Defaults among corporate health care issuers have reached records in 2024 for the second consecutive year despite increasing health care utilization, moderating inflationary pressures, an easing labor environment, and declining interest expenses.

North American for-profit health care companies have recorded 14 defaults and selective defaults this year, after 15 in 2023. Despite other sectors seeing fewer defaults in 2024 than in 2023, health care is one of few that has maintained pace. This is in the larger context of continued ratings deterioration among low speculative-grade issuers despite improving revenue growth and EBITDA margins.

S&P Global Ratings views a slower pace of interest rate reductions, regulation restraints, high labor costs, and lower cash flow as the leading contributing causes for defaults among publicly rated North American for-profit health care entities since the start of 2022, when the credit markets began to stall. We also examine common factors that led to 'D' (default) or 'SD' (selective default) ratings and the rating distributions after the entities emerge from default, highlighting instances of repeat defaulters. Finally, we discuss why we believe that defaults in health care should moderate in 2025, though likely remain historically elevated.

Chart 1

Record Defaults...Again, And Health Care Services Takes The Brunt

Historically, the number of health care defaults has been in the single digits annually, less than other industries such as consumer products; media, entertainment and leisure; and restaurants and retail. Defaults have increased in the sector, both in absolute terms and in comparison to other industries. Health care's 14 defaults and selective defaults so far in 2024 and 15 in 2023 are up from six in 2022. The sector was among the top three for defaults in 2023 (media was the leader) and is leading all industries in 2024.

This default rate is despite the improved operating environment, with the return of health care demand, near normalization of acuity and utilization, and moderation of inflationary pressures on supplies and labor. Indeed, continued ratings deterioration in health care is mainly concentrated among highly leveraged, low speculative-grade issuers.

The slower path to interest rate cuts has been a drag on free cash flow generation while the industry grappled with other challenges. The No Surprises Act, Change Healthcare Holdings Inc. cyber attack, and insurers increasingly rejecting initial claims have increased working capital usage, impairing free cash flow, limiting liquidity and the ability to deleverage. Meanwhile, although health care labor costs, a major component of the cost base for service providers, have moderated from peaks, the cost of labor remains higher than in the past. As such, EBITDA margins for the health care services group remain slightly below margins before the COVID-19 pandemic.

Table 1

Health care services:   From 2022-2024, health care services accounted for more than 60% of health care defaults, with elevated labor costs the most cited cause, closely followed by inflationary pressures and the No Surprises Act, which seeks to protect patients from unexpected medical bills. In addition, most issuers were tackling high leverage and elevated interest expense, often constraining liquidity, and upcoming maturities.

Pharmaceuticals:   Five companies experienced a default or selective default over the past three years, largely due to litigation or competitive pressures. Mallinckrodt PLC and Endo International PLC endured material opioid settlement payments while Bausch Health Cos. Inc., Akorn, Inc., and Endo faced increasing competition in some of their larger products (see "Mortality In Health Care: What Factors Lead To Default For Pharmaceutical Companies", published Feb. 14, 2022).

Medical devices:   Three companies--LifeScan Global Corp., Carestream Health Inc., and Exactech Inc.--defaulted over our timeline. Two were navigating a difficult inflationary environment amid competitive pressures in core products. LifeScan's revenue declined in its core blood glucose monitoring business, while Carestream's digital print film business was in decline. Exactech in its recent default cited significant product litigation in addition to tight liquidity and approaching debt maturities.

Health care IT:   Only FinThrive Software Intermediate Holdings Inc. experienced a selective default in this subsector due to operational challenges, including longer sales cycles and lack of resources at hospitals that impaired customers' ability to quickly implement and use the company's software. FinThrive also had elevated interest costs as well as restructuring costs related to integration of acquisitions.

High Private Equity Ownership Burdens Balance Sheets

The health care industry has relatively high private equity participation--56% of rated companies compared to about 35% among all corporate entities. Furthermore, many of these highly leveraged companies are in the health care services subsector, which has lower margins than other subsectors and is more exposed to labor costs.

Significant interest from private equity investors, combined with very high valuations, increased the concentration of highly leveraged firms rated 'B' and below and increased S&P Global Ratings-adjusted leverage in comparison with the corporate average. As such, the sector entered a period of increasing interest rates, elevated labor costs, inflationary pressures, and regulatory changes--notably the No Surprises Act--with highly leveraged balance sheets and little cash flow production to begin with.

More recently, the U.S. Federal Trade Commission (FTC) voted to expand information collected under the Hart-Scott-Rodino Act, adding hurdles to mergers and acquisitions. The FTC has taken a particular interest in private equity activity in health care, which could make it more difficult for private equity firms to monetize the investments they've made in heath care and alter their investment horizon and exit strategies.

Types Of Default And Redefaults

When rerating issuers downgraded to 'SD', we raised about 70% of the ratings to the 'CCC' category, indicating that we continue to view their capital structures as unsustainable despite extended maturities, lower interest, or increased liquidity. Companies may remain at the 'CCC' category for several reasons. For some downgraded to 'SD' due to a below-par debt repurchase, such as Community Health Systems Inc., the heightened risk of another limits our rating and outlook over the near term. For others, such as Quincy Health LLC and HealthChannels Intermediate HoldCo LLC, significant near-term debt maturities limit rating upside. In 2024, an increasing number of defaulting issuers reemerged into the 'B-' category, indicating we expect them to have resolved their capital structure difficulties through the transaction.

Table 2

About one-quarter of rerated issuers endured a second default or selective default, and some entities in selective default during our time frame had already experienced one (or more) prior to 2022. This indicates that the liability management transaction did not resolve the capital structure problem. Of the 35 defaults in the list, eight were repeat defaults by six companies (table 3). Envision Healthcare Corp. and Mallinckrodt filed for bankruptcy after one or more events that S&P Global Ratings viewed as a selective default.

Table 3

Industry Remains Vulnerable Even As Defaults Moderate

Going into 2025, we expect fewer defaults, though more than the historical norm, with a decline in health care defaults lagging the overall decline across industries (see "Default, Transition, And Recovery: The Pace Of Global Corporate Defaults Slows", published Oct. 16, 2024). Despite the improving operational environment and expected further interest rate relief, challenges remain.

While nonprofessional labor costs have decreased, we expect elevated skilled labor costs to plateau rather than decrease to pre-pandemic levels, continuing to weigh on EBITDA margins for health care service entities. Nevertheless, most health systems have reduced their utilization of more expensive temporary nurse staffing, improving their cost structures and generating stable margins over the past several quarters. At the same time, the constraint on cash flow from the No Surprises Act and the Change Healthcare cyber breach is dissipating in the second half of 2024, though we are watching the increase in initial claim denials from insurers.

As long-delayed interest rate relief also helps cash flow generation (see "Economic Outlook Emerging Markets Q4 2024: Lower Interest Rates Help As Pockets Of Risk Rise", published Sept. 24, 2024), we project that health care services firms' EBITDA margins and cash flow will improve in 2025 and 2026. However, we expect rates will remain well above the rates at the time when the capital structures were first put in place, somewhat permanently impairing free cash flow, and leaving less cushion for other typical operational headwinds.

As of Nov. 18, 2024, we rate 22 companies 'CCC+' and below, a figure nearly equal to year-end 2023. However, the rating concentration in 2024 is tilted toward those we rate at the stronger 'CCC+' (chart 1). We also have materially fewer 'B-' ratings with negative outlooks. A 'CCC+' rating indicates that a company depends upon favorable business, financial, and economic conditions to meet its financial commitment. A 'CCC' rating indicates it is likely that the issuer will default without an unforeseen positive development and that we envision specific default scenarios over the next 12 months. A 'CCC-' rating indicates a default, distressed exchange, or redemption appears inevitable within six months, absent unanticipated significantly favorable changes in the issuer's circumstances. The rating concentration among the stronger 'CCC+' rating category indicates slightly positive rating momentum, as we expect more favorable economic conditions on the horizon.

Related Research

• Default, Transition, and Recovery: The Pace Of Global Corporate Defaults Slows, Oct. 16, 2024
• Economic Outlook Emerging Markets Q4 2024: Lower Interest Rates Help As Pockets Of Risk Rise, Sept. 24, 2024
• Despite Some Improvement, Weaker Health Care Services Companies Continue To Struggle, May 2, 2024
• Mortality In Health Care: What Factors Lead To Default For Pharmaceutical Companies, Feb. 14, 2022