S&P: Private Equity Hurts Healthcare Bond Ratings

With the increased likelihood of a recession this year, S&P says lower credit ratings for private equity-backed issuers may increase, making the sector vulnerable to downgrades and defaults.

Private equity firms' increasing ventures into the healthcare sector may be harming the credit ratings of their newly acquired, highly leveraged assets, according to a report published by S&P Global Ratings.

The report – Leveraged Finance: Private Equity-Backed Investor Interest In Health Care Has Taken A Toll On Ratings – notes that the growing incursions into healthcare by private equity is making the sector less predictable, with revenues and cash flows that are less visible than in prior years, increasing risk from a ratings perspective.

"The influx of private equity-backed healthcare companies, as well as continued high valuations has led to significantly higher debt levels," said S&P Global Ratings credit analyst Alice Kedem.

Because of this increased debt burden, Kedem said, credit ratings continue to fall into the 'B' category, with the proportion of "B-" rated companies in the healthcare sector doubling in past few years.

Higher risk of the private equity-backed issuers is also reflected through a high ratio of downgrades to upgrades, with private equity-backed issuers having limited to no upside, according to the report.

The report identified a combination of factors that prompted the negative rating actions in private equity-backed ratings originated from transactions from 2014 through 2019, including "lower demand or negative reimbursement changes for service-oriented issuers with higher-than-estimated operating costs, integration challenges, or disruption stemming from a transition of the enterprise resource planning."

Kedem said there are no signs that private equity interest in healthcare is abating, and that the highly leveraged arrangements will persist.

"As many transactions are in services-oriented subsectors that are highly fragmented and where size and scale can bring operational leverage, we expect that private equity-owned issuers will continue to pursue merger and acquisition strategies, maintaining leverage at high levels," she said.

With the increased likelihood of a recession this year, S&P forecasts that downward bias for private equity-backed issuers may increase, making the sector more vulnerable to downgrades and eventually to defaults.