Market for Loans to Health-Care Firms Ailing

When Long-Term Credit Bank of Japan sought to dump more of its U.S. loans in the secondary market last month, health-care paper was near the top of its list.

The bank put its $10 million stake in a loan to FPA Medical Management Inc. up for auction. By the time it was sold, Long-Term Credit had little more than $50,000 to show for its loan.

Market experts say the price may be the lowest ever paid for second-hand domestic bank debt. That is not exactly the legacy lenders at Lehman Brothers were hoping for when they arranged the $275 million credit facility in 1997.

But Long-Term Credit's experience with FPA Medical, a company struggling under federal bankruptcy protection, is just the latest-albeit extreme- example of the sick state of the health-care loan sector these days.

Health-care credit is not only tightening among lenders, but existing loans are trading at historic lows, mostly between 50 and 80 cents on the dollar.

Hardest hit are nursing home companies faced with a new Medicare payment system that is cutting revenues at some firms by 50%. The change came as a big blow to an industry that was already fully leveraged after a consolidation binge.

On Wednesday, Standard & Poor's cut the credit ratings for five such companies, which have been slow to react to the new system, S&P said.

"The new system is going to require some right-sizing for these companies," said Elie Radinsky, an analyst with S&P. "There are serious cash flow implications."

Companies receiving downgrades are among banks' best customers: Genesis Health Ventures Inc.; The Multicare Cos.; Integrated Health Services Inc.; Mariner Post-Acute Network Inc.; and Sun Healthcare Group Inc.

"Many of these companies are in the hands of the banks," Mr. Radinsky said. "How well they do depends on how well they work with the banks."

The health-care sector's plight has left many lenders feeling a little frustrated. Banks syndicated 90 loan packages worth more than $22 billion in 1998 to health-care companies. Now, a healthy percentage of those borrowers are back at the negotiating table because they have failed to meet the terms of their loan agreements.

"The companies need to help us a little and perform," said one banker who specializes in the industry. "I really think some companies are holding out hope the government will change the rules to get them out of this mess."

In the meantime, health-care loans continue to flood the secondary loan market. Traders said Vencor Inc.'s $1 billion loan was trading at 70 cents on the dollar. Sun Healthcare is being bid at 65% its face value. Integrated Health is among the strongest health-care credits trading at as much as 93% of face value.

Traders also say that the banks are doing the selling, and that hedge funds, high-yield bond funds and regular loan investors looking for bargains are doing the buying.

Those investors may be taking on more risk than they realize, according to Robert Rosenberg, a bankruptcy attorney with Latham & Watkins in New York. As many health-care companies file for bankruptcy protection, most are being broken up by the court.

He warns that unsecured loans will not fare well in a reorganization under Chapter 11 of the U.S. Bankruptcy Code.

"The piecemeal sale of assets in bankruptcy court has maximized the value for everyone," Mr. Rosenberg said. "But whether or not it gets down the food chain to unsecured creditors is another story."

Making matters worse, Mr. Rosenberg said, is the quality of companies filing for bankruptcy. Until the mid-1990s most Chapter 11 companies were simply "overleveraged," he said.

Now there is a lot of bad management across the board, Mr. Rosenberg said. Health care, an industry where consumer, government, and expense changes have been dramatic, has been a tougher industry for marginal players to survive, he said.

"My sense is we will see a huge increase in filings in the near future," Mr. Rosenberg said. "The overcapacity problems are huge among the various types of providers."

But not everyone has soured on the sector. Lucine Kerchhoff, a principal in BankAmerica's health-care lending department in Charlotte, N.C., said the firm is willing to back health-care companies with strong management and fundamentals.

"Some sectors of health care are doing poorly, putting a bad cloud over the sector," she said. "There's so much appetite from investors they'll take good health-care deals if there's a good story."

By far, BankAmerica has the most to gain or lose if the sector crashes or revives. Both NationsBank Corp. and BankAmerica had huge health-care franchises before their merger last year. Now the firm ranks first, with a 42% market share, according to Securities Data Co.

Ms. Kerchhoff points to one deal BankAmerica is managing that she says is meeting good reception-a $190 million loan for Team Health Inc. Another $1.6 billion loan BankAmerica is co-leading with Merrill Lynch & Co. for Quest Diagnostics is among the most popular in the market.

Still, she acknowledges that syndicating health-care credits requires a lot of persuasion.

"It can be a tough sell before you walk in the door," Ms. Kerchhoff said.

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