CHICAGO - Health care providers, already facing a host of challenges in 2008, will likely come under increasing pressure from the faltering auction-rate market and confront a new set of risks if restructuring that debt, said Standard & Poor's health care analysts in a recent report on the sector's outlook.
Double-digit increases in interest rate costs are prompting a slew of health care providers with outstanding auction-rate debt to consider restructuring the debt, said Standard & Poor's analyst Martin Arrick yesterday in a conference call.
"We've seen lots and lots of failed auctions, and all of a sudden most credits are trying hard to make reasoned decisions about what to do next," said Arrick.
But obtaining the necessary liquidity can be a problem for some providers, especially the smaller, lower-rated credits. Larger, higher-rated credits will likely have an easier time obtaining letters of credit or standby bond purchase agreements - and many even have the ability to provide their own liquidity.
"For the higher-rated issuers, there's more interest than I thought on self-liquidity," said Arrick. "Now [obtaining a standby agreement or letter of credit] is more expensive and the banks are choosier - everyone in the world wants to do standbys, and all of a sudden the market is different."
Analysts warned of other risks associated with variable-rate bond deals - including a failed remarketing, when the bank covers the puts and charges the obligor a higher interest rate, and the "renewal risk" associated with the relatively short duration of most liquidity facilities.
Arrick said one health care provider with auction-rate exposure recently decided to enter into a "custodial trust transaction," putting its auction-rate debt into a trust for 270 days, after which the provider is responsible for any calls if an auction fails at that point. "That's a buy-some-time strategy," said Arrick.
For providers restructuring to fixed- or variable-rate issues, Standard & Poor's is taking a closer look at the risks associated with "puts," the ability of the holders to put the securities back to the issuer, said Arrick.
"If there's a put or a call, and you have to take it out, is it good or bad for your credit? For the stronger players it could be a nonevent, but further down the credit spectrum it could be dicier," he said. "That's the challenge for us, evaluating the put risk into the long-term rating."
Meanwhile, for those providers that either cannot or will not restructure their auction-rate debt, the rising interest rate costs could, if sustained, take a bite out of the year's balance sheet, warned Arrick.
"If you don't do anything, and you were paying 3.5% to 4% on auction-rate paper, and now you're at the default rate and paying 10%, 12%, 18%, how long can you be doing that without generating margin compression?" said Arrick,
The problems stemming from the faltering auction-rate market - like other challenges across the health care sector - are more likely to hurt the smaller, lower-rated credits than the larger, higher-rated providers. This so-called credit gap is expected to grow throughout the year, said analysts.
And while all providers face greater challenges borrowing in the current market, the smaller, lower-rated credits face an uphill battle when it comes to borrowing and maintaining a sufficient balance sheet. This difficulty could aggravate the credit gap even more, leaving the smaller, lower-rated providers struggling with aging facilities, inadequate information technology systems and other disadvantages in what is an ever-more competitive market.
