OREANDA-NEWS. Fitch Ratings has assigned an 'AA-' rating to the approximately \\$200 million California Health Facilities Financing Authority refunding revenue bonds, Sutter Health, series 2015A .

In addition, Fitch has affirmed the 'AA-' on Sutter Health's (Sutter) outstanding debt, listed at the end of the press release.

The series 2015A bonds will be fixed rate and expected to price the week of Oct. 19th. The bond proceeds will refund the outstanding series 2005A bonds.

The Rating Outlook is Stable.

SECURITY

Gross revenue pledge of the obligated group.

KEY RATING DRIVERS

STRONG OPERATING PLATFORM: Sutter is a large system with a concentrated geographic presence in Northern California. Its physician alignment strategies, Epic implementation, and recent formation of a health plan should position the organization well as it focuses on transitioning from the fee for service model to total cost of care. Sutter is undergoing a consolidation of its operating units from five regions to two, which should be complete by 2017 and is expected to increase operational efficiency.

SIZABLE SYSTEM TRANSFORMATION INVESTMENTS: Sutter is investing in support function consolidation, care management initiatives, and a health plan, which is expected to enhance performance, lower its cost structure, and transform healthcare delivery across the system. Profitability was pressured in 2013; however, operating cash flow rebounded in 2014, which has been sustained through the six months ended June 30, 2015.

DELIBERATELY LOWER LIQUIDITY: Sutter has historically had a weaker liquidity position compared to Fitch's 'AA' category medians due to its long standing philosophy of deploying its free cash flow into capital investments and fully funding its pension plan, which otherwise would have increased days cash on hand. In addition, Sutter maintains a 100% fixed rate debt profile.

LARGE CAPITAL PLAN: Sutter has significantly invested in capital mainly driven by state seismic requirements and the majority of its large scale hospital replacements are complete or near complete. The only major projects remaining are for the San Francisco facilities. Future capital spending is projected to total \\$7.2 billion for fiscal 2015-2024 with a significant drop in fiscal 2019. This plan is slightly larger than at the time of Fitch's last review in May 2014 and reflects an increase in discretionary projects. Capital spending is funded through cash flow and Sutter generally issues additional debt for reimbursement financing.

MANAGEABLE DEBT BURDEN: Sutter has a manageable debt burden with maximum annual debt service (MADS) accounting for 2.2% of total revenue compared to the 'AA' category of 2.4%. Debt service coverage is solid. Sutter may issue additional debt for reimbursement as capital spending increases over the next few years to complete the rebuild of its San Francisco facilities.

RATING SENSITIVITIES
FINANCIAL FLEXIBILITY: Fitch believes Sutter has financial flexibility at its rating level due to its size and scale and views Sutter's strategic investments favorably, which should further differentiate the organization in the changing healthcare industry.

CREDIT PROFILE
Headquartered in Sacramento, California, Sutter is a large, integrated healthcare provider that was historically organized into five regions (since 2009) - Central Valley, East Bay, Peninsula Coastal, Sacramento Sierra, West Bay with each region having an aligned medical foundation and affiliated surgery centers. These five regions are being consolidated into two operating units - Sutter Health Bay Area and Sutter Health Valley Area, which should be completed by 2017 and is expected to streamline decision making, coordinate resources, and leverage economies of scale. Other services include home health and hospice, long-term care, and medical research and education. The obligated group accounted for 92% of total assets and 96% of total revenue of the consolidated entity in fiscal 2014 (Dec. 31 year end). Fitch's analysis is based on the consolidated entity. Sutter's total revenue in fiscal 2014 was \\$10.2 billion. Fitch notes that the current CEO has announced his retirement effective January 2016 and succession planning has been in place with the current COO moving into the role of CEO as of January 2016. In addition, there is a new CFO as of January 2015, who was also with the organization prior to the planned transition to the CFO role.

System Transformation Investments
The organization is preparing for anticipated changes to the delivery and financing of healthcare, where Sutter is expected to be accountable for patient clinical outcomes, service experience and overall cost of care. Fitch believes Sutter's operating platform with its geographic concentration, physician alignment and electronic medical record should position the organization well in the new environment. One example is Sutter's success under its Advanced Illness Management program, which has reduced hospital stays, emergency room visits, and time in the intensive care unit due to coordinated care management.

Sutter has made significant investments to fund several system initiatives targeting the organization's healthcare delivery models and business support functions. These one-time investments, totaling \\$575 million and lasting through 2017, will integrate the organization's IT platforms (Epic installation complete at all facilities), reengineer healthcare delivery processes, lower the cost structure, increase efficiency and enhance performance.

In addition, Sutter's health plan is in its infancy and there are gradual growth plans. The organization is also partnering with other insurers in various payment arrangements and providing a cost effective alternative to a high deductible PPO plan. Fitch views management's actions positively and believes these investments should allow the system to better coordinate and deliver care in the most cost effective setting, strengthen its competitive position, and prepare it to manage population health.

Rebound in Profitability
After a weak 2013 due to several large one-time items related to the system strategic investments, profitability rebounded in 2014 and has been sustained through the six months ended June 30, 2015. Operating and operating EBITDA margins were 4% (\\$410 million operating income) and 10.5%, respectively compared to negative 0.3% and 6.8%, respectively in 2013. Through the six months ended June 30, 2015, these margins were 3.7% and 10.1%, respectively. Management indicated that the one time items in 2014 had a negative \\$69 million impact on profitability.

Volume growth has been very strong especially at the medical foundations and outpatient setting compared to flat volume at the hospitals. In addition, bad debt expense was significantly reduced due to the benefits from Medicaid expansion.

Fitch notes that similar to many California hospitals, Sutter has been a net beneficiary under the California provider fee program, receiving a net benefit of \\$94 million in 2012, \\$122 million in 2013, and \\$109 million in 2014. Sutter is expecting \\$140 million in 2015.

Deliberately Lower Liquidity
At June 30, 2015, Sutter had \\$4.2 billion of unrestricted cash and investments, which translated to 155.2 days cash on hand and 111.6% cash to debt compared to Fitch's 'AA' medians of 289.4 and 201.7%, respectively. Sutter's liquidity metrics have historically been low when compared to Fitch's 'AA' category medians, due to its philosophy in deploying cash to a fully funded pension plan.

Large Capital Plan
Sutter has spent a considerable amount of capital with major hospital replacements complete or near complete in each region except for San Francisco. After a 10-year negotiation with the city, Sutter has started the construction of two new hospital buildings in San Francisco that includes a 274-bed (up to 304) hospital at Cathedral Hill and a 120-bed hospital on the St. Luke's campus with a total project cost of \\$2.1 billion. The San Francisco facilities are expected to open in the second quarter of 2019.

Future projected capital spending totals \\$7.2 billion for the next 10 years with the amount spent for the state mandated seismic requirements reducing to zero in 2021. For 2015-2017, capital spending is over \\$1 billion a year. In addition to seismic requirements, other spending includes discretionary projects, routine, and information technology. Management stated that capital spending will be scaled back if cash flow is not sufficient to fund the capital plan.

Capital Structure
Sutter had \\$3.8 billion of outstanding debt as of June 30, 2015, which is 100% fixed rate. Sutter issued \\$300 million series 2013A-C taxable bonds, which are structured with mandatory tender dates in August 2016, 2018, and 2020 of \\$100 million each. MADS was calculated according to the master trust indenture treatment for balloon maturities and pro forma MADS reduced to \\$227 million from \\$231 million due to the refinancing. Fitch believes Sutter has good market access and solid liquidity to handle the mandatory tenders.

The debt burden is moderate with MADS accounting for 2.2% of 2014 revenue. Fitch notes that Sutter's debt service coverage calculation includes unrealized gains/losses on investments. MADS coverage per Fitch's calculation (excluding unrealized gains/losses on investments) was 5.7x in 2014 compared to 3.4x in 2013 and 5x in 2011 and the 'AA' category median of 5.7x. Sutter's calculation resulted in debt service coverage (for the obligated group) of 4.6x in 2014.

Disclosure
Sutter covenants to provide annual disclosure within 180 days of fiscal year end. Sutter will provide quarterly disclosure within 75 days of quarter end for the first three quarters at the request of a bondholder. Annual and quarterly disclosure has been available on Municipal Rule Making Board's EMMA system.

Fitch has affirmed the following Sutter Health bonds at 'AA-':

--\\$95,840,000 California Statewide Communities Development Authority (CA) revenue bonds, series 2003A&B;
--\\$68,600,000 California Statewide Communities Development Authority (CA) revenue bonds, series 2004C&D;
--\\$224,460,000 California Statewide Communities Development Authority (CA) revenue bonds, series 2005A;
--\\$47,430,000 California Statewide Communities Development Authority (CA) revenue bonds, series 2005B&C;
--\\$756,410,000 California Health Facilities Financing Authority (CA) revenue bonds, series 2007A;
--\\$217,090,000 California Health Facilities Financing Authority (CA) revenue bonds, series 2008A;
--\\$252,675,000 California Statewide Communities Development Authority (CA) revenue bonds, series 2008B;
--\\$47,325,000 California Statewide Communities Development Authority (CA) revenue bonds, series 2008C;
--\\$275,000,000 California Statewide Communities Development Authority (CA) revenue bonds, series 2011A;
--\\$475,000,000 California Health Facilities Financing Authority (CA) revenue bonds, series 2011B;
--\\$36,535,000 California Statewide Communities Development Authority (CA) revenue bonds, series 2011C;
--\\$310,300,000 California Health Facilities Financing Authority (CA) revenue bonds, series 2011D;
--\\$118,510,000 California Statewide Communities Development Authority (CA) revenue bonds, series 2012A;
--\\$450,000,000 California Health Facilities Financing Authority (CA) revenue bonds, series 2013A;
--\\$100,000,000 Sutter Health taxable bonds, series 2013A;
--\\$100,000,000 Sutter Health taxable bonds, series 2013B;
--\\$100,000,000 Sutter Health taxable bonds, series 2013C.