Healthcare companies used to be some of the safest to lend to during economic downturns, until private equity firms bought them out and larded them with debt. Now they’re some of the riskiest borrowers in the world of leveraged loans.
Five companies in the healthcare space defaulted last year, compared with a historical average of roughly one default a year for an industry that often has stable demand, according to S&P Global Ratings. And 33 healthcare companies saw their credit grades cut by S&P in 2022, while bond graders were generally increasing ratings a year earlier as the economy emerged from the pandemic.
The outlook for healthcare companies, especially service providers, looks bleak. They face labor shortages as medical professionals retire en masse, and regulatory changes are weighing on how much they can charge government payers and insurers.
And as leveraged loan investors pare back their exposure to riskier healthcare borrowers, the companies face higher refinancing costs. The industry’s financial difficulties may hit not just investors, but also patients seeking treatment or care.
“We are seeing more troubled healthcare companies than at any point I can remember, particularly hospitals and pharmaceutical companies,” said John Fekete, managing director and head of capital markets at Crescent Capital Group.
The trouble comes in part because of steadily rising debt levels for the firms. The median healthcare company had debt levels equal to about seven times a measure of earnings in 2021, compared with closer to six times for the other industries in the high-yield universe outside the financial sector, according to S&P. In 2014, the median ratio for both healthcare and non-financial borrowers in the leveraged loan market was closer to five times.
“Healthcare has been traditionally seen as one of the safest and more recession-proof industries, and had good growth prospects, so private equity firms entered the sector and levered the companies up,” said Arthur Wong, healthcare analyst at S&P Global Ratings.
The heavy debt loads and the rapidly rising interest rates made healthcare one of the leaders in downgrades in 2022. Now, more than 70 percent of the companies are rated in the B tier or lower, at least four levels below investment grade, up from less than 30 percent in 2005, according to S&P.
When a rating agency downgrades a company or its debt, it can quickly push loan prices lower, as some of the biggest holders are inclined to sell. Those holders, money managers that buy loans and bundle them into bonds known as collateralized loan obligations, face constraints on how much debt they can own that’s rated below the B tier.
For a loan at the low end of that tier, in particular at the B- level, many CLOs will look to offload their exposure, fast, instead of risking holding it while it’s later cut to the CCC range.
CLOs are already close to the amount of CCC debt they prefer to own, making them reluctant to buy much more debt from companies at or near that level. A raft of healthcare credits joined this tier over the past year, including Bausch Health Cos., Blackstone-backed Team Health Holdings, and a subsidiary of KKR’s Envision Healthcare Corp.
“CLOs are not a natural buyer of CCCs and we’ll need to see an improvement in fundamental performance of the healthcare sector for this industry to fall into favor,” said Joseph Rotondo, senior portfolio manager at MidOcean Credit Partners.
As of December, healthcare issuers represented 20 percent of the CCC buckets in CLOs, according to S&P. More companies could fall into the CCC area as their profits and cash flow get squeezed by higher interest rates. Margins are expected to dip this year because of persistently high fixed costs.
“It’s not clear to me when labor costs are going to stabilize,” Roberta Goss, head of the bank loan and CLO platform at Pretium Partners LLC, said in an interview.
These companies also face difficulties in their businesses. Envision Healthcare said its cash collection may significantly shrink amid protracted lawsuits over emergency room visit bills with insurance giant United Healthcare, according to people with knowledge of the KKR-backed company’s third-quarter results.
“We believe that the increasing number of health insurers failing to contract with providers puts patients’ access to care at risk, while excessive claims denials undermine the stability of the U.S. healthcare system,” an Envision representative said in an emailed statement. The company will continue to pursue fair and sustainable reimbursement for its clinicians, the spokesperson said.
A KKR spokesperson declined to comment.
Cash flow pressures are mounting at U.S. Renal Care, too. The dialysis services company has been squeezed by the pandemic, which increased death rates among patients and intensified staffing shortages. It also faces continued pressures on reimbursement rates from insurers. Its term loan due 2026 is currently quoted at around 64 cents on the dollar, down from roughly 99 cents a year ago.
“We continue to recover from elevated costs per treatment as a direct result of Covid which caused staffing inefficiencies, high turnover and labor shortages,” a spokesperson at U.S. Renal told Bloomberg. “At the same time, we made record investments in recruiting, training, and retention, amid burnout that led many to retire early or to leave the industry altogether.”
Bain Capital Private Equity, which is part of an investor group backing U.S. Renal, declined to comment.
Regulators Clamp Down
The companies face legal and regulatory pressures too. The No Surprises Act, which makes it harder for medical providers to charge patients large amounts of money for work done outside their health insurance network, has weighed on some companies.
Loans to Radiology Partners, a group of radiology practices, have deteriorated since the end of 2021 in part due to the law, according to Moody’s Investors Service, which downgraded the company to Caa1 in November. The company’s $1.6 billion first-lien loan due 2025 is currently quoted at about 86.8 cents on the dollar, Bloomberg-compiled data show, down from nearly par a year ago.
“Notwithstanding the economic and policy headwinds that radiology practices face and must be addressed, we remain committed to adapting to the current environment by reducing debt and strengthening our balance sheet through organic Ebitda growth,” said a Radiology spokesperson in an emailed statement, adding the firm has positive cashflow, substantial liquidity and continued year-over-year Ebitda growth.
Unless inflationary pressures subside and the economy improves, there’ll likely be fewer loan sales coming to the market, money managers said. Companies with bloated debt and projected weaker cash flow will probably pursue transactions such as debt swaps and capital raises to create more breathing room.
“Rising rates and labor costs will no doubt pressure bonds and loans of highly leveraged healthcare providers,” said Mike Holland, a senior credit analyst at Bloomberg Intelligence. “While labor cost growth has tempered a bit from highs, increased cost for capital-intensive providers like hospitals will pressure earnings and liquidity profiles as the credit markets become less forgiving.”