Selling debt is getting more complicated for healthcare borrowers

The easy money of the last seven years is over. Healthcare borrowers face new calculations for when—and how much—to borrow.

The Federal Reserve raised the short-term interest rate last week for the first time in nearly a decade, and by doing so, set off some skittishness about how swiftly borrowing costs may rise. That could push some hospitals into the market to get ahead of future rate increases. But it could also mean tighter credit for heavily indebted hospital operators if anxious investors pull back from buying junk bonds.

Short-term interest rates, which the Federal Reserve held near zero for seven years to stimulate the economy, increased by 0.25 percentage points. The cost of borrowing remains low, but it is finally rising.

As she announced the rate hike, Federal Reserve Chairwoman Janet Yellen said future increases would follow in “a prudent and, as we have emphasized, gradual manner.” She also stressed that the initial boost to borrowing costs was minor and would be closely monitored. “I think it's important not to overblow the significance of this first move,” she said.

But for not-for-profit hospital borrowers that have delayed capital projects, the widespread expectation that rates will rise further could compel borrowers to come to market now to get ahead of the Fed's next action.

“We've all talked about it, and now it's going to happen,” said Steve Kennedy, a senior managing director at investment bank Lancaster Pollard, who works with not-for-profit healthcare organizations and senior-living borrowers.

However, hospitals hoping to avoid higher borrowing costs could end up pushing interest rates higher as they enter the market. That's because investors can demand higher interest rates when more borrowers compete for their cash.

“That really drives what the average hospital is going to pay, way more so than whether the Fed is going to raise interest rates,” said Pierre Bogacz, a managing director at HFA Partners, Tampa, Fla.

Not much will change immediately for investor-owned healthcare companies, which have already capitalized on the extended period of cheap borrowing to refinance debt and borrow for mergers and acquisitions, said Megan Neuburger, a managing director for Fitch Ratings. It's “probably business as usual tomorrow,” she said as the Fed announced the rate hike.

But there may be turmoil ahead for publicly traded healthcare companies, which generally have credit ratings that investors consider “speculative” or “junk.” That includes Community Health Systems, HCA, LifePoint and Tenet Healthcare Corp.

Investor anxiety has roiled junk bond markets in recent weeks as defaults have started to edge upwards from historic lows, said Christina Padgett, director of leveraged finance research at Moody's Investors Service. “It was kind of eye-opening,” she said. “It made the whole market jittery.”

Plunging oil prices have increased default rates from oil and gas companies this year. The default rate for U.S. junk bonds in November was 3%, based on the prior 12 months, Moody's data show. That's compared with 1.7% for the previous year.

Concern that the Federal Reserve's higher rates will further distress heavily leveraged companies has added to investor anxiety.

Still, the healthcare sector is growing, and its demand for debt depends less on ups and downs in the economy than in other industries. Both of those factors make healthcare companies more attractive to investors, Padgett said.

Most hospital companies have already moved ahead of the rate hike to extend favorable rates, said Frank Morgan, a healthcare analyst at RBC Capital Markets.

That means for-profit hospitals have less need to borrow during the current turmoil. HCA and Tenet have roughly 5% and 1%, respectively, of their bonds and notes that must go to market or be repaid by the end of next year, Fitch data show. Community Health Systems has no bonds that must be refinanced or paid off before 2017.

But Community Health Systems will enter the market with a planned spinoff of 38 hospitals into a new company called Quorum Health. How investors respond will depend on the timing of the spinoff, how much debt the company will seek and the outlook for the small and rural hospitals that make up Quorum's operations, Neuberger said.

And the market's overall appetite for junk bonds (which is likely how Quorum's debt will be rated) depends on whether recent investor anxiety reflects temporary jitters or more permanent aversion to risk, said Bonnie Baha, head of the global developed credit group for DoubleLine Capital, which manages roughly $80 billion in assets.

Investors have so far flooded back to junk bonds after recent bouts of uncertainty. “Every dip is seen as a buying opportunity,” she said.

That may change now that the Federal Reserve is moving to end its extraordinary efforts to prop up the economy's recovery. And companies are highly leveraged after assuming piles of debt during the extended stretch of easy money.

Given all of these factors, investors may finally lose some appetite for risk, Baha said. “Everybody is waiting for the other shoe to drop.”