Fitch Rates Univ. of California's Ser 2015 General Rev Bonds 'AA' & Limited Project Rev Bonds 'AA-'
--Up to \$770 million GRBs, 2015 series AO 'AA';
--Up to \$370 million GRBs, 2015 series AP (Taxable) 'AA';
--Up to \$1.22 billion LPRBs, 2015 series I 'AA-';
--Up to \$440 million LPRBs, 2015 series J (Taxable) 'AA-'.
The bonds are expected to sell via negotiation the week of March 9. GRB proceeds will be used to finance or refinance the acquisition, construction, improvement and renovation of all or a portion of certain university facilities. LPRB proceeds will be used to finance or refinance the acquisition, construction, improvement and renovation of certain athletic, parking, dining, and student and faculty housing facilities of UC. Of the up to \$2.8 billion in total par expected to be issued, about 80% is for refunding purposes.
Fitch has also affirmed UC's long- and short-term ratings as detailed at the end of this release.
The Rating Outlook is Stable.
GRBs are secured by a broad pledge of UC's unencumbered revenues, namely gross tuition and fees, indirect cost recovery revenues, auxiliary receipts, and a portion of state general fund appropriations. LPRBs are secured by a lien on the gross revenues of LPRB-financed projects, subordinate to debt service on GRBs.
KEY RATING DRIVERS
EXCEPTIONAL REPUTATION: The rating is supported by UC's strong reputation for academics, research and medical care that continues to promote consistently strong student demand and selective admissions, and growing patient volumes.
SOLID FINANCIAL CUSHION: Substantial balance sheet resources; diverse revenues; and a manageable debt burden despite increasing financial leverage, partially offset UC's trend of operating deficits, albeit narrowed in fiscal 2014; significant pension and retiree health benefit liabilities; and substantial capital needs.
OPERATING IMPROVEMENT: While still negative on a full accrual basis, UC's operating margin improved in fiscal 2014 as a result of continued, modest enrollment growth across the system; ongoing efforts to contain expense growth; and the state's improved fiscal position (California GOs rated 'A' with a Stable Outlook by Fitch).
IMPROVED FUNDING ENVIRONMENT: State funding increases in fiscal years 2013-2015, following several years of significant cuts, added some stability to UC's operating budget. Partly offsetting past funding declines is UC's limited reliance on the state for operating support (10% in fiscal 2014) and timely measures taken by its seasoned management team during times of state fiscal stress. Another increase is anticipated in fiscal 2016, but may be contingent on a continued tuition freeze.
SUFFICIENT LIQUID RESOURCES: UC has the ability to cover the maximum potential liquidity demands presented by its variable-rate debt programs by more than 2x from internal resources. Such resources include cash, and highly liquid, highly rated investments.
SUSTAINED MARGIN IMPROVEMENT: The rating is sensitive to UC's ability to sustain recent operating improvement, with annual progress towards returning to a breakeven level of performance.
BALANCE SHEET PRESERVATION: Failure to maintain balance sheet liquidity and leverage at or near current levels, which is particularly important given UC's prospective future capital plans, could pressure the rating.
Chartered in 1868, UC is a comprehensive research university with 10 campuses located in Berkeley, Davis, Irvine, Los Angeles, Merced, Riverside, San Diego, Santa Barbara, Santa Cruz, and a graduate campus in San Francisco for health sciences. It operates five academic medical centers, including 11 hospitals; four law schools; and a statewide agricultural and natural resources division. In addition, UC operates and manages one national laboratory under direct contract and is a member in joint ventures operating and managing two other national laboratories.
UC's exceptional reputation is the basis for its strong demand and selective admissions. Fiscal 2014 full-time equivalent enrollment totaled approximately 242,000 students and applications to the university continue to grow. Based on preliminary data, more than 193,000 applicants applied to UC campuses for fall 2015, up almost 6% from the prior fall term. Freshmen applications totaled just over 158,000, or 6.5% more than for fall 2014. While it varies by campus, UC's overall freshmen acceptance rate was 58% for fall 2014, which is selective for a public institution. UC's Berkeley and Los Angeles campuses are the most selective at 17% and 18%, respectively.
FINANCIAL CUSHION CONTINUES TO OFFSET OPERATING PERFORMANCE
UC's maintains a solid financial cushion, with a substantial level of balance sheet resources that Fitch believes continues to support the rating and partially offset the university's pressured operating margins. UC's three primary investment funds held assets totaling approximately \$24.5 billion as of Dec. 31, 2014 (unaudited). These include its short-term investment pool (STIP; \$8.8 billion), total return investment pool (TRIP; \$7.4 billion) and general endowment pool (\$8.3 billion).
Available funds (defined as cash and investments less nonexpendable and certain expendable restricted net assets) grew to a substantial \$19.74 billion as of June 30, 2014 from \$18 billion as of June 30, 2013. Available funds covered fiscal 2014 operating expenses (\$27.56 billion) and pro forma debt (about \$19.5 billion) by a solid 71.6% and 101.1%, respectively. Pro forma debt includes revenue bonds, commercial paper (CP), bank loans, capital leases, and total future payments on non-cancellable operating leases (about \$800 million). Pro forma debt also includes up to \$500 million of additional debt expected to be issued in the near-term, but that has not yet been approved by UC's Board of Regents.
UC also benefits from a diverse revenue base, a credit factor continuing to be viewed favorably by Fitch. Its largest funding sources include revenues derived from the operation of its five medical centers (30.3% of fiscal 2014 operating revenues), grants and contracts generated by its substantial sponsored research activities (20.3%), and student-generated revenues, including tuition, fees, and auxiliary receipts (18.5%).
State support for UC has been uneven over the past several years, with significant funding cuts in the years following the financial crisis (fiscal 2009 - 2012), followed by modest increases over the past three years (fiscal 2013 - 2015). Total state support is \$2.99 billion for this current year (fiscal 2015), up 5% from \$2.84 billion in fiscal 2014 and \$2.38 billion in fiscal 2013. Since fiscal 2014, state appropriations have included GO debt service support. As a percent of revenues, state appropriations declined to 9.9% in fiscal 2014 compared to 16% in fiscal 2008, while healthcare and student-generated revenues became larger contributors to UC's bottom line.
OPERATING IMPROVEMENT EVIDENCED IN FISCAL 2014
As expected by Fitch, UC's financial results demonstrated improvement in fiscal 2014, following several years of management efforts to contain expenses and grow revenues. This growth is mostly attributed to past tuition increases, growing medical center revenues and stabilizing state funding after several years of cuts. Implementation of several cost savings initiatives by UC's management team over the past several years has also contributed to the university's operating improvement. UC's fiscal 2014 operating margin (on a full accrual basis) was still negative, but the deficit narrowed to negative 3.7% from negative 8.9% in fiscal 2013.
Fitch views additional state funding positively, although it remains partially offset by UC not raising tuition for 2014-2015, the third year of flat student charges. UC management plans to raise tuition up to 5% annually over the next five years if the state does not increase funding over the 4% base adjustment as proposed in the governor's budget. However, the governor wants UC to maintain its tuition freeze in return for increases in base appropriations. The governor's fiscal 2016 budget proposal includes a 4% (\$119.5 million) increase for UC. Dialogue continues between UC and the state over the university's tuition setting plans. Fitch will continue to monitor the progress of these negotiations, which are expected to continue throughout the state's FY16 budget season.
UC raised tuition considerably over the past few years, before implementing the freeze in fall 2012. Tuition rose by more than 50% from fall 2007 to fall 2011. Despite the increases, UC's cost of attendance remains relatively affordable when compared to its public university peers and especially when compared to private institutions. Moreover, UC maintains generous aid programs, in addition to state sponsored programs.
GROWING, BUT MANAGEABLE DEBT OBLIGATIONS
UC's debt obligations have grown in recent years, including use of variable-rate, put bond, and bullet maturity structures (including a century bond). However, its debt burden remains manageable as a result of the university's large and growing revenue base. Total pro forma maximum annual debt service (MADS) occurs in fiscal 2016 at roughly \$1.1 billion, assuming amortization of UC's various variable-rate and put bonds and the century bond. MADS consumed a moderate 4.2% of fiscal 2014 operating revenues of \$26.58 billion. While Fitch believes UC maintains the management sophistication to manage the risks attendant to non-traditional debt structures, it underscores the need to sustain recent operating improvement and maintain balance sheet strength.
Fitch notes that GRBs, LPRBs and medical center pooled revenue bonds (MCPRB) are each secured by separate, designated revenue streams. General revenues securing GRBs totaled a substantial \$13 billion in fiscal 2014 compared to pro forma MADS of about \$715 million, assuming amortization of UC's put bonds and bullet maturities, including the series 2012 century bond. Pledged revenues securing LPRBs totaled \$730 million, compared to pro forma MADS of about \$164 million. Pledged revenues securing MCPRBs totaled \$8.6 billion compared to pro forma MADS of about \$209 million.
Based on its large size and operating scope, UC has significant future capital needs, portions of which will continue to be debt-financed. Due to its moderate debt burden and solid balance sheet cushion, Fitch believes the amount of new debt associated with the series 2015 transactions (approximately \$600 million) is manageable for UC at the current rating level, assuming recent operating improvements are sustained.
In addition to UC's approved capital plan, there are potential plans to expand the Merced campus. The proposed P3 project, which has not been approved by UC's Board of Regents, is expected to include academic, research, housing/dining, parking, and infrastructure related facilities. The goal is to address growing student demand for UC by enabling the campus, UC's newest and smallest, to increase enrollment from about 6,000 presently to 10,000 by 2020. Specific details regarding the structuring or financing of the project have not been decided, nor has the project been approved by the university's finance team that approves all capital plans. Fitch will monitor the progress of the transaction, and notes that depending on the structure, the project could have an impact on UC's credit profile should the university be obligated.
INTERNAL LIQUIDITY SUPPORTS SHORT-TERM DEBT OBLIGATIONS
Liquidity support for UC's variable-rate debt programs is primarily derived from the strength of its STIP fund. As of June 30, 2014, the market value of STIP holdings, primarily U.S. Treasury and agencies securities and highly rated corporate debt securities, totaled \$8.34 billion. Of this amount, approximately \$6.67 billion (after discounts based on asset type and maturity per Fitch's short-term rating criteria) provided solid 2.4x coverage of UC's \$781.3 million of variable-rate debt (excluding \$500 million of outstanding 2011 series Y taxable floating rate notes that have a mandatory tender in July 2017) and maximum CP authorization of \$2 billion (\$1.32 billion outstanding as of Dec. 31, 2014). The STIP balance rose to about \$8.8 billion as of Dec. 31, 2014 (unaudited).
To manage potential calls on its liquidity, UC limits the amount of CP maturing daily to \$200 million. In addition, the university maintains the ability to draw on a \$700 million general purpose bank line of credit. UC's liquidation procedures plan adequately addresses the steps to be followed in advance of maturing CP notes, mandatory tender dates, and for how a potential failed remarketing of variable-rate demand bonds would be addressed.
Fitch affirms the following ratings:
--\$4.84 billion tax-exempt GRBs at 'AA';
--\$3.88 billion taxable GRBs at 'AA';
--\$600 million GRBs 2013 series AL (variable-rate demand bonds) at 'AA/F1+';
--\$150 million GRBs 2011 series Z (taxable variable-rate demand bonds) at 'AA/F1+';
--\$48.7 million California Statewide Communities Authority, Recovery Zone Economic Development Bonds (UC Merced Student Housing Phase 4) 2010 series A at 'AA';
--\$1.97 billion LPRBs at 'AA-';
--\$2.75 billion MCPRBs at 'AA-';
--\$31.3 million MCPRBs 2013 series K (weekly rate) at 'AA-/F1+';
--\$2 billion taxable and tax-exempt CP program at 'F1+'.