CHICAGO - The tough times plaguing U.S. not-for-profit health care borrowers are likely to continue through 2010, Fitch Ratings warned in a report on the sector issued yesterday.

Chief among the sector's problems are debt structures that, stemming from various disruptions in the tax-exempt bond market last year, continue to pressure providers' already strained liquidity positions, analysts said.

Fitch's report comes a week after Standard & Poor's released a similarly gloomy report on the health care industry. All three rating agencies maintain a negative outlook on the sector, and Fitch analysts predicted that despite some credit strengths, fiscal woes would persist through the next 18 to 24 months.

Internal problems, such as suddenly costly variable-rate demand bonds, declining liquidity, and lack of access to new debt, are compounded by external problems such as state budget crunches, meaning tighter Medicaid reimbursements, and growing unemployment, meaning more uninsured patients.

"While bond ratings allow for a certain amount of performance variability, the combined effects of significant liquidity declines, increasing uncompensated care, and higher capital costs are adversely affecting many hospitals' credit profiles," the report said. "Economic stimulus initiatives and health care reform efforts could be beneficial over the longer term, but are not expected to provide significant immediate relief."

In a teleconference on the outlook yesterday, Fitch analyst Jeff Schaub predicted downgrades would outpace upgrades this year, while the majority of actions would be affirmations of current ratings. Schaub estimated that Fitch would upgrade 10 to 15 credits and downgrade 20 to 25. The firm reviews a total of 275 health care credits.

Despite the dark clouds, the sector has retained many of its fundamental credit strengths, and many providers will be able to rely on those strengths to get them through the next few years, Schaub said.

"In some ways, the current climate has made it easier to differentiate between strategically strong providers and those that may have been benefiting more from the rising tide of the sector," he said.

Fitch has started to take a closer look at a handful of credit characteristics in light of the troubled economy, including debt structures that starting last year began to present some unexpected problems.

"The current credit crunch has highlighted many of the risks of variable-rate debt structures," said Fitch analyst Anthony Houston.

"We are focusing particular attention on how and to what level debt structures expose borrowers to risk," he said. "We believe a diversified debt structure is as important as a diversified asset portfolio."

Debt structures with excessive put terms, accelerated term-outs, or interest rate risk can unduly pressure liquidity, Fitch said. The number of bonds put back to banks - which often feature accelerated principal payments - seemed to peak late last year, but analysts warned that another wave could be looming as one-year letters of credit expire if the enhancement is not extended and long-term financing is unavailable.

"In addition, further distress in the financial institutions sector could spur another period of failed remarketings and LOC draws," the report said. "The reduced liquidity positions of many hospitals and constrained access to long-term debt have raised the risk of bank bond term-outs and could result in negative rating pressure."

While Fitch generally praised the use of swaps as a useful tool to hedge interest-rate risks, it warned that the current market has left many providers with swap positions that have significant negative market valuations. Many borrowers have been forced to post collateral, and others are considering terminating swaps and paying the often-large fees associated with termination - in order to avoid posting collateral, Houston said.

Nonprofit hospitals have often favored variable-rate debt in the past but are now expected to turn increasingly to issuing fixed-rate debt to achieve interest rate stability and avoid put risks, Fitch predicted.

Fixed-rate debt likely means borrowers will pay higher interest rate costs, but that's not expected to present a problem for most providers, analysts said.

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