Vaccine Mandate for Nursing Home Staff Threatens to Exacerbate Pressure on Omega's Tenants

The Biden administration last week announced plans to require staff vaccinations within America's Medicare and Medicaid-participating nursing homes, which include the vast majority of Omega's tenants.

Most nursing facilities have been trying to incentivize their workers to get vaccinated from the beginning, but only 61% of the nation's staff was vaccinated as of August 15.

Already struggling with disruptive labor shortages, nursing homes may now face even more challenges. A vaccine mandate will make it harder to recruit talent, and some existing staff members may leave the profession for jobs with no such requirement.

Additional labor market tightness creates upward pressure on wages to attract and retain talent, increasing a facility operator's costs. But labor shortages pose the biggest risk.

A number of Omega's facilities already have self-imposed admission bans as they cannot staff at clinically appropriate levels. With these restrictions in place due to labor shortages, a facility cannot improve its biggest earnings driver: occupancy rates.

Across Omega's portfolio, occupancy has improved from a low of 72.3% in January to an average of 75.7% in July. But management has said the REIT's operators need occupancy to return to over 80% in order to meaningfully mitigate the cash flow reductions caused by the pandemic.

The Biden administration's vaccine mandate could slow the recovery in occupancy. Without additional federal and state aid, this could push more operators to the brink. Cracks are starting to show already.

In June, Omega had an operator, representing 3% of annual revenue, inform the company it would no longer be able to pay rent due to occupancy and labor issues. This marked the first major lease default in Omega's portfolio since the pandemic began.

Operators with weak rent coverage ratios (i.e. pre-rent cash flow, or EBITDAR, to rent expense) are also on the rise. Tenants with rent coverage ratios below 1.0x represented 8% of Omega's rent (excluding the operator that stopped paying in June) as of March 2021, the latest data available.

That's up from about 3% in September 2020 and double Omega's pre-pandemic level despite an abundance of government aid received by these facilities.

With a vaccine mandate likely to increase pressure on Omega's operators, we are downgrading the company's Dividend Safety Score from Borderline Safe to Unsafe.

This is a complicated situation because additional aid could arrive to help nursing homes, allowing more of them to keep honoring their leases while the recovery unfolds.

About $24 billion remains in unallocated funds in the government's Provider Relief Fund, which initially had around $175 billion available for providers of health care services. More of this money could find its way to nursing home operators in the months ahead, though Omega has warned the industry could still face a funding shortfall.

The Biden administration is still finalizing its vaccine mandate guidelines as well. Aware of existing labor shortages, legislators could seek ways to soften the requirements (e.g. mandate weekly testing for staff who refuse the vaccine) or provide more financial assistance to help mitigate compliance costs.

With more companies and healthcare organizations mandating the vaccine following its full approval by the FDA earlier this week, it's also possible that nursing staff hoping to find new jobs will have fewer options. This would help with employee retention.

Omega's dividend coverage provides some flexibility to absorb lease defaults, and management has shown a willingness to tolerate a payout ratio above 90% in the past. Given this buffer, we would be surprised if the dividend was reduced by more than 20% to 30% if a cut occurs.

That said, Omega's top 10 operators account for 60% of rent. The REIT's cash flow outlook could change quickly if more operators experience liquidity issues. And some of the issues weighing on tenants, such as higher labor costs, could represent the new normal.

Ultimately, we believe a more conservative outlook for Omega's dividend profile is prudent. We would consider upgrading the REIT's Dividend Safety Score if tenants see a stronger recovery in occupancy rates and can cover rent without requiring federal aid.

We will continue monitoring Omega's situation and provide updates as needed.