Hospital leaders must prepare for higher interest rates

Hospitals have dealt with the COVID-19 pandemic and subsequent financial pressures, and now another challenge is looming: the prospect of higher interest rates.

The Federal Reserve has indicated that it could start raising interest rates as soon as March. It has been a long time coming. The Fed last raised interest rates in December 2018.

Interest rates have been at historic lows, but it’s unclear how high they will go. So what does it mean for leaders of hospitals and healthcare organizations?

Rick Gundling of HFMA

The prospect of higher interest rates adds to the pressure on hospitals and healthcare systems, said Rick Gundling, senior vice president of professional practice for the Healthcare Finance Management Association.

“It adds one more complexity to an already complex system,” Gundling said in a phone interview. “It’s one more factor of raising costs that they’re going to deal with.”

Hospitals have weathered serious financial pressures during the pandemic, including higher labor costs and higher prices for supplies. They've also curbed non-urgent surgeries at times, reducing a key source of revenue.

Investors are preparing for increases in interest rates. Bank of America and J.P. MorganChase have both predicted several increases in interest rates this year.

Eric Jordahl, managing director of Kaufman Hall, a consulting firm, said the likelihood of higher interest rates brings a couple of different potential impacts.

“For organizations, the cost of borrowing is likely going to increase,” Jordahl told Chief Healthcare Executive.

Healthcare leaders may want to reevaluate projects they are considering to be sure they are economically feasible.

“If you’re planning capital expenditures, you may want to start planning now,” Gundling said.

Healthcare leaders will need to ask some tough questions about their plans for major building projects in the near future. As Gundling said, “When you’re doing your projections of repaying the debt at higher interest rates, does it still make sense?”

Eric Jordahl of Kaufman Hall

If hospitals are looking to borrow money for larger projects, it may be wise to do so sooner than later, Jordahl said.

“It is important to step back and say interest rates remain at historically low levels. It’s going to take a lot of movement where we’re at much higher rates,” he said.

But Jordahl added, “If it all lines up, and it makes sense, the sooner organizations can access capital, the better.”

Amid the uncertainty and upheaval of the pandemic, hospital systems have relied on the health of their investment portfolios, which have been a key factor in bolstering or at least sustaining their financial performance, Jordahl said.

The wild card is how the markets respond to higher interest rates.

“Given how important the investment side is, that’s the wild card that’s very difficult to defend against,” he said.

“If, and this is an if, if those markets start to become more volatile or there’s a slowing down of growth and performance of portfolios lags, that’s another stress point that’s going to emerge,” Jordahl said.

During the pandemic, healthcare organizations have dealt with tumultuous conditions, including higher labor costs, staff shortages, supply chain challenges and higher expenses for drugs and other materials.

Plus, hospitals have dealt with waves of COVID-19 patients jamming their facilities. In recent months, hospitals are seeing more patients who deferred treatment during the pandemic for non-COVID issues finally showing up. Because they've delayed treatment, some of those patients have been sicker and required longer stays.

“Since COVID, there’s been so much strain on the operating side of healthcare organizations,” Jordahl said.

If there’s more volatility on the balance sheets, Jordahl said, “It’s another headwind organizations are going to have to confront.”

“The possibility is there for disruption,” he said. “Any organization should look at their balance sheet composition and what happens if that side gets as wobbly as our operations side has.”

Even if interest rates do help apply the brakes to inflation, as investors hope, hospitals are still going to have to deal with one financial headache for the foreseeable future: higher labor costs.

Labor costs are about 20% higher than they were in 2019, before the coronavirus pandemic changed the world, according to a recent Kaufman Hall report.

“All the wage increases are there. That’s now structural,” Jordahl said. “For healthcare executives, there’s a new cost base and they are going to have to deal with that.”

Investors have been projecting greater interest in mergers and acquisitions in healthcare and the life sciences, according to a KPMG survey. Mergers among hospital systems actually dropped to a 10-year low last year, according to a Kaufman Hall report, but analysts have predicted there will be more merger activity involving hospitals in 2022.

Could higher interest rates cool down interest in healthcare mergers? Analysts said they didn’t expect that to happen.

“I don’t think that changes,” Jordahl said. “What it might start to do, if the Fed starts to withdraw liquidity, it raises asset prices.”

“My suspicion is that the absolute pace of M&A activity may not change.”

Even if interest rates rise, Gundling said he expected there to be larger deals that are more strategic. Deals could be made to bolster advantages in certain geographic areas. Analysts also expect hospital systems will try to acquire or merge with firms that could help them in other areas, such as outpatient services or telehealth.

Ultimately, analysts agreed hospital and healthcare organization leaders should be developing strategies now to deal with the expected increase in interest rates, and the potential fallout.

As Jordahl said, “How is your balance sheet composed? Take the time now to think about what you should be doing.”