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A fifth of U.S. bond issues now rated as being in distress were issued by healthcare corporations, according to ICE Data Services.

Bonds in “distress” are seen as headed for default in the near future. 

The healthcare industry lags behind only the software sector in the proportion of distressed debt, the Financial Times reported.

S&P Global Ratings expects to downgrade credit ratings for more companies than it upgrades this year, “with speculative grade and health care providers leading the way downward,” S&P said in a late January statement.

Health care businesses are “most vulnerable,” S&P said, because they have “the lowest margins and [are] most exposed to high labor costs.”

In recent years, the industry loaded up on leveraged debt engineered by private equity firms gathering smaller companies together into larger conglomerates.

Leveraged loans frequently are issued by companies already heavy with debt and offer variable interest rates to entice investors.

As the U.S. Federal Reserve steadily raised its rates over the past eight months, those companies owed larger and larger regular payments to bondholders.

“Capital structures will become unsustainable” for many firms “rated B3 or lower,” which is junk bond territory, a January report from Moody’s Analytics predicted.

Companies with “high financial leverage, high levels of floating-rate debt, and weak operating performance” are especially vulnerable, Moody’s said.

“Finding lenders willing to refinance will become increasingly difficult in the year ahead as the market retrenches,” the report warned.

“Probably 80 percent of [health care] companies are fine,” Peter Abdill, a managing director at Moody’s, told The Wall Street Journal, but “there’s a growing number we’re worried about.”

About 95 percent of healthcare companies on its distressed-debt “watch list” are controlled by private equity firms.

Debt among companies on the watch list virtually doubled from $33 billion in January 2019 to almost $65 billion last month.

The debt spike was due largely to just two deals by takeover firm KKR, which used debt to buy Bausch Health Companies and Envision Healthcare, a staffing service.

“What we’re hearing about now in U.S. health care is labor pressure, pressure from employees demanding higher wages, at the same time that government reimbursement rates [for Medicare and Medicaid] are lagging,” Deutsche Bank credit strategist Steve Caprio told the FT.

“There are a number of zombie companies in [health care] that need to be addressed either through recapitalization or elimination,” portfolio manager John McClain at Brandywine Global Investment Management commented to the FT.

TREND FORECAST: Health care is not the only industry whose bonds are drifting toward default, as we reported in “Value of Corporate Bonds Rated as ‘Junk’ Doubles in 2022” (10 May 2022) and “Corporate Bonds Take a Beating as Interest Rates Rise” (15 Nov 2022).

In “Will Junk Bonds Turn to Junk?” (14 Sep 2021), we said junk bonds were in trouble as soon as the U.S. Federal Reserve laid out a timetable for ending its bond-buying spree and raising interest rates.

The rate of corporations defaulting on bonds will increase every time the Fed raises its benchmark interest rate.

Even if the Fed pauses its campaign of rate hikes, defaults will continue to rise: only speculators will want to bet on overborrowed companies floundering in a weak economy.

This is the case not only in the U.S., as we pointed out in “Global Junk Bond Markets Reeling” (1 Feb 2022). Junk bonds are in trouble around the world. Their rising rates of default, especially among developing nations, will speed the world’s fall into recession.

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