Hospitals suffer from spiking bond interest rates, investment losses

November 3, 2008

The past two months have been a white-knuckle roller-coaster ride for Indiana hospital executives.

Hospitals have suffered a double whammy of spiking interest rates on their bonds and heavy losses in their investment portfolios.

They've survived so far. But with national health care spending trends slipping, hospitals are fearful enough that they're trying to save cash any way they can.

No Indianapolis-area hospital has announced delays to any major building projects yet. But they are delaying purchases of expensive imaging equipment and renovations to their facilities. And they are looking for ways to avoid filling vacancies on their payroll.

"Hospitals and health care have always thought they were recession-proof. But I think this is going to be deeper and longer," said Bill Corley, CEO of Community Health Network.

If Corley is right, it's not great news for the Indiana job market. Hospitals are some of the state's largest employers. And with housing construction dried up, hospitals are one employer of construction firms that's still looking to build.

Community, for example, is the 11th-largest employer in the state, with nearly 11,000 workers. But Community is looking for ways to leave some of those positions unfilled by combining two jobs into one or by asking nurses to work overtime instead of hiring new ones.

And, just last month, Community decided to push off $10 million in capital purchases and the renovation of a nursing unit until next year.

St. Francis Hospital & Health Centers in Indianapolis is looking at similar tactics, CEO Bob Brody said.

"We are approaching 2009 more cautiously in some respects than we have in the past—at least in terms of capital expenditures," Brody said. He added, "We're looking at our non-labor costs very deliberately. We're being very deliberate with respect to our non-clinical hires."

Ed Abel, director of health care at Indianapolis accounting firm Blue & Co., said all four of Indianapolis' hospital systems delayed the start of projects when bond rates spiked in mid-September.

"They're scared," Abel said. "Justifiably so."

Credit market mayhem

In fact, the entire year has been rocky for hospitals and their bond financing. Auction markets for variable-rate municipal bonds collapsed in February. That sent rates up and sent hospitals scurrying to refinance their bonds into fixed rates.

The auction-rate meltdown delayed an attempt by the St. Francis system to sell $125 million in bonds to pay for a new hospital in Lafayette and a new patient-bed tower at the St. Francis Indianapolis campus.

Both of those hospitals are among the 10 in Indiana owned by Sisters of St. Francis Health Services Inc., which is based in Mishawaka.

St. Francis delayed its bond issue until summer, as it worked to refinance its most expensive auction-rate bonds.

But in the spring, some bond insurance companies had their financial strength ratings lowered by ratings firms, which sent rates up on more of St. Francis' bonds. So it refinanced more variable-rate bonds and pushed off its bond sale until Sept. 29.

But two weeks before that, the investment bank Lehman Brothers collapsed, rendering its bonds worthless. A money-market mutual fund that held Lehman Brothers bonds saw its value plummet, which caused investors to yank money out of nearly all money-market mutual funds.

Since money-market mutual funds are the leading buyers of hospital and other kinds of municipal bonds, rates on those bonds soared. Bond rates rise when fewer buyers are demanding them.

Jack Horner, interim CEO of Major Health Partners in Shelbyville, said rates on his hospital's variable-rate bonds seesawed from about 2 percent to nearly 8 percent, which added $25,000 in extra interest payments every week.

"That cost a significant amount of money for those two months," Horner said. "We really were behind the 8 ball. We had been unable to convert that [variable-rate debt] to long-term rates, even if we had wanted."

It was virtually impossible to sell new bonds. But Sisters of St. Francis Chief Financial Officer Jennifer Marion kept looking for an opening.

Her team held a daily call with Merrill Lynch and Citigroup, the underwriters of its bond sale. Every call featured the same bad story.

Then, in the middle of their call Oct. 7, the underwriters said there might be an opening in the market. So they put the Sisters of St. Francis' bonds on the market the next day. They sold for rates ranging from 3.5 percent to 4.5 percent.

Sisters of St. Francis was the first hospital system in the nation to successfully sell new bonds after the markets froze, Marion said. But rates have been trending favorably since. The rates on the bonds the system sold in October are now down to 1.5 percent.

"We were very delighted by the rates that we received on those bonds," Marion said.

Clarian Health in Indianapolis, the state's largest hospital system, has seen its average bond rates climb to 5.6 percent in the first nine months of this year, compared with less than 4 percent normally.

That's cost the system "at least millions, several millions," said CEO Dan Evans.

"We really don't even know right now," he added. "It's that chaotic."

Investment anxiety

One problem still hanging over hospitals' heads is how much their investment portfolios have suffered.

The Dow Jones industrial average has fallen 20 percent since mid-September. And if hospitals owned bonds in the financial companies that have collapsed, such as Lehman Brothers and Washington Mutual, they could have taken hits there, too.

Even before October, it hasn't been a good year. Hancock Regional Hospital in Greenfield saw its portfolio lose 12 percent of its value, as of Sept. 30. The hospital system usually earns 6 percent a year on its investments.

"We do count on these investments for operations and future sustainability," said Hancock Regional's Chief Financial Officer Rick Edwards. "So it is very important."

By contrast, Community Health Network doesn't count on investments to cover losses on its health care operations. But it does use the money to fund its employee pension plan.

Because of investment losses this year, Corley estimates Community will have to spend up to $20 million next year to keep its pension plan fully funded.

Fewer patients?

Perhaps more worrisome for hospitals, however, is the possibility that patients will curtail their use of medical care.

In an August survey, 22 percent of U.S. consumers said they were going to the doctor less often because of economic troubles. About 11 percent of patients said they're taking fewer prescription drugs to save money.

The survey included 686 people and was sponsored by the National Association of Insurance Commissioners.

No Indianapolis-area hospitals said they'd seen a drop in volume of patient visits and procedures.

Kyle De Fur, CEO of St. Vincent Indianapolis Hospital, said that, if he does, it will likely be patients putting off such elective procedures as joint replacements or sinus surgeries.

What De Fur worries about is a rise in unpaid bills.

"As the economy struggles, it's likely we'll see an increase in patients who aren't able to pay," he said.

Some hospitals already have seen it happen. At Hancock Regional, rates of unpaid bills have risen this year from 5.5 percent of revenue to 7.1 percent—a difference of $2.5 million.

Major Hospital in Shelbyville reports that overall patient volume has held up, but it's seen fewer visits from people covered by commercial insurance—the main source of profits for hospitals.

Horner, the interim CEO, said commercially insured patients spent 1.3 percent less since April, compared with the same period last year. That drop-off has shaved 1.5 percentage points off Major's operating margin.

"When we see a downtick in our commercial base, that has a significant effect on our profitability," Horner said.

Unfortunately, Brody, the CEO of St. Francis in Indianapolis, sees more of that trend on the horizon.

"In the health care industry, the situation is not improving. In fact, it's deteriorating," he said.

"As we anticipate 2009, we can continue to expect to see a payer mix with more uninsured, more unemployed, more people in distress."

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