OREANDA-NEWS. Fitch Ratings has assigned an 'AA-' rating to the Pennsylvania Higher Educational Facilities Authority's approximately $110 million series AR bonds to be issued on behalf of the Pennsylvania State System of Higher Education (PASSHE or the system).

The bonds are expected to sell competitively on or about August 27. Bond proceeds will be used to construct student housing facilities at Bloomsburg University of Pennsylvania; construct and renovate a student union at California University of Pennsylvania; construct and renovate dining facilities at Millersville University of Pennsylvania; purchase off-balance-sheet student housing at California University of Pennsylvania ($76.8 million); and upgrade a steam plant at Bloomsburg University of Pennsylvania.

In addition, Fitch has affirmed the rating on PASSHE's approximately $800.5 million outstanding revenue bonds at 'AA-'.

The Rating Outlook is Stable.

SECURITY
PASSHE's payment obligations pursuant to a loan agreement with the issuer are an unsecured general obligation of the system.

KEY RATING DRIVERS
'AA-' RATING CHARACTERISTICS: The 'AA-' rating reflects the statewide system's broad reach within Pennsylvania as well as its relatively-solid financial cushion. Offsetting factors include PASSHE's weakened GAAP-based operating margins likely to continue for fiscal 2015, continued pressures associated with an uncertain commonwealth funding environment, and uncertain expense pressures related to collective bargaining negotiations that are still in progress.

WEAKENED SYSTEM-WIDE ENROLLMENT: PASSHE's broad reach in Pennsylvania promotes overall credit strength and stability consistent with the rating category. Yet, system-wide full-time equivalent (FTE) enrollment has declined 11.4% since fall 2009 to 97,394 in fall 2014. Management projects modest enrollment declines again for fall 2015.

SOLID FINANCIAL CUSHION: Solid balance sheet resources continue to support the rating. Fitch-calculated ratios of available funds to fiscal 2014 operating expenses (63.9%) and pro forma debt (110.9%) compare favorably to rating category medians. Including off-balance-sheet student housing debt more than halves the latter ratio, which remains within range of the medians at about 52%.

PRESSURED DEBT SERVICE: Compressed operating margins have pressured debt service and maximum annual debt service (MADS) coverage to a low 1.1x and 0.9x, respectively, in fiscal 2014. However, the system's moderate MADS burden (5.4%) and limited new debt issuance plans provide some comfort.

RATING SENSITIVITIES

COMMONWEALTH APPROPRIATIONS IN QUESTION: The level of the Pennsylvania State System of Higher Education's fiscal 2016 state operating appropriation remains uncertain, as does the state budget timing. A significant reduction in commonwealth funding, or protracted time delay of appropriation receipts, could negatively pressure the rating.

ADDITIONAL DEBT: Issuance of significant new debt (beyond what management is contemplating during fiscal 2016), without a commensurate increase in resources, would negatively pressure the system's rating.

CREDIT PROFILE
PASSHE is the Commonwealth of Pennsylvania's (GO bonds rated 'AA-'/Outlook Stable by Fitch) largest higher education provider, and its universities offer the lowest cost four-year baccalaureate degree programs in the commonwealth. The system includes 14 universities, four branch campuses, several regional centers, and the McKeever Environmental Learning Center.

OPERATIONS UNLIKELY TO IMPROVE

Negative GAAP-based operating margins in each of the past two fiscal years, as well as various revenue- and expense-related pressures, drove Fitch's rating downgrade in April 2015. Operating margins on a full accrual basis were negative 1.7% and negative 3% in fiscal years 2013 and 2014, respectively, following an average of 1.6% the preceding three years. However, PASSHE's scale and affordability as a broad-based higher education system, the financial flexibility its strong balance sheet provides, and its typically positive operations on a cash basis should provide rating stability at the current level. Fitch will monitor these results and management's decisions going forward.

ENROLLMENT PRESSURES

Enrollment declines reflecting, in part, a declining number of high school graduates in the state have contributed to recent operating pressures. The Western Interstate Commission for Higher Education projects uneven trends over the next several years; commonwealth high school graduates reach a 1997-2028 low of 136,000 (2020) from a peak of 150,000 (2010).

Full-time equivalent enrollment has declined by an average of 2.4% annually since fiscal 2010 to 97,394 at fall 2014. Preliminary fall 2015 application and admissions data through suggest another decline. However, management notes that enrollment declines have reversed for some member institutions, but not yet on a system-wide basis.

COMMONWEALTH FUNDING UNCERTAINTY

An uncertain commonwealth funding environment remains a major challenge for the system heading into fiscal 2016. After proposing a $45 million (11%) funding increase for PASSHE, the governor vetoed the legislature's budget, which included only a $12.5 million (3%) increase for the system. The commonwealth budget stalemate has not yet resolved. Management reports no cash-flow issue with operations as well as the scheduled interest-only debt payments in December 2015. Further, Fitch takes comfort in PASSHE's favorable liquidity levels and management's track-record of implementing cost-savings measures.

APPROVED TUITION INCREASE FOR OFFSET

The system's focus on student affordability somewhat limits its ability to implement tuition increases. However, as noted by Fitch four months ago, an average of 5.2% annual tuition and mandatory fee increases since fiscal 2010 has helped offset flat commonwealth funding levels to some extent. Fiscal 2015 average tuition and mandatory fees increased to $9,418, which compares favorably to regional institutions. The PASSHE Board of Governors voted to increase tuition by 3.5% for fiscal 2016.

ONGOING COLLECTIVE BARGAINING NEGOTIATIONS

Contractual increases for compensation largely drive PASSHE's operating expenses. PASSHE has eight collective bargaining agreements representing about 87% of employees. Most contracts expire at fiscal 2015 year-end, and negotiations on the largest employee groups are still in progress. Fitch notes that PASSHE's fiscal year 2010-2014 average rate of unrestricted operating expense growth (2.1% annually) was double that of operating revenues (1.1%). PASSHE reports that agreements with four of the eight contracts (which expire June 2016) have been reached.

SOLID BALANCE SHEET RESOURCES

The system's available funds provide considerable support at the current rating level, in light of ongoing operating pressures. Addressing imbalances over the past several years with budgetary adjustments, including workforce reductions, has helped maintain available funds at an average of $1.27 billion annually since fiscal 2012.

Fiscal 2014 available funds ($1.29 billion) covered unrestricted operating expenses and pro forma debt by 63.9% and 110.9%, respectively. Both ratios compare favorably to Fitch's respective rating category medians of 49.7% and 86.2%.

MODERATE DEBT BURDEN

Debt service coverage has weakened due to the system's broader operating pressures to a low 1.3x and 1.1x in fiscal years 2013 and 2014, respectively. However, entirely fixed-rate debt provides for some budgetary stability, and a moderate debt burden provides some comfort. Pro forma MADS occurring in 2021 ($105.1 million) represents 5.4% of fiscal 2014 unrestricted operating revenues.

PASSHE expects to issue an additional $69.3 million during fiscal 2016, in addition to this series AR issuance, to complete funding of projects at Bloomsburg University and Indiana University of Pennsylvania.