Fitch Rates University of North Carolina at Chapel Hill's Ser 2016C Revs 'AAA'; Outlook Stable
The bonds are expected to price via negotiation the week of Feb. 22. Bond proceeds will be used to refinance a portion of the outstanding series 2005A GRBs, refinance up to all of the outstanding series 2007 GRBs and pay costs of issuance.
In addition, Fitch affirms the various long- and short-term ratings on UNC-CH's GRBs as detailed at the end of this release.
The Rating Outlook is Stable.
GRBs are secured by legally defined available funds of UNC-CH, including unrestricted general fund balances and unrestricted quasi-endowment fund balances (\\$1.56 billion in fiscal 2015). Specifically excluded from legally available funds are state appropriations, tuition and fees, and restricted funds.
KEY RATING DRIVERS
STRONG CREDIT PROFILE: The 'AAA' rating primarily reflects UNC-CH's substantial financial cushion; balanced operating performance, supported by a diverse revenue base and robust fundraising; strong student demand and academic quality; and experienced senior leadership team.
MANAGEABLE DEBT BURDEN: Typical of similarly rated institutions, UNC-CH utilizes bullet maturities for certain debt issuances that result in a moderately high pro forma maximum annual debt service (MADS) burden. However, the university's debt burden is low after adjusting for bullets. Offsetting the pro forma MADS burden are UNC-CH's good debt service coverage from operations; conservative capital structure, with mostly fixed-rate debt; and manageable forward capital plans.
MODERATE CAPITAL NEEDS: Major initiatives to construct, expand or renew academic and research facilities and infrastructure have been funded and implemented by the university. Forward capital improvement plan (CIP) projects are manageable.
INTERNAL LIQUIDITY: The 'F1+' rating is based on UNC-CH's ability to cover the maximum potential liquidity demands presented by its variable-rate debt programs by at least 1.25x from internal resources, including cash; highly liquid, highly rated investments; and dedicated liquidity facilities.
FUNDING ENVIRONMENT: As implied by the 'AAA' rating, overall credit risks to the University of North Carolina at Chapel Hill's (UNC-CH) operating and financial profiles are minimal. However, similar to other public research universities, UNC-CH remains exposed to potential cuts to federal research funding, as well as state funding reductions, which together typically make up over 40% of the university's operating revenue.
Established in 1789, the University of North Carolina at Chapel Hill is the flagship institution of the 17-member University of North Carolina System. UNC-CH's demand indicators continue to reflect its market position as a highly selective, research oriented public university. Fall 2015 headcount enrollment totaled 29,084 students, of which approximately two thirds are undergraduates. Full-time equivalent (FTE) enrollment is estimated at 26,878. Both headcount and FTE enrollment are flat with fall 2014 levels.
Admissions statistics demonstrate continued strong demand. UNC-CH received 31,955 freshmen applications for fall 2015, up from 31,332 for fall 2014. The freshman acceptance rate was a selective 30%, with a solid 43% of accepted students choosing to enroll.
In June 2015, UNC was placed on 12-month probation by its accreditor, the Southern Association of Colleges and Schools Commission on Colleges (SACSCOC) stemming from past academic irregularities in a single academic department. Fitch does not consider UNC-CH's probation status with its accreditor to be a material negative credit factor at this time. The university continues to benefit from an excellent academic reputation and strong student demand in- and out-of-state. Probationary status does not affect federal funding eligibility, although NCAA athletics sanctions are still a possibility. Actual loss of accreditation would negatively affect UNC-CH's credit profile. However, Fitch considers that possibility remote given the university's considerable reforms to prevent recurrence of academic irregularities that ceased in 2011.
See Fitch's press release dated June 19, 2015, available at 'www.fitchratings.com' for additional information.
HEALTHY BALANCE SHEET CUSHION
UNC-CH's substantial resource base is fueled by balanced GAAP-based operations and substantial fundraising ability. Available funds (defined by Fitch as cash and investments less restricted non-expendable and certain expendable net assets) totaled \\$4.4 billion as of June 30, 2015, up from \\$3 billion at June 30, 2011. As a percentage of fiscal 2015 operating expenses (\\$3 billion) and pro forma debt (about \\$1.5 billion, including bonds, notes, capital leases and non-cancellable operating leases), available funds represented a strong 148% and 300%, respectively.
Similar to many well-endowed institutions, UNC-CH maintains considerable exposure to alternative, illiquid asset classes (typically around 60%). Concern over the university's exposure to alternative investments is partially mitigated by the fact that it does not rely on these holdings for potential liquidity needs and instead maintains a temporary investment pool and an investment in the state treasurer's short-term investment fund for this purpose. Fitch continues to view UNC-CH liquidity and investment management practices favorably.
REVENUE DIVERSITY SUPPORTS OPERATING PERFORMANCE
UNC-CH's primary revenue streams include grants and contracts (32.3% of fiscal 2015 operating revenue); student generated revenues (28.7%); state appropriations (16.1%) and net patient service revenues (10.8%).
The university's generally positive operating results have helped bolster its financial resources over time. For fiscal 2015, the operating margin flattened out to breakeven, down from an unusually strong 6.8% margin in fiscal 2014. The weaker operating results reflected ongoing expense pressures despite lower current-year investment returns and slightly lower state operating support. Fitch expects that UNC-CH will maintain balanced or positive operations over time which are consistent with the 'AAA' rating, given its considerable balance sheet resources, student demand and pricing flexibility.
MANAGEABLE DEBT LEVELS AND CAPITAL PLANS
UNC-CH's debt structure is conservative, with the majority (roughly 80%) of outstanding bonds issued with fixed interest rates. However, not unlike many similarly rated institutions, UNC periodically utilizes large bullet maturities. Including bullets, pro forma MADS totals approximately \\$203 million (fiscal 2042). Current debt service was about \\$90 million in fiscal 2015. Total debt outstanding of \\$1.5 billion includes revenue bonds, notes payable, commercial paper (CP) and non-cancellable operating leases. The university has three interest rate swaps for a total notional value of \\$266 million. The mark-to-market valuation of the swaps was estimated at negative \\$114.2 million as of Nov. 15, 2015, although no collateral posting is presently required. Fitch believes the various risks attendant to variable-rate debt, swaps and bullet maturities remain manageable for UNC-CH's sophisticated management team.
In conjunction with the series 2016C bonds, the university will issue two unrated series of bonds for direct bank purchase. Series 2016A (\\$100 million) variable-rate GRBs will refinance CP, which was used to cover a scheduled mandatory tender of the series 2012A GRBs in Dec. 2015. Series 2016B (\\$50 million) variable-rate GRBs will refinance a portion of the outstanding series 2005A GRBs, increasing UNC's proportion of variable-rate debt slightly to maintain the university's interest rate hedging position over the next few years.
UNC-CH's pro forma debt burden remains manageable. Pro forma MADS (including bullets) would consume a moderately high but still manageable 6.8% of fiscal 2015 operating revenues; however, the current debt burden is a low 3%. Importantly, Fitch notes that UNC-CH covered pro forma MADS, including the 2042 bullets, by 1x from fiscal 2015 net operating income. Coverage of current debt service obligations was sound at 2.2x. The university's CIP includes \\$117 million of debt needs for approved projects, and up to \\$600 million of potential borrowing for projects yet to be approved, over the next seven years to fund various academic, research, student life and athletic facilities. The university's debt capacity at the current rating level sufficiently supports these financings. Certain projects may also be part or fully funded by gifts, and the university will continue to amortize principal over that period.
LIQUID RESOURCES SUPPORT SHORT-TERM DEBT
As of Dec. 31, 2015 UNC-CH's had identified liquid investments, consisting primarily of cash, U.S. government and agencies securities, and investment grade U.S. corporate debt, totaling approximately \\$246.7 million (after discounts based on asset type and maturity per Fitch's short-term rating criteria). To supplement internal liquidity, the university maintains the ability to draw on dedicated lines of credit in the aggregate amount of \\$400 million. On a combined basis, these liquid assets cover the university's \\$44.4 million of variable-rate demand bonds and full \\$350 million of authorized CP (including \\$100 million for North Carolina State University) in excess of the 1.25x Fitch expects for an 'F1+' rating. To limit potential calls on its liquidity, UNC-CH restricts the amount of CP that may come due on any given day to \\$50 million.
Fitch affirms the ratings on the following series of bonds issued on behalf of UNC-CH:
--\\$1.1 billion fixed-rate GRBs at 'AAA';
--\\$44.4 million variable-rate demand GRBs at 'AAA/F1+';
--\\$100 million GRBs, series 2012B (index floating rate notes - five-year put structure) at 'AAA'.