Credit stress is rising in the U.S. healthcare sector, with a growing number of healthcare companies on its B3 Negative and Lower Corporate Ratings List, Moody's Investors Service said in a new report.
While favorable long-term trends have generally underpinned the sector's credit quality, cracks are becoming increasingly evident.
Healthcare companies on Moody's list of lower-rated companies have approximately $41.6 billion of outstanding debt, a 28% increase in the past year. Of this, $1.2 billion, $3.3 billion and $6.3 billion come due in 2020, 2021 and 2022, respectively. Several healthcare firms with significant debt burdens joined the list last year, while CHS/Community Health, Mallinckrodt and Team Health account for about 55% of the debt held by healthcare companies on the list.
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Poor execution, including weak integration of acquisitions, has driven most rating downgrades among healthcare companies, which increased to 32 in 2019 from 18 in 2018, and downgrades have been concentrated among firms at the lower end of Moody's rating spectrum.
Under Moody's definition, eight healthcare companies defaulted in 2019, against just two a year earlier, while the number of healthcare names with probability of default ratings of Caa1-PD or lower, posing a greater risk of default, rose to 22 in February from 16 companies a year earlier.
Meanwhile, social factors pose high risk for pharmaceutical companies and hospitals, and moderate risk for medical device-makers. If enacted, proposals around surprise medical bills or drug pricing would have negative credit impacts, while many companies also face significant potential payouts related to opioid litigation. But, as evidenced by the steady rise in downgrades and weakly rated companies, the industry today has less flexibility to handle these risks.
WHAT'S THE IMPACT?
The healthcare companies on the B3N List are spread among multiple sectors. 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 the outstanding healthcare debt on the list, largely reflecting high debt burdens at CHS/Community Health ($13.6 billion) and Mallinckrodt. About 43% of outstanding healthcare debt on the list is issued by private-equity owned companies, which make up 20 (71%) of the 28 healthcare issuers on the list.
Sponsors have a penchant for burdening companies with high levels of debt, which can pressure their cash flows and limit their ability to adapt to changing circumstances. That said, private-equity sponsors will also step in to provide a liquidity boost in certain circumstances. This happened in 2019 with Vyaire and BW NHHC Holdco, Inc. (doing business as Elara Caring). By contrast, public companies like AAC and Mallinckrodt have no backstop when they run into challenges – both defaulted in 2019.
Downgrades were concentrated at the lower end of the rating spectrum, where companies have less financial flexibility. There were no downgrades of any investment-grade company. Only one company in the Ba-range, Mallinckrodt, was downgraded in 2019. The vast majority of downgrades were concentrated in companies with ratings of B2 or lower.
The downgrades took place in the context of largely stable-to-positive fundamental industry conditions. Moody's outlooks for the global pharmaceutical and the U.S. for-profit hospital industries are stable, while the outlook for U.S. medical-device companies is positive. These outlooks reflect a weighting toward large, relatively highly rated companies, which benefit from significant market positions.
When it comes to social risks, it's difficult to predict which, if any, policy proposals may be enacted and what the specific terms would include. But as evidenced by the steady rise in downgrades and weakly rated credits, the industry has less flexibility to handle rising social risks, particularly at the low end of the rating scale.
Plus, uncertainty around social risks, like regulatory changes or litigation, can significantly weigh on companies' debt-trading prices. This can lead to distressed exchanges if companies decide to buy back their debt at steep discounts. Uncertainty around social risks may also result in higher interest rates, and already weakly-positioned companies would have limited capacity to absorb higher funding costs.
THE LARGER TREND
The upcoming presidential election is likely to prominently feature proposals to address rising healthcare costs, which will further increase social risk, said Moody's. Importantly, the level of maturing debt in 2020 is relatively modest for companies in the sector on the B3N List. But refinancing needs will increase in 2021 and 2022, soon after the election.
Curbing the cost of healthcare and increasing its affordability remain the top priorities for 93% of employers over the next three years, according to the 24th annual Best Practices in Health Care Employer Survey by Willis Towers Watson, published in October. Despite that, nearly two in three employers see healthcare affordability as the most difficult challenge to tackle over that same period.