. You have Texas Children's Building in North Austin, you have Children's of Dallas building in their Plano facility and now expanding downtown. You have Bexar County Hospital district building two community hospitals. You have expansions going on in West Texas. And so expansion is the name of the game for the next decade. Plus, I think that there'll be questions of marks about how do we staff all those beds? And I think that there's pipelines that are being developed to address those questions, but I do think that the outlook is bright in terms of volume and utilization for the state. And I think that we've had a good six or so some odd percent growth in population over the past five years. And I think we expect that to continue to happen. And as long as we are on a positive trajectory in terms of the economy and West Texas supported by mineral assets and the values over there, the outlook is really stable here for Texas. And I think that there's going to be continued questions about how to manage the volume growth that is expected over the next 10, 20 years and beyond. So labor and growth,



Michele Vobach (43:53):

Michele, again, I'll give a shout out to the hospital districts. I think it is a unique feature of our state that we have local government run hospitals of the highest level and we get bond elections, most of which have passed by margins of 85% or better. I think that really helps to bolster the overall healthcare system, whether we're talking about taking care of indigent populations, providing academic medicine, just creating a nice foundation, particularly since we don't have expansion here, we're under a waiver program. I think the hospital districts help us a lot. I think the rural part of the state is going to continue to be challenged, and I think that the high quality academic systems and the specialty children's hospitals and other specialty systems will continue to be attractive here. I do think there is, even with all the medical schools we have in this state, there's a real shortage of physicians and I think that's going to continue to be a challenge going forward, just really being able to get people the care they need. But I think that is an area being addressed, and certainly I cover clients and systems all over the country. I think we have a more favorable situation and story here in Texas than what I've seen in a number of other states. So again, not without challenges, but I'm pretty optimistic.



Karen Pierog (45:26):

Great. Any questions?



Audience Member 1 (45:34):

Good afternoon. My question is with regard to post pandemic world, we're looking at liquidity in the hospitals in general with regard to day's, cash on hand, those kind of metrics really looking quite strong kind of at pre pandemic levels. So I think from that perspective, things are going well. My question is with regard to looking forward, what are the threats to the liquidity in the system in that regard, and what can the healthcare systems do to manage through that process?



Doug Kilcommons (46:02):

I'll start it off. I would just say the days cash on hand number is when you look at it as a static number. The questions are often around well to be, how are you going to be using this cache? And if you're, especially, we talked about many systems in expansion mode with lots of projects going on, questions around what is the floor that day's cash number might get to at the peak of your building? And understanding kind of what the plan is to draw down and then what the plan might be after that to bring it back up. So really thinking about again, or recognizing its point in time today and what it might look like down the road is going to really depend upon what the hospital or system is doing in terms of projects, what it might be planning to do in terms of even changes to its operation.



(46:50):

One of the things that we often will hear, if you're a system that is not yet advanced in terms of electronic medical records and you're going to be embarking on a project to address that, your margins often suffer as a result of embarking on those projects, not because of necessarily something going wrong, they're just expensive. You often have consultants, there's a lot of expense pressure in that period of implementation. So liquidity might be used to support years that the margins are declining. So getting a sense of what the plan is. And also as you watch that number over time, that's where you can have that more fulsome conversation around the liquidity management strategy more broadly what's playing in it. And for some reason you're tolerating a lower day's cash number. There may be a reason for that. And also trying to get to the root cause of that and why that number might be lower going forward versus where it is today.



Karen Pierog (47:46):

Okay. Any other questions?



Richard Park (47:50):

I just wanted to throw a little bit of a curve ball on that answer because I think one of the things that's a unique function of hospitals is that they're very, very liquid organizations with very strong balance sheets, but that comes along with very heavy investment portfolios. So if you look at how hospitals have fared in the first half of fiscal 2023 from 2022, a lot of the gains in liquidity have been associated with investment market gains that have happened over the past year. And so though days cash on hand might be strong, if you look at the underlying fundamentals, it's not necessarily because the industry was able to generate operating margins that supported cash generation. A lot of it was because these organizations have very strong balance sheets that are heavily invested into the market that have had very strong returns to date. And so in some ways, those returns have outpaced expense growth. And so I would say that that's another risk that I would add to the conversation that if you see a downturn in the market, not necessarily that a hospital is going to react very harshly to that, but that's going to have an effect on the balance sheet of an organization that's heavily invested into the market.



Karen Pierog (49:06):

Okay. Well, we're kind of out of time. I hear the people out there. So thank you so much and have a nice break.