Credit stress continues to rise in healthcare as maturities approach and social risks increase

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Credit stress is rising in the U.S. healthcare sector, with a growing number of healthcare companies on its negative and lower B3 corporate rating list, Moody’s Investors Service said in a new report.

While favorable long-term trends have generally supported the sector’s credit quality, the cracks are becoming increasingly evident.

Healthcare companies on Moody’s list of lowest-rated companies have about $41.6 billion in outstanding debt, a 28% increase over the past year. Of this amount, $1.2 billion, $3.3 billion and $6.3 billion mature in 2020, 2021 and 2022, respectively. Several highly indebted healthcare companies joined the list last year, while CHS/Community Health, Mallinckrodt and Team Health account for approximately 55% of the debt held by healthcare companies on the list.

Poor execution, including weak integration of acquisitions, drove the most rating downgrades among healthcare companies, which fell from 18 in 2018 to 32 in 2019, and downgrades were concentrated among companies located at the bottom. lower end of Moody’s rating spectrum.

According to Moody’s definition, eight healthcare companies defaulted in 2019, up from just two a year earlier, while the number of healthcare names with a probability of default rating of Caa1-PD or less, posing a greater risk of default, rose to 22 in February from 16 companies a year earlier.

At the same time, social factors present a high risk for pharmaceutical companies and hospitals, and a moderate risk for medical device manufacturers. If passed, the proposals for surprise medical bills or drug pricing would have negative credit impacts, while many companies also face large potential payouts related to opioid litigation. But, as evidenced by the steady increase in downgrades and low-rated companies, the industry today has less flexibility to manage these risks.

WHAT IS THE IMPACT ?

Healthcare companies on the B3N list are spread across multiple industries. This suggests that their credit stress is largely the result of idiosyncratic company-specific issues rather than industry trends.

Public companies account for about 57% of outstanding health care debt on the list, largely reflecting the high debt burdens of CHS/Community Health ($13.6 billion) and Mallinckrodt . About 43% of the outstanding health care debt on the list is issued by private equity firms, which represent 20 (71%) of the 28 health care issuers on the list.

Sponsors tend to burden companies with high debt levels, which can put pressure on their cash flow and limit their ability to adapt to changing circumstances. That said, private equity sponsors will also step in to provide increased liquidity in certain circumstances. This happened in 2019 with Vyaire and BW NHHC Holdco, Inc. (doing business as Elara Caring). By contrast, state-owned companies like AAC and Mallinckrodt have no safety net when they run into trouble – both defaulted in 2019.

The downgrades have been concentrated at the lower end of the rating scale, where companies have less financial flexibility. There was no downgrading from a top quality company. Only one company in the Ba range, Mallinckrodt, was downgraded in 2019. The vast majority of downgrades were to companies rated B2 or below.

The downgrades took place against the backdrop of broadly stable to positive sector fundamental conditions. Moody’s outlook for global pharmaceutical industries and for-profit US hospitals is stable, while the outlook for US medical device companies is positive. This outlook reflects a weighting in favor of relatively well-rated large companies, which enjoy significant market positions.

With regard to social risks, it is difficult to predict what policy proposals, if any, might be adopted and what the specific conditions would include. But as evidenced by the steady rise in downgrades and low-rated credits, the industry has less flexibility to manage rising social risks, especially at the low end of the rating ladder.

Additionally, uncertainty around social risks, such as regulatory changes or litigation, can significantly weigh on corporate debt trading prices. This can lead to troubled exchanges if companies decide to buy back their debt at steep discounts. Uncertainty around social risks may also lead to higher interest rates, and companies that are already in a bad position would have limited ability to absorb higher financing costs.

THE GREAT TREND

The upcoming presidential election is expected to highlight proposals to address rising health care costs, which will further increase social risk, Moody’s said. It is important to note that the level of debt maturing in 2020 is relatively modest for companies in the sector on the B3N list. But refinancing needs will increase in 2021 and 2022, shortly after the election.

Reduce the cost of health care and increase its accessibility remain top priorities for 93% of employers over the next three years, according to Willis Towers Watson’s 24th Annual Healthcare Best Practices Employer Survey, released in October. Despite this, nearly two out of three employers consider health care affordability to be the most difficult challenge over the same period.

Twitter: @JELagasse

Email the author: jeff.lagasse@himssmedia.com

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