Count Sacramento, Calif.-based Sutter Health among the issuers using a taxable bond sale to make up for the loss of advance refundings to the federal tax bill.
Sutter plans to price $684 million in taxable refunding bonds and $606 million in tax-exempt revenue bonds in a two-day sale starting Monday.
“The best [alternative] to advance refundings right now is through taxables,” said Svend Ryge, Sutter Health’s treasurer. “The economics are not too much different from tax-exempt.”
Sutter is refunding tax-exempt bonds issued in 2011 through the California Health Facilities Financing Authority, when the muni market was still relatively “locked up,” Ryge said. The longest maturities on the bonds were issued at 6.2% interest rates, he said.
In what Ryge called a rough estimate based on the spread to treasuries, they are expecting interest rates on the taxables to be 3.7% on the 10-year bullet and 4.2% on the 30-year bullet; and that the tax exempt bonds will price 40 to 50 basis points lower.
Morgan Stanley is lead manager and PFM is financial advisor on both bond sales. Dentons is bond counsel on the taxables and Orrick Herrington & Sutcliffe is bond counsel on the tax-exempt bonds. CHFFA is conduit issuer for the new tax-exempt debt and the taxables will be sold directly by Sutter Health.
Ryge said he doesn’t expect the downgrade to A-plus from AA-minus by Fitch Ratings ahead of the sale to affect pricing, particularly since Sutter Health retains double-A ratings from S&P Global Ratings and Moody’s Investors Service on its $3.8 billion in outstanding bonds. Moody's rates the debt Aa3 and S&P assigns its AA-minus rating. Outlooks are stable.
The downgrade is based on the application of Fitch’s recently upgraded criteria, said Kevin Holloran, a Fitch senior director. Sutter’s leverage profile exhibits characteristics consistent with the A-level category when an economic stress cycle scenario is applied, Holloran said.
“We were disappointed by it, but they did it by their own statement by a change in rating criteria,” Ryge said. “We believe all the metrics in 2017 are better than they have been the past several years.”
Sutter’s market position and profitability will adequately sustain the system’s continued capital and strategic investments with only a modest amount of debt in future years, Fitch said, supporting the A-plus rating and stable outlook. Sutter expects to issue $500 million more in debt over the next two years.
“Sutter has a great strength and presence, they are in good markets and are good operators,” Holloran said. “But when we look at the balance sheet and the leverage ratios, it just falls out of the level of tolerance for an AA rating, but it is still a strong A-plus.”
Sutter has 24 hospitals in northern California where it dominates along with Kaiser Health. It had total revenues over $12 billion in 2017.
The downgrade isn’t a reflection of the additional debt in the upcoming bond sale, which Holloran said is neutral, because it is largely a reimbursement for prior expenditures.
Fitch placed 34 healthcare providers on ratings watch when it released the new criteria in January; half are expected to be upgraded and half downgraded. Fitch has a negative outlook for the healthcare sector, because of challenges in the industry including a limited ability to generate additional revenues and expenses to keep growing.
Sutter has spent a considerable amount of capital to accomplish state mandated seismic requirements with all major hospital replacements complete in each region except for San Francisco, according to Fitch. Since 1996, the hospital has completed nine hospital replacement projects.
The tax-exempt bonds will partially fund California Pacific Medical Center’s new hospitals in San Francisco. Sutter expects a premium on the $606 million of tax-exempts, Ryge said. They are the third round of financing for the projects and will reimburse some of the costs incurred for them, he said.
The 274-bed CPMC Van Ness replaces the current Pacific and California campuses at a total cost of $2 billion and is expected to open in March 2019. The 120-bed CPMC Mission Bernal, formerly St. Luke’s, constructed for $538 million, is scheduled to open in August.