Mercy Iowa City credit rating downgraded due to ‘severe cash flow deterioration’

IOWA CITY — Moody’s Investors Service — esteemed internationally for its credit ratings, risk analyses and bond research — again has downgraded Mercy Iowa City Hospital’s credit rating following “severe cash flow deterioration, from historically weak levels, which has resulted in material and rapid cash burn.”

Of Moody’s 21 long-term rating categories — from Aaa at the top to C at the bottom — Mercy has been downgraded three spots from B1 to Caa1, putting it just four ranks from the lowest C, according to a Moody’s report released Thursday.

“Our Caa1 reflects our view of Mercy's continued weak cash metrics and leverage ratios as well as its small size and limited clinical array relative to a stronger and much larger local competitor,” according to Moody’s March 16 report. “Competition will remain a factor with a large academic medical center in the primary service area.”

Moody’s assigns its Caa1 rating to entities with financial obligations in “poor standing” and “subject to very high credit risk.” Mercy’s larger nearby competitor referenced in the report — the University of Iowa Hospitals and Clinics — last year received a Aa2 rating on its debt, putting it near the top of the scale.

Moody’s recent Mercy report said the Iowa City hospital had $74.4 million in outstanding debt at the close of the 2022 budget year last June; Moody’s in May 2022 reported UIHC’s total outstanding debt was about $515 million.

'Extremely difficult time’

In alerting employees to the Moody’s downgrade last week, Mercy Iowa City Acting President and CEO Mike Trachta in an email said the change was based on “past financial performance.”

“While this decision is disappointing, our focus must remain on providing high-quality care and improving business operations,” Trachta wrote. “Our patients, their families and community need the type of medical care only provided at a community hospital like Mercy Iowa City.”

Acknowledging Mercy’s struggles, Trachta said the hospital is not alone.

“The past few years have presented many challenges to all hospitals, making it an extremely difficult time to work in health care,” he wrote. “The pandemic, higher operating costs and inflation have converged to create an environment where it is increasingly harder to grow revenue and reduce expenses.”

The 194-bed Iowa City hospital — one of 23 affiliated with the MercyOne network, despite Mercy’s recent efforts to find a new partner or owner — last summer had to retain a performance-improvement consultant after breaching debt coverage obligations.

In December, the hospital reported net assets at $34.5 million — down $60.3 million or 64 percent from $94.9 million in December 2021, according to disclosures published by the Municipal Securities Rulemaking Board.

Mercy’s cash and cash equivalents fell from $22.1 million in the 2021 budget year to $5.8 million at the end of fiscal 2022; its total assets in December were down to $179.1 million from $209.9 million six months earlier in June.

The Moody’s report said Mercy’s “cash flow losses are largely reflective of elevated labor and supply costs and a slowed revenue cycle after implementation of a new billing system.”

“While labor and inflation pressures are sector-wide challenges, the impact to Mercy has been disproportionate and has been exacerbated by the implementation of the new billing system which caused receivables to balloon during the last quarter of FY 2022,” according to Moody’s. “Additionally, sluggish recovery of inpatient volumes and ongoing shifts in care to outpatient settings has impaired demand, with inpatient volumes continuing to lag pre-COVID levels.”

A recent Mercy disclosure showed its occupancy for the quarter that ended Dec. 30 was down to 27 percent, compared with 31 percent during the same period in 2021. Meanwhile, the $2.3 billion UIHC operation in February reported an adult occupancy of 96 percent for the 2022 calendar year, with an average midnight census of 600 patients — to its 627 staffed beds.

Trachta in his employee email said Mercy is focusing in the short term on several “opportunities for continued operational and financial improvements”:

Mercy officials didn’t provide The Gazette details on its performance improvement initiatives or answer questions about how its billing system has affected operations. But Trachta in his email suggested Mercy is focusing on “strengthening the overall network by keeping referrals within our system, which includes our employees choosing Mercy Iowa City for their care.”

Moody’s outlook

Addressing some of Mercy’s responsiveness, Moody’s reported its downgrade incorporated “management’s implementation of a performance improvement plan in an effort to stabilize operating results” but suggested “governance is a key driver to the rating action.”

“Mercy has continued to face challenges in securing a long-term strategic partner, high management turnover, and inability to achieve lasting performance improvement,” according to the rating report. “The continuation of all of Mercy's revenue and expenses pressures are expected to be prolonged such that we don't expect operating performance to reach break-even levels for the foreseeable future.”

With the downgrade, Moody’s shifted its outlook for Mercy from negative to stable, reflecting “expectations that Mercy will continue to face operating challenges and weak liquidity for the next 12 to 18 months with the potential for meaningful short-term swings in performance.”

Factors that could compel Moody’s to upgrade Mercy include material and sustained operating performance improvement; positive cash flow; and a substantial rebuild of unrestricted cash and investments, according to the report.

Factors that could lead to another downgrade include more cash flow losses; an inability to execute performance improvement plans; and discontinuation of its MercyOne affiliation without another partnership established.

Comments: (319) 339-3158; vanessa.miller@thegazette.com