As one of the major drivers of GDP in the U.S. — and the largest local employer in many communities — the health care industry attracts substantial interest and scrutiny from the public, government bodies and other groups whose wellbeing are tied to its success.

So how did the sector weather the financial impacts of COVID-19 over the past two years? It’s been a mixed bag, based on the provider and the type of care they offer.

In a recent interview for the Debtwired podcast, Paul Rundell, Managing Director with Alvarez & Marsal was interviewed by Debtwire Deputy Editor, Reshmi Basu about the financial pressures on the industry and the anticipated restructuring trends in 2022.

You can listen to the podcast here.
 

Which Health Care Sectors Are Faring Poorly?

Long-term and acute hospitals have managed better over the past two years than post-acute care facilities, such as assisted living, skilled nursing and inpatient rehabilitation services. Acute hospitals are set up to deal with severe COVID cases, whereas post-acute facilities have seen revenue and profitability declines resulting from lower resident census levels as patients found other care options.

Restructuring activity in health care is expected to be quiet in 2022, but the sector already tends not to use the courts for relief. Instead, companies rely on out-of-court debt agreements with lenders that cater to the sector. Most activity occurs with mid-market, niche lenders.

To understand how infrequently health care companies turn to the courts for restructurings, simply look at the number of health care companies with liabilities above $500 million that have filed over the past five years. Only nine have used the courts, and three of them were pharmaceutical firms. The fact that merely six large health care providers filed over five years is generally a surprise to most people unfamiliar with restructuring in the industry.

The bulk of health care workouts with lenders are private. The reasons many end up restructuring out of court is largely a factor of companies’ debt structures. Most health care companies have private debt from a tighter number of lenders. Alternately, if the companies don’t carry a lot of debt, they have leases, and those are offered by a relatively few real estate companies. The fewer number of creditors and stakeholders means fewer people are needed to arrive at an agreement on how to restructure.

Will Restructurings Pick up in 2022 and What Are the Red Flags?

Restructurings increased modestly in the fall, but there were fewer than expected. The CARES Act funds that provided health care companies with government assistance during the pandemic had been mostly or completely depleted by then, so their ability to continue operating without fallout is now limited. For that reason, expect a slight pickup in restructurings in the new year, and particularly in the third quarter as interest rates rise, leading to more workouts, mostly out of court.

Just as with retailers, hospitality companies and airlines, health care companies enjoyed the extreme tolerance of generous lenders during the pandemic. But unlike in those other industries, health care lenders are very reticent to be aggressive even now.

Typically, banks and lenders generally avoid the industry because failing health care companies bring both negative headlines, and lenders also don’t want the risk of owning the company (including the medical malpractice and other liabilities) if there’s trouble finding new owners or better performing leadership team. Those are two big reasons they have not gotten aggressive.

The problem is lenders can offer interest only payment options or no debt service for so long before they must look at alternative options. At some point lenders will have to be paid back and their patience will run thin.

But how long will that last? Liquidity could be impacted in 2022, depending on how lenders deal with health care companies.

One red flag to watch in 2022 and moving forward is reimbursement rates. They are one of the largest drivers of revenue and can make a subset industry attractive or not. For example, skilled nursing and rehabilitation providers are getting hit pretty hard because the reimbursement rates have changed and aren’t high enough to sustain many of those non-acute companies.

As the reimbursement environment changes, different sub sectors rise or fall. When 70 percent of health care company costs go to cover employees who provide care, it makes it tough to drive profitability in a landscape of inadequate reimbursement rates.

How Do You Evaluate EBITDA Targets for Health Care Companies?

The pandemic makes it incredibly challenging to assess company performance. With changing reimbursement rates, you would usually go back in time, before COVID, but that’s a problem because reimbursement have fundamentally changed in some areas. So, looking backward is irrelevant.

Understanding what level of performance companies can attain in a post-COVID environment is one of the greatest challenges that advisors face. To begin to approach a fair assessment, advisors must evaluate the current run rate of the business, look at current EBITDA and then subtract COVID from the picture. What should the business look like if COVID was gone and you eliminate other factors such as growth?

That at least approaches a target EBITDA that stakeholders should expect.

Why Aren’t There National Health Care Operators?

Unlike many other industries that can benefit from economies of scale, health care is a highly localized business. The largest employers in most towns are health care providers.

Each market has unique demographics. The local pool of workers from which providers can tap can look quite different from one market to another. With most costs wrapped up in paying employees, the ability to attract and hire the right staff that fits the market becomes a very localized exercise.

Health care also has a connection to their clientele that’s very personal. When people get sick, they tend to go to a local hospital. Many patients want to be close to their relatives.

The ability to build out a national platform is very challenging, since each facility services its own local market.

The Health Care Business Is Unique, and Requires a Unique Approach

Health care is a very intimate industry, unlike so many others. The industry is also dependent on revenue from reimbursement rates, which change over time.

The connection to the public, plus the pressure on revenue and profitability from the pandemic will eventually force some of the mid-market lenders to become more aggressive, but for 2022 and beyond, a significant amount of the restructurings will likely be out of court, as they have been historically. Evaluating where in the business lifecycle a company is requires intimate knowledge of the industry, its revenue drivers and its lenders.