Offices of Medical Doctors are largely physicians' practice management firms. These firms acquire a practice of physicians based on a multiple of the practice's discounted cash flow. The multiple can be several times the practice's asset value at the time of purchase. However, these firms have had difficulty achieving profitability because of legal restrictions on referrals among affiliated groups of physicians, as well as the reluctance of physicians to submit their medical practice to the criteria of cost control.⁶ Total liabilities in this sector have grown rapidly over the past few years.

⁶ Gruehn, Charles. April 2000. Healthcare Industry Manual. Federal Reserve Bank of Atlanta.

Skilled Nursing Care Facilities' earnings have been hurt badly by the BBA. However, they stand to benefit from the Medicare "giveback" provided by the recently enacted BIPA, which seeks to rectify the deeper-than-expected cuts in funding resulting from the BBA. Skilled nursing care facilities' performance has also been adversely affected by (1) declining occupancy rates caused at least partly by increased competition from lower-acuity facilities such as assisted living facilities; (2) rising labor and legal costs; and (3) surging debt service costs. Many of these firms are experiencing severe financial stress. The stressed facilities have registered negative net income for the past year or so, as well as burgeoning debt levels. The high debt levels are the result of acquisitions of ancillary support services that in many cases are not generating adequate cash flow because of the BBA.⁷ Most of these firms have seen their interest coverage ratios decline sharply over the past few years.

⁷ Ibid.

Home Health Care Services focus primarily on respiratory therapy programs and intravenous and infusion services. The industry is undergoing financial stress as a result of the Health Care Financing Administration's implementation of a prospective payment system that reduced reimbursements on respiratory therapy and infusion therapy.

Specialty Outpatient Facilities, NEC are primarily engaged in outpatient care of a specialized nature, such as alcohol and drug treatment and birth control/family planning. They have permanent facilities and medical staff to provide diagnosis, treatment, or both for patients who are ambulatory and do not require inpatient care. Many of the firms in this sector have experienced a rising debt burden over the past few years, pushing default risk to higher levels.

Health Services firms are engaged primarily in furnishing medical, surgical, and other health services. Firms listed in this broad category rather than more specific categories include companies providing dental services, laser eye correction, and physical and occupational therapy. Many publicly traded firms in this category have experienced sharply rising liabilities over the past three to four years.

Moderate-Risk Sectors

Moderate-risk health care sectors include medical laboratories, hospitals, and HMOs.

Medical Laboratories provide professional analytic or diagnostic services to the medical profession or to the patient as prescribed by a physician. Companies with diverse financial performance and risk of default are included in this sector. A number of medical laboratories have registered deteriorating interest coverage ratios in the past year or two.

Hospitals, as defined for these purposes, are specialty hospitals. They are primarily engaged in providing diagnostic services, treatment, and other hospital services for specialized categories of patients. Only eight publicly traded firms are listed in this category. They are involved in providing specialized hospital care such as rehabilitation, diabetes treatment, and drug and substance abuse treatment.

Hospital and Medical Service Plans (HMOs) are primarily engaged in providing hospital, medical, and other health services to subscribers or members in accordance with prearranged agreements or service plans. Generally, these service plans provide benefits to subscribers or members in return for specified subscription charges. Also included in this industry are separate HMOs that provide medical insurance. After several years of intense competition among HMOs, which restricted premium-rate hikes when medical costs were rising sharply, HMOs began to pursue a more aggressive approach toward price increases. This new approach has improved the near- and intermediate-term outlook for this sector. Yet, the prospect of the passage of a Patients' Bill of Rights suggests that rising costs could be an issue for HMOs in the future. As an industry, HMOs are highly concentrated, with the top 10 HMOs accounting for nearly two-thirds of total HMO enrollment in the United States.

⁸ See Standard & Poor's. August 31, 2000. Industry Surveys--Healthcare: Managed Care.

Lower-Risk Sectors

The lowest-risk sectors in the health care industry include miscellaneous health and allied services, and general medical and surgical hospitals. Many of these firms have an estimated default risk that puts them in speculative credit risk categories in spite of the fact that they are considered lower risk compared with other health care sectors.

Miscellaneous Health and Allied Services firms are involved in providing kidney or renal dialysis services and outpatient care of a specialized nature, such as alcohol and drug treatment and birth control/family planning. Some firms are engaged in providing health and allied services such as blood banks, blood donor stations, childbirth preparation classes, medical photography and art, and oxygen tent services.

General Medical and Surgical Hospitals provide general medical and surgical diagnostic and treatment services, other hospital services, and continuing nursing services. They have an organized medical staff, inpatient beds, and equipment and facilities to provide complete health care. According to a study conducted by HCIA-Sachs and Ernst & Young, "The BBA created the greatest financial instability that hospitals have experienced since the creation of Medicare in 1965. Yet the most severe reductions have just begun to impact hospitals, and will continue to do so through 2002. The recently enacted Balanced Budget Refinement Act provides little sustained relief to the industry, and significant financial problems are likely to remain."⁹ The study also indicates that smaller hospitals (fewer than 100 beds) are in the "greatest financial jeopardy." The recent enactment of BIPA will help to stabilize the finances of hospitals over the next several years. However, other trends adversely affecting hospitals include as much as 40 percent estimated excess capacity, rising labor costs, a severe shortage of nurses, continued HMO penetration, breakthrough pharmaceutical therapies, and increased outpatient volumes (see Charts 5, 6, and 8).

⁹ HCIA-Sachs, LLC, and Ernst & Young, LLP. May 1, 2000. The Financial State of Hospitals: Post-BBA and Post-BBRA.

Chart 8

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Outlook

The outlook for the health care industry has improved substantially in the past year. Industry consolidation and legislation to give back some of the Medicare cuts implemented in the Balanced Budget Act of 1997 have gone a long way to stabilize health care providers' financial prospects, particularly those of hospitals and nursing homes.

The passage of a Patients' Bill of Rights in 2001 could also strengthen the hand of health care providers relative to HMOs. Such a bill could contain provisions that would weaken the position of managed care organizations to contain costs and negotiate with health service providers.

Longer term, the demographic trends are positive, with the population aging and life expectancy increasing. The result should be a growing demand for health care services in the future. On the negative side, however, the current trends toward greater use of outpatient procedures and drug therapies will dampen the demand for inpatient hospital services.

Implications for Banks

The opportunities for financing health care firms will continue to grow into the future. Recent experience has shown that the financial performance of many health care providers is profoundly influenced by changes in Medicare policy. As Medicare expenditures grow to occupy a greater and greater place in the federal budget, Medicare policy will be scrutinized to an unprecedented degree, magnifying the importance of understanding the policy risk associated with health care lending.

Powerful demographic trends should lead to the growth in demand for many health care services over the next 10 to 20 years. For example, demand for nursing homes and assisted living facilities will increase sharply as baby boomers reach old age. However, regional supply and demand for these services can get out of balance as providers add facilities to meet demand. Monitoring local demand and supply trends is an important part of assessing the credit risks in these loans.

Textiles

The textile industry has been plagued by excess capacity, fierce competition from cheaper imports, and sagging textile prices. The result was a sharp drop in industry profits in 1999 and continued weakness in 2000.

Recent Trends and Developments

The textile industry is a mature industry that by a number of measures has been declining. Intense competition from low-cost imports has taken its toll on domestic textile businesses. Since 1995, textile imports have increased nearly 50 percent while exports have grown just under 10 percent. A strong dollar should help textile imports continue to outpace exports. As a result of industry consolidation and the movement of many operations offshore, textile employment has continued to fall steadily. Textile employment has dropped from 663,000 in 1995 to an estimated 544,000 in 2000.¹⁰

¹⁰ Economy.com. November 2000. Apparel and Textiles, Precis Industry.

Closely linked to all these trends, labor productivity in the textile industry is low relative to the average for other manufacturing industries because of low output prices and a heavier reliance on labor in the production process.

The Department of Commerce reports that the industry's profit as a percentage of sales declined from 3.2 percent in 1998 to just 1.3 percent in 1999 (see Chart 9).¹¹ Also, drought in the South has had an adverse effect on textile manufacturing firms, as these firms use a large amount of water in bleaching and dyeing fabric.¹²

¹¹ Office of Textiles and Apparel, U.S. Dept. of Commerce. September 6, 2000. Current Situation in the U.S. Textile, Apparel, and Manmade Fiber Industries.

¹² Kilman, Scott, and Amy Merrick. July 25, 2000. "Drought in the South Crimps Economy in Region." Wall Street Journal.

Chart 9

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Chart 10

Because of improving global demand and plant closings in the United States, many analysts believe textile prices have now reached a low point. Indeed, data for 2000 show a slight increase and some firming of prices in the first three quarters of the year (see Chart 10). Nevertheless, the profit picture seems to have weakened further in 2000 because of an increase in nonoperating expenses.

Publicly traded firms in the textile industry can be separated into six major categories: knitting mills, textile mill products, broadwoven fabric mills-cotton, broadwoven fabric mills-manmade fiber/silk, carpets/rugs, and miscellaneous fabricated textile products. The default risk characteristics of these sectors vary significantly as measured by the median EDF^TM.

Higher-Risk Sectors

The higher-risk sectors include knitting mills, Broadwoven Fabric Mills-Cotton, and Textile Mill Products (see Chart 11).

Chart 11

Knitting Mills are engaged in knitting, dyeing, and finishing hosiery, stockings, outerwear, underwear, and other products from yarn or knitted fabrics. Two public firms in this industry accounted for 66 percent of the sector's 1999 sales. Three out of eight firms in this sector reported net losses and six out of eight reported declining sales in 1999. The trends are similar in 2000 based on incomplete available data.

Broadwoven Fabric Mills-Cotton are engaged primarily in weaving fabrics more than 12 inches in width, wholly or chiefly by weight of cotton. One dominant firm accounted for nearly 38 percent of the sales of all publicly traded firms in this sector in 1999. The performance of firms in this sector was mixed in 1999. Six out of nine of these firms recorded negative net income in 1999. Two companies reported a sizable increase in 1999 net income. Incomplete 2000 results suggest that six firms are in the black, leaving just three with negative net income.

Textile Mill Products is a broad category that includes establishments engaged in performing any of the following operations: (1) preparation of fiber and subsequent manufacturing of yarn, thread, braids, twine, and cordage; (2) manufacturing broadwoven fabrics, narrow woven fabrics, knit fabrics, and carpets and rugs from yarn; (3) dyeing and finishing fiber, yarn, fabrics, and knit apparel; (4) coating, waterproofing, or otherwise treating fabrics; (5) the integrated manufacture of knit apparel and other finished articles from yarn; and (6) the manufacture of felt goods, lace goods, nonwoven fabrics, and miscellaneous textiles. Two firms dominate this sector. Together, they accounted for over 60 percent of the sector's sales in 1999 (considering publicly traded firms only). Net income for both firms was off sharply in 1999. Still, some companies registered net income gains in 1999, building on several years of growth in net earnings. Although the 2000 data are incomplete, most firms in this sector have reported weak earnings. Indeed, several firms have reported more quarters of negative than positive net income.

Moderate-Risk Sectors

The moderate default risk sectors include Miscellaneous Fabricated Textile Products and Broadwoven Fabric Mills-Manmade Fiber/Silk.

Miscellaneous Fabricated Textile Products includes businesses primarily involved in manufacturing curtains and draperies, house furnishings, textile bags, and canvas and related products; performing pleating, decorative and novelty stitching, and tucking for the trade; manufacturing automotive trimmings, apparel findings, and related products; Schiffli machine embroideries; and manufacturing fabricated textile products, not elsewhere classified. Net income for three out of the five publicly traded firms in this sector was negative in 1999. Two of those firms have experienced losses for at least two years' running. Most of these firms reported negative net income through the first two or three quarters of 2000. The three largest firms' total debt has grown considerably over the past few years. The increase is related primarily to financing acquisitions.

Broadwoven Fabric Mills-Manmade Fiber/Silk are engaged in weaving fabrics more than 12 inches in width using primarily silk and manmade fibers, including glass. Net income for each of the six publicly traded firms in this category was down in 1999-in most cases down sharply. Earnings for most of these firms appear to have continued to deteriorate in 2000. Interest coverage ratios for several firms were down in 1999 and 2000 because of lower income, higher liabilities in some cases, and higher interest rates.

Lower-Risk Sector

Manufacturers of carpets and rugs represent the only lower-risk sector in the textile industry.

Carpets/Rugs businesses are involved in manufacturing woven, tufted, and other carpets and rugs. This sector, as a group, experienced strong income growth in 1999. Only one out of six publicly traded firms failed to make a profit in 1999, and several firms reported sizable profit increases. Available 2000 data suggest that each of these firms will have generated positive earnings. Two firms dominate the carpet and rug sector, accounting for about 65 percent of 1999 sales for the group. Carpet and rug manufacturing is capital and research intensive, which gives the U.S.-based firms a comparative advantage over overseas companies, which do not have the same level of access to capital markets and an educated workforce.

Outlook

Some positive factors could temper the adversity being experienced by the U.S. textile industry. Low fiber costs and an improved trade situation with Asia should strengthen the textile industry in the future. Labor productivity has been rising slowly, as firms continue to invest in labor-saving computer technology and equipment. The industry is pursuing various strategies to remain competitive, including consolidations and mergers and setting up operations in Mexico.¹³ Nevertheless, the current slowdown in the U.S. economy and the increased risk of an actual recession has posed challenges for the textile industry.

¹³ Reichard, Robert. January 2000. "New Year Offers Problems and Opportunities," Textile World.

Another concern for U.S. producers is trade liberalization and its effect on textile imports. The normalization of trade relations with China and the elimination of import quotas by 2005 according to the World Trade Organization (WTO) Agreement on Textiles and Clothing could lead to even greater imports.

Implications for Banks

Banks lending to textile firms face an array of risks emanating from the economic environment in which these firms operate. These risks include the ebb and flow of demand associated with the business cycle of the U.S. and world economies; the exchange rate of the U.S. dollar, which affects the competitiveness of domestically produced textile products; and the prices of both inputs and textile products. U.S. trade policy will also have a profound impact on the competitive environment in which domestic textile firms operate. Banks need to monitor these developments carefully.

Concentration risk can be a significant issue for some banks. Textile mill employment is highly concentrated geographically. About 72 percent of all textile mill jobs are located in five southeastern states (North Carolina, Georgia, South Carolina, Alabama, and Virginia). Almost 29 percent of these jobs are in North Carolina alone. Another 18 percent are in Georgia. Even within these states, textile employment can be regionally concentrated, introducing concentration risk to banks with significant exposures to local textile firms. This risk is measured in terms of not only the volume of textile loans in the portfolio but also the spillover effects that plant layoffs can have in the community.¹⁴

¹⁴ See "Regional Economy," Atlanta Regional Outlook, second quarter 1998.

In an increasingly global market, credit risk in textiles will depend on decisions about production processes and intercompany linkages. For example, capital-intensive domestic producers may be in a better position to compete with offshore firms with greater access to cheap labor resources. Some textile firms may be able to enhance profitability and control risk by entering into partnerships with domestic and overseas organizations.