Fitch Affirms Methodist University's Revs at 'BBB'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed the 'BBB' rating on North Carolina Capital Facilities Finance Agency's approximately $14.65 million of series 2012 revenue bonds issued on behalf of Methodist University (MU).
The Rating Outlook is Stable.
MU's obligations pursuant to a loan agreement with the issuer are a general, unconditional obligation payable from all legally available university funds. MU secures its obligations under the agreement with a mortgage interest in its core campus.
KEY RATING DRIVERS
SMALL PRIVATE UNIVERSITY: MU is a small, private liberal arts university serving a diverse student base from expanding academic programs in health sciences, education and engineering.
POSITIVE BUT THINNING OPERATIONS: MU's GAAP-based operating margin, though weakened in fiscal 2015, remained positive, supporting healthy debt service coverage levels. Margins have averaged nearly 3.7% annually since fiscal 2011, including 0.5% in fiscal year 2015. Fiscal 2016 operating results are expected to be similar to the prior year.
LIMITED FINANCIAL CUSHION: Liquid resources provide somewhat limited financial cushion to absorb operating margin compression or capital spending associated with academic program expansions. The ratios of available funds to fiscal 2015 operating expenses and pro forma long-term debt equaled 35.2% and 43.1%, respectively.
STABLE ENROLLMENT: A newly instituted, but aggressive, strategic plan positions the university to potentially continue enrollment growth through new program offerings. Full-time equivalent enrollment growth has averaged about 1.2% annually since fiscal 2011, with slower growth (0.5%) to 2,324 in fiscal 2016. Preliminary fiscal 2017 admissions remain favorable, though management is budgeting for less growth than in prior years.
HIGH DISCOUNTING: Aggressive tuition discounting topping an estimated 43% in fiscal 2016 could challenge revenue growth, as revenue sources are highly concentrated in student fees. Nevertheless, net tuition and fees have grown by about 20% from fiscal 2011 through fiscal 2015 through a combination of enrollment and moderate tuition increases, though remained essentially flat in fiscal 2015.
MARGIN EROSION: Given Methodist University's limited balance sheet flexibility, rating stability is contingent upon the continued generation of positive GAAP-based operating performance. Unmanaged fluctuations in student demand could negative impact financial performance and drive downward rating pressure.
DEBT MANAGEABILITY: The issuance of additional debt beyond stated plans without a commensurate growth in financial resources and revenues would yield negative rating pressure.
MU, located in Fayetteville, North Carolina, was founded as Methodist College in 1956, initiated operations in 1960 and graduated its first class in 1964. The university's regional accreditation with the Southern Association of Colleges and Schools Commission on Colleges was most recently reaffirmed in 2009 for a 10-year term.
The university serves a diverse set of traditional residential students, commuters, and military personnel from the nearby Fort Bragg, as well as evening and part-time students. Active duty and related students represented approximately 24% (or 600 students) of fall 2015 total headcount enrollment (2,474), which presents some exposure to shifts in associated federal benefits.
AGGRESSIVE GROWTH PLAN
MU continues to expand programs to position it to potentially build on enrollment trends and bolster its financial position. New graduate and doctoral level health sciences and education programs and a new undergraduate engineering program starting in fall 2016 serve as the catalyst for the forecasted growth in headcount enrollment to a goal of 3,000 by fall 2020 from 2,474 in fall 2015. This appears aggressive but consistent with historical growth rates, despite some year-to-year unevenness.
New academic programs will require faculty and facility investments that present a degree of financial risk if enrollment fails to materialize, given narrower operating margins in recent years and the somewhat limited cushion provided by available funds. The university anticipates strong student demand to offset the risk of these associated up front investments. Improving student retention to nearer 65% annually (revised down from 70%) through ongoing efforts from the current 60% retention rate is critical to the success of the plan.
ADEQUATE FINANCIAL POSITION
A mixed financial position includes healthy cash flows and modest financing plans countered by limited financial cushion, as noted. Operating margins (including the endowment draw) have averaged 3.7% annually since fiscal 2011, including 0.5% in fiscal year 2015. Tighter margins in recent years result, in part, from increased student aid used to bolster enrollment. Gross tuition and fees grew by 28% from fiscal 2011-2015, while student aid grew by 41% during the same period.
Management expects fiscal 2016 results to remain thin but positive, similar to fiscal 2015, largely due to flat headcount enrollment and increased institution aid requirements. A 5% increase in student charges provides some offset, though slightly lower than the historical approximately 6% rate increase. A slightly lower but similar increase in tuition (4.75%) is expected for fiscal 2017 due to potentially limited pricing flexibility and a competitive operating environment.
A third-year housing requirement effective fiscal 2016 should provide additional financial benefit and drive better retention of students. MU estimates that on-campus housing capacity is adequate to serve additional students currently housed in rental units and 100% occupancy is expected with the new requirement in fiscal 2017. No new housing projects are currently planned.
Positive operating performance is integral to rating stability, given expected faculty and facility investments and the university's more limited balance sheet flexibility. Available funds (defined as cash and investments less permanently restricted net assets) of about $18.2 million equal just 35.2% and 43.1% of fiscal 2015 operating expenses and pro forma long-term debt, respectively. The retention of annual operating surpluses is necessary to pursue capital plans and support growth in available funds.
INTEREST RATE EXPOSURE
The university faces some interest rate exposure on its unhedged variable rate debt, absent sizable liquid reserves. Outstanding long-term debt totals approximately $35.2 million at fiscal year-end 2015, including series 2012 fixed-rate bonds ($16.2 million) and series 2014 VRDBs ($17.3 million, not rated).
The series 2014 parity obligations were a direct placement to refund series 2005 VRDBs and provide $4.5 million of financing for the new health sciences building, which Fitch includes in pro-forma debt. As with the series 2005 bonds, MU maintains two floating- to fixed-rate swaps on 50% of the par amount. The swaps have no rating triggers or collateral posting requirements, which is viewed favorably as it limits financing risks.
As expected, the university successfully amended the bank continuing covenant agreement to add a 180-day cure period before the bank can accelerate payment in the event of a default, which allows MU adequate time to address related issues.
MANAGEABLE DEBT LOAD AND CAPITAL PLANS
Manageable capital plans principally address new program offerings. MU completed a new health sciences building in March 2016 which was primarily financed with fundraising and operating cash, with a small portion debt financed ($4.5 million).
The university's is at the tail end of a comprehensive fundraising campaign and has raised $37.9 million in commitments to date, exceeding its goal of $35 million. The campaign is expected to conclude in June 2016 with a portion of the proceeds supporting capital projects.
Pro forma debt includes the expectation that additional debt (an estimated $5.4 million) will be issued by fiscal 2019 with proceeds used to finance phase II of the construction of the Matthews World Ministry Center/Reeves Renovation project. Phase I of the project is expected to start in Jan. 2017 and cost about $8.9 million.
Timing of Phase I construction is contingent upon successful collection of capital campaign pledges and achievement of budgeted operating reserves. Additional debt associated with the project is expected to be bank financed over a 10-year maturity but this is based on preliminary information provided to Fitch. However, there are no plans for additional debt within the fiscal years ending 2016 or 2017.
A track record of good maximum annual debt service (MADS) coverage (1.5x in fiscal 2015) mitigates the university's moderately high pro forma MADS burden of 6.6%. Current debt service coverage for fiscal 2015 was stronger at 1.9x.