Healthcare (Short Predictions. Nobody Effing Knows Part II)

Remember all of those early year surveys about where the distressed activity was going to be? Yeah, so do we. Everyone was bullish about healthcare distress. And, sure, there have been pockets here and there but nothing that’s been truly mind-blowing in that sector. In other words, wishful thinking. Unless you’re DLA Piper LLP, the (limited) healthcare activity has meant basically f*ck all for you.

Fitch Ratings recently released a report indicating that it expects healthcare-related defaults to remain low. Choice bit:

"We don't see any catalyst for there to be a great increase in defaults in the sector," said Megan Neuburger, Fitch's team head for healthcare and an author of the report. "It tends to be a fairly stable sector from a cyclical perspective, so the drivers of bankruptcies tend to be more idiosyncratic."

In other words, the chief drivers of healthcare bankruptcies aren't the same as in other sectors, which are more influenced by economic downturns or factors related to the commodity cycle, she said. Neuburger said her team doesn't see any catalyst on the horizon that would prompt an uptick in healthcare defaults this year or in 2019.

We’ll see if the early 2019 surveys reflect this view.

Oil & Gas (Short Underwriting & Defaults)

Sometimes distressed investing returns get upended by practical realities. The question is: were those realities accounted for in the underwriting?

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What to Make of the Credit Cycle (Part 2)

In Sunday’s “What to Make of the Credit Cycle (Part 1),” we noted various takes on the credit cycle by Moody’s, Fitch, Guggenheim Partners and Frank K. Martin. In his letter to shareholders, JPMorgan ($JPM) CEO Jamie Dimon chimes in and offers a similar conclusion to that of Guggenheim Partners’ Scott Minerd. That is: there’s a good chance that interest rates will go up faster than expected. And that will have ramifications. Here’s what he had to say,

“Since QE has never been done on this scale and we don’t completely know the myriad effects it has had on asset prices, confidence, capital expenditures and other factors, we cannot possibly know all of the effects of its reversal. We have to deal with the possibility that at one point, the Federal Reserve and other central banks may have to take more drastic action than they currently anticipate – reacting to the markets, not guiding the markets. A simple scenario under which this could happen is if inflation and wages grow more than people expect. I believe that many people underestimate the possibility of higher inflation and wages, which means they might be underestimating the chance that the Federal Reserve may have to raise rates faster than we all think.”

He continues,

“If growth in America is accelerating, which it seems to be, and any remaining slack in the labor markets is disappearing – and wages start going up, as do commodity prices – then it is not an unreasonable possibility that inflation could go higher than people might expect. As a result, the Federal Reserve will also need to raise rates faster and higher than people might expect. In this case, markets will get more volatile as all asset prices adjust to a new and maybe not-so-positive environment.”

There’s a whole industry of restructuring professionals…gulp…hoping that he’s correct. There are a number of funds raising cash right now hoping that he’s correct.


Still, it’s a question of how much how fast. Wells Fargo ($WFC) yesterday indicated that a 300 bps increase in LIBOR would not immediately pressure most issuer’s capital structures. Also:

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So. Yeah.

What to Make of the Credit Cycle (Part 1)

Moody's, Fitch & Guggenheim Partners Chime In

Earlier this week, Moody’s Default and Ratings Analytics team forecasted that the US’ trailing 12-month high-yield default rate will sink to 2% — from its February 2018 3.6% level — by February 2019. That is not a good sign for restructuring professionals itching for an uptick in activity.

FitchRatings chimed in as well, noting that underwriting standards underscore that the leveraged debt market is in the later stages of the credit cycle. But, it added,

“Aggressive documentation terms now prevalent could challenge recoveries in the next downturn. However, a surge in refinancing activity since 2016 should increase time between the credit cycle's bottom and peak in default rates. Looser documentation, such as the prevalence of covenant-lite (cov-lite) loans, should also lower the risk of technical default while enabling issuers to access additional funding via secured debt and unrestricted subsidiary provisions.” (emphasis ours)

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Interest Rate Increases + Tax Reform = ?!? (Short High Leverage Ratios)

Restructuring professionals have been waiting for interest rate increases for some time. Now that they're here, certain leveraged loan creditors are going to see an increase in interest expense. And just in time for a potential double whammy…

At the time of this writing, Congress has approved of the tax reform bill and President Trump is champing at the bit to sign it. Analyses are incomplete but one provision, in particular, is of note for restructuring professionals: the new limitations on deductibility of interest. Indeed, Fitch Ratings issued a press release confirming that the “impact of the deduction will be more severe on highly leveraged firms.” Choice quote: “Based on a sample of 575 leveraged loan and high-yield issuers, Fitch estimates that 37% of the issuers will lose a portion of their interest deductions under the EBITDA definition. In addition, 27% would be unable to deduct 20% or more of their interest and 10% would be unable to deduct 50% or more of their interest.” Get ready to see this in a First Day Declaration coming to a bankruptcy court near you.

Indeed, the prolific Baker McKenzie firm already has published its assessment. Choice quote, "These changes are significant to the struggling US corporation that has declining earnings.  Indeed, the path to bankruptcy for a highly-leveraged company could be accelerated as a result of an increase in its effective tax rate caused by these rules.  Moreover, the reduced allowance for deductions would mean fewer NOLs would be available for use should the company attempt a bankruptcy reorganization." There's also no grandfathering: you should read the piece. We're looking at you Tenet Healthcare (and others). Who knew tax could be so interesting?

That said, certain industries in need of relief could be potential winners. Retailers who generate profits domestically stand to benefit from the corporate tax rate reduction. On average, they pay 30.6% currently so a reduction to 21% could be meaningful. Likewise, restaurants with domestic profits would also stand to benefit (multi-nationals with a higher mix of U.S. debt to earnings could run into the deductibility issue above). These two spaces could use all the help they can get after a bumpy 2017.

Finally, tax lawyers and tax advisors are already getting busy poking holes through the thing