At Kaufman Hall’s Healthcare Leadership Conference in October 2023, a panel of three buy-side investors offered their views on the not-for-profit healthcare market. Panelists included Chris H. Carey, CFA, Managing Director at New York Life Investors - Private Capital Investors; Robin Kenny, Vice President, Research Analyst at Franklin Templeton; and Jim LeBuhn, Director at Northwestern Mutual. The discussion was moderated by Matt Robbins and Jeffrey Sahrbeck, managing directors in Kaufman Hall’s Treasury & Capital Markets practice.
Current market conditions
While investors maintain their appetite for not-for-profit healthcare debt, low debt issuance has made it difficult to fulfill that appetite. At the same time, high volatility in performance quarter over quarter has made investors more selective.
For investors affiliated with an insurance company, investment appetite is especially stable. Chris Carey of New York Life Investors noted, “market dislocation is usually good for our market in the sense that when public markets shut down, we still have money to put to work.” For investors with a focus on long duration assets—including, but not limited to, those affiliated with insurance companies—healthcare is also an attractive market.
Industry volatility has sharpened the focus on high-quality opportunities. Factors that are considered include market share leadership and demonstrated ability to manage the challenges in the healthcare market today. The structure of existing debt obligations—including existing covenants—are also a significant factor in investor decision-making.
Investors that maintain high-yield funds can be more opportunistic in buying health systems that are stressed right now (e.g., at a triple-C rating level) but have a good chance for recovery. Robin Kenny noted that as you move down the rating spectrum, considerations like covenants, the ability to restructure debt, relationships with management teams, disclosure, and insights into strategic initiatives become increasingly paramount.
Disclosure is also important for investors who are seeking opportunities in the secondary market. Jim LeBuhn observed that with issuance of new debt at low levels, his portfolio manager is spending more time in the secondary market, and decisions there are driven by relative value assessment. Participation in the secondary market requires relatively quick reads of opportunities, and health systems that have up-to-date and robust disclosure are better positioned to attract investor attention.
The importance of disclosure—especially at a time when organizations are managing a very challenging environment—was a major theme of the discussion, with the panelists agreeing that the more detail provided, the better. As Robin Kenny noted, there is not a risk of disclosure overkill: “We are very good at skimming.” Jim LeBuhn highlighted the forward guidance provided by for-profit health systems—which are regulated by the Securities and Exchange Commission—as a model. He also noted that larger systems that are more regularly accessing the capital markets understand the importance of disclosure and have both the motivation and resources to keep disclosure up to date.
For organizations that are pursuing performance improvement plans to turn around operations, or that have run into covenant issues, disclosure is particularly important. Investors want to know what is working, what is not, and how much time will be required before operations recover. Organizations should be proactive in managing expectations and avoiding surprises. Chris Carey described investors’ relationship with the health systems they have invested in as a partnership; as partners, investors want to receive relevant information early on and understand how management is addressing challenges.
The significance of credit ratings
All the panelists pay attention to public ratings from the rating agencies, but all of them have their own internal rating processes as well. “We don’t rely on the agencies,” Robin Kenny noted, “but we read their reports and often get information that has not been relayed to us.” In the majority of cases, investors’ internal ratings align within a notch or two of the agencies’ ratings.
Key metrics that investors track include operating margin (including EBIDTA margin), balance sheet strength, cash to debt ratio, debt service coverage ratio, and debt to capital ratio. For lower rated organizations (below the A category), days cash on hand becomes more important.
One area where the panelists diverge from the rating agencies is on the importance of scale. Investors are more interested in market share and balance sheet strength than revenue size. Chris Carey said, “I think scale is the biggest difference between how we and the rating agencies look at organizations. "We don't view smaller scale as negatively as the ratings agencies do.”
The panelists agreed that it is important to have ratings from at least two agencies. Jim LeBuhn commented on the risk that an organization with a single rating can face if criteria change; a second rating can mitigate that risk. Robin Kenny also noted that, although they are willing to buy a deal without a rating on it, there can be a red flag if an organization has always been rated and decides to drop its lowest rating.
ESG and the political environment
Environmental, social, and governance (ESG) issues are not as significant a concern to investors in healthcare as they are in other industries. That is not to say that investors are not considering ESG risk—especially those related to environmental and natural disaster concerns—but those considerations have always been part of the credit analysis. Chris Carey added that while ESG is part of their investment decision-making, it really does not impact the healthcare sector, which by its nature aligns with ESG concerns: “We have bigger fish to fry in fossil fuels and utilities.”
Political and macroeconomic risks have far more influence. This can play out at the regional or state level: Where do investors want to be? In the Southeast? In the North? Do they want to stay out of union states? At the federal level, concerns center on payer risk (increased funding and expansion of Medicare and Medicaid programs) and potential changes to the 340B Drug Pricing Program. At the same time, investors take some comfort in healthcare’s role as an essential service that ultimately will be funded, whether at the national, state, or local level.
The panelists anticipate that issuance supply will pick up again. “Capital spending has been an area to cut back,” said Jim LeBuhn, “but you can only do that for a certain amount of time.” Chris Carey agreed: “We think with capital spending, generally speaking, there is going to be more spend and more opportunities coming in the next couple of years.” And Robin Kenny noted, “there is always an appetite for healthcare in our shop.”