Fitch expects healthcare defaults will remain low

(Updated on July 11)

Stable cash flows and robust capital markets have kept the U.S. healthcare sector's 16-year default rate well below the overall market rate, according to a new report from Fitch Ratings.

The sector that includes healthcare and pharmaceuticals saw an average high-yield default rate of 1% between 2002 and 2017, materially lower than the 4.1% rate for the market overall during that period. Given the short list of bonds Fitch is concerned about, the ratings agency wrote that it expects the sector's below-average default environment to stick around another year, absent unexpected regulatory changes or other external factors.

"We don't see any catalyst for there to be a great increase in defaults in the sector," said Megan Neuburger, Fitch's team head for healthcare and an author of the report. "It tends to be a fairly stable sector from a cyclical perspective, so the drivers of bankruptcies tend to be more idiosyncratic."

In other words, the chief drivers of healthcare bankruptcies aren't the same as in other sectors, which are more influenced by economic downturns or factors related to the commodity cycle, she said. Neuburger said her team doesn't see any catalyst on the horizon that would prompt an uptick in healthcare defaults this year or in 2019.

Fitch's U.S. High Yield Default Index includes those that stem from bankruptcy filings, missed payments and out-of-court distressed debt exchanges, such as the one that hospital chain Community Health Systems recently performed.

The report noted that a number of defaults were caused by challenges from regulators that ultimately led to lower cash flows. For example, Able Laboratories had to suspend manufacturing and recall products after the Food and Drug Administration raised concerns about its manufacturing practices. Similarly, vitamin maker Leiner Health Products had to shut down production and recall products after an FDA inspection cited deficiencies at a South Carolina facility.

In some cases, reductions to government reimbursement levels were the culprit. Case-in-point: Curative Health Services became insolvent after the state of California and the federal government materially reduced reimbursement for its blood-clotting product.

Fraud was a factor in five of the 36 bankruptcies that took place between 2003 and 2017, according to the report. Millennium Health reached a $256 million settlement with the federal government in 2015 after the company allegedly billed for lab services that either weren't performed or weren't medically necessary.

Nursing home provider HCR ManorCare's March bankruptcy filing was the result of its inability to sustain high rental payments on leases signed before Medicare and Medicaid reimbursement rates were reduced in 2012, according to the report. After multiple master lease amendments to restructure the terms, HCR ultimately agreed to be acquired by its landlord, Quality Care Properties, in a prepackaged bankruptcy. QCP has since received two offers to be acquired.

Fellow skilled-nursing provider 4 West Holdings filed for bankruptcy in March because of money-losing vendor contracts, liabilities and lawsuits, declining reimbursement, revenue cycle challenges and high rent and capital spending obligations, Fitch wrote.

Franklin, Tenn.-based CHS recently exchanged a portion of its bonds due in 2019, 2020 and 2022, a maneuver that lowered the company's total debt by $92 million to $13.6 billion.

Fitch wrote that the move enhanced CHS' near-term liquidity by extending those maturities and giving the company more time to execute on its turnaround plan. However, the agency still categorized the move as a default under its own criteria. A CHS spokeswoman did not return a request for comment.

"The operating profile is considered to be among the weakest of the investor-owned acute-care hospital chains because of a focus on rural and small suburban markets that are facing secular headwinds to organic growth," the report said. "Key credit concerns that still need to be addressed are the high overall debt burden, persistently weak operating results and significant unsecured note maturities in 2021."