More healthcare organizations are at risk of credit downgrades and defaults as they continue to battle high costs in an inflationary economic environment.
Twenty-five North American entities across the hospital, pharmaceutical, medical device and healthcare services sectors have been downgraded this year to B3- or lower, according to Moody’s Investors Service. A report from Moody’s called it “a material deterioration in the sector’s credit quality.” Besides economic factors, legislation like the No Surprises Act and opioids-related litigation are also creating more risk.
A rating of B3- or lower is reserved for companies in a precarious financial situation, but it does not necessarily signal imminent default. Most of this year’s downgrades took place during the year's second half, said Jean-Yves Coupin, senior analyst at Moody’s.
A total of 34 healthcare organizations are rated B3- or lower by Moody's, and they have almost $65 billion of outstanding debt, according to the ratings agency. Twelve of the 34 are categorized as hospitals or other facilities-based providers.
The organizations that set debt agreements in a stronger economy are now encountering declining cash flow while interest expenses are going up.
“Your leverage is getting to a point where it’s much higher than anybody had ever planned because you’re not generating enough earnings and cash flow the way you thought you were going to,” said Peter Abdill, managing director at Moody’s. “You’re spending all of your cash just to cover your interest expense. You don’t have enough money to put back into the business sometimes, and you’ve got no cushion in order to absorb any more bad news.”
Most of the healthcare entities rated B3- or lower by Moody's are owned by private equity – the result of investors consolidating fragmented services within the industry and loading them with higher debt levels that pressure cash flow at a time when operating performance is already strained.
Private equity investors have shown an increasing interest in the healthcare industry, particularly in specialized services. Healthcare has been viewed as a more stable investment, as investors did not expect factors, such as the COVID-19 pandemic, rapidly rising interest rates and government-led changes to reimbursement plans.
“Nobody counted on this,” Abdill said. “They really didn’t think this was going to happen -- nor did we, by the way.”
Since January 2020, 13 healthcare companies have defaulted on debt, 10 of which were due to distressed exchanges, an option for struggling organizations to avoid bankruptcy, and three due to bankruptcy, the report found. Moody's considers distressed exchanges as defaults.
Nashville, Tennessee-based Envision Healthcare, which Moody's downgraded in September, has defaulted twice since January 2020 and is at a high risk for bankruptcy, challenged by pandemic-related and labor costs, weak liquidity and poor operating performance.
Franklin, Tennessee.-based for-profit Community Health Systems defaulted in December 2020, driven in part by high debt leverage, bloated cost structure and weak liquidity.
