Provider debt levels up due to low rates, looser conditions

Healthcare providers looking to issue new debt are finding it's never been cheaper or less restrictive to do so.

But in an era of easy money, many systems are increasing their debt loads at a time when ratings agencies already have a negative outlook on the not-for-profit healthcare sector because of falling inpatient volumes and reimbursement rates. That could further pressure systems that are already operating with thin margins.

While most providers are still focusing on refinancing existing debt, historically low interest rates are driving movement toward high-yield bond offerings for some issuers. Leverage ratios are climbing back to the pre-Great Recession levels of 2005 to 2007, said Rob Harris, a Nashville-based partner at law firm Waller. “We're starting to see leverage ratios pushing toward five to six times senior (debt),” he said, referring to secured debt that would be the first to be paid out in a bankruptcy.

Moreover, lenders are providing issuers with greater flexibility through “covenant-lite” deals or looser conditions placed on borrowers. These deals are starting to creep into the senior debt market, which hasn't been seen since 2007, Harris said.

While covenant tests place more restrictions on borrowers, they also provide early warning signs to lenders when a company is at risk for default. “When a company has more leverage, it has less room for error to meet its financial covenants and service its debt,” Harris said.

One of the largest drivers of rising debt has been the mergers and acquisitions market, which saw a spike in year-over-year deal value in the first quarter of 2014, even as deal volume declined.

A report from Moody's Investors Service last month identified a number of healthcare companies with a “Baa” rating—mostly in the pharmaceutical, medical device and diagnostics sectors—that have increased their leverage to finance large deals. As a result, these companies are at greater risk of an operating setback and may be less able to make more acquisitions, according to the report.

Still, while not-for-profit providers are seeing an opportunity to issue new debt, the increase is still modest. Leverage ratios are at 39.2% this year, up from 38.1% in 2013 but still below the 42.2% seen in 2008, said Kevin Holloran, senior director at Standard & Poor's.

While taking on too much debt can lower a provider's credit ratings, bondholders are likely to look at a system's long-term strategy, Harris said. “If a company is not doing well, it will be more difficult to take on debt in the first place,” he said.

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