Global Credit Research New Issue 21 MAY New Issue: University of Houston System, TX

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1 Global Credit Research New Issue 21 MAY 2009 New Issue: University of Houston System, TX MOODY'S ASSIGNS Aa3 RATING TO UNIVERSITY OF HOUSTON SYSTEM'S $73.9 MILLION CONSOLIDATED REVENUE AND REFUNDING BONDS, SERIES 2009A; OUTLOOK REMAINS STABLE SYSTEM HAS APPROXIMATELY $710 MILLION OF RATED DEBT OUTSTANDING, INCLUDING COMMERCIAL PAPER PROGRAM AT FULL SIZE Board of Regents the Univ of Houston Sys., TX Higher Education TX Moody's Rating ISSUE RATING Consolidated Revenue and Refunding Bonds, Series 2009A Aa3 Sale Amount $73,910,000 Expected Sale Date 06/02/09 Rating Description Public University Revenue Moody's Outlook Stable Opinion NEW YORK, May 21, Moody's Investors Service has assigned an Aa3 rating to the University of Houston System's (UHS or the System) $73.9 million of Consolidated Revenue and Refunding Bonds, Series 2009A. We are also affirming the Aa3 underlying rating on $410 million of outstanding parity debt (see RATED DEBT below.) The rating outlook is stable. The Series 2004 bonds are rated Aa3/VMIG1, reflecting the System's credit quality and liquidity support provided by the System's own internal funds. In addition, we are affirming our P-1 rating on the System's Consolidated Revenue Commercial Paper (CP) Notes, Series A. The System will continue to support the commercial paper program with its own ample internal funds available on a same day basis in the event of a failed remarketing. With the full $125 million authorized amount of the CP program, the System's debt is 80% fixed rate and 20% variable rate with a put feature. USE OF PROCEEDS: Bond proceeds will be used to finance the construction of a 1,128 bed residence hall on the System's main campus. The remaining proceeds will be used to fully refund the Series 1999 bonds. LEGAL SECURITY: The bonds are secured by a broad pledge of student tuition, fees and other unrestricted revenues and fund balances. INTEREST RATE DERIVATIVES: None. STRENGTHS *Strong market position in the Houston area as the primary provider of four-year education in the region (City of Houston general obligation debt rated Aa3 with a positive outlook). Fall 2008 System-wide full-time equivalent (FTE) enrollment was 44,349 students and future growth is expected based on growth in the Houston area and in the State of Texas. Enrollment for fall 2009 is projected to grow by 2% over 2008, and to date, applications and acceptances have increased. *Consistently healthy operating performance with a three-year average operating margin of 4.0% providing solid 2.6 times average actual debt service coverage in Fiscal Year (FY) 2008, as calculated by Moody's. *Growth in financial resource base, with expendable resources of $600 million cushioning pro-forma direct debt, including the CP program at full size, by a satisfactory 0.9 times and covering operations by 0.7 times. The cushion of expendable resources to debt declines to 0.4 times assuming a 30% decrease in expendable resources to reflect investment losses and endowment spending.

2 *Reduced reliance on state funding (33% of operating revenues), but increased state support for operations and capital. *Healthy levels of liquid reserves provide for timely debt repayment of variable rate debt and commercial paper program supported by self-liquidity. CHALLENGES *Ongoing capital needs with high age of plant (17.3 years) and expected debt issuance of approximately $100 million over the next twelve months. While the projected debt will not be eligible for debt service reimbursement from the state, nearly half of the System's outstanding debt is eligible. *Ambitious plan to expand research enterprise on an ongoing basis may be delayed by slowing growth of federal research budget increases and competitive pressure for sponsored research activities, resulting in upfront investment that lowers the net contribution of research to the System's financial performance in the near term. *Modest gift revenue with 2008 gift revenue of $78 million and low alumni participation rate of 5%. MARKET/COMPETITIVE STRATEGY: STRONG MARKET POSITION AS PRIMARY PROVIDER OF EDUCATION IN SERVICE AREAS Located in Houston, Texas, the University of Houston System is comprised of four campuses: the University of Houston, University of Houston-Clear Lake, University of Houston-Victoria and the University of Houston- Downtown, as well as two teaching centers: Sugar Land and Cinco Ranch. The System is the primary provider of higher education in the Houston area and the state's only metropolitan higher education system. The University of Houston campus, the largest for the System, enrolls two-thirds of the total student body (FTE of 29,387) and functions as a comprehensive research institution. The University of Houston-Clear Lake and University of Houston-Victoria are upper-level undergraduate and graduate institutions, and the University of Houston-Downtown is primarily focused on undergraduate education and maintains a mission to provide access to higher education. Students from the Houston metropolitan area represent the majority of enrollment. Houston (general obligation debt rated Aa3 with a positive outlook) is the nation's fourth largest city with a population of over two million. While its economy has been diversifying steadily over the past several years, the City's energy sector remains a vital part of the area's economy and is a primary driver for current growth. For more information on the City of Houston, please refer to Moody's report dated February 23, The System has seen limited enrollment growth over the past few years. Total FTE of 44,349 in the fall of 2008 reflects a 7% increase from the fall of UHS plans to increase systemwide enrollment from a headcount of 59,219 in the fall of 2008 to 65,000 over an intermediate term. The plan calls for expanding the graduate student population from 23% of enrollment to 30% and increasing the representation of international students from 10% to at least 15%. Although enrollment has been fairly stagnant in recent years, Moody's expects the System will benefit from growth in the Texas high-school graduate population (18% increase anticipated over the next decade) and potentially from any economic downturn that reduces employment opportunities. Enrollment is projected to increase System-wide by 2% for fall 2009 and to date applications and selectivity have both improved. In addition, we believe the System could gain enrollment as a result of the "Top 10% Rule," under which graduates of Texas high schools who rank in the top 10% of their classes are guaranteed admission to all state-funded institutions, particularly as other institutions reach capacity limits. OPERATING PERFORMANCE: HEALTHY OPERATING PERFORMANCE PRODUCES SOUND DEBT SERVICE COVERAGE UHS has demonstrated consistently positive operating performance, generating a three-year average operating margin of 4.0%, as calculated by Moody's. Operating cash flow provided a solid 3.7 times coverage of debt service responsibilities in 2008, and peak annual debt service accounts for 6.4% of operating expenses. The System is projecting an operating surplus for FY 2009 similar in size to recent experience. Pledged revenues in 2008 cover maximum pro-forma debt service by a strong 15.6 times. The State of Texas funds approximately 40% of the debt service on the System's debt excluding CP through the Tuition Revenue Bond (TRB) program. Under the TRB program, the debt remains a legal obligation of the system, but the State reimburses debt service. This program for the State's public higher education institutions has been in effect since the early 1970s, with the State consistently funding the full amount of debt service even during difficult economic periods. Moody's expects that going forward, the State will continue to fund this debt service at the 100% level. Student charges comprise the largest share of operating revenues, as calculated by Moody's, at 40% (Includes both net tuition and fees and auxiliary revenues) in FY Net tuition and fee revenue increased by 70% after tuition deregulation in 2003 through 2008, and net tuition per student of $7,152 is higher than the $4,825 median for Texas public higher education institutions. For FY 2009, tuition and fees increased on

3 average 5.5% systemwide. State appropriations continue to support operations, though they represent a smaller share of revenue. With an increase of $56 million, or 25%, between 2003 and 2008, annual state appropriations provide good support for the System's operations. Under tuition deregulation, state appropriations have declined from nearly 37% of operating revenues in 2003 to 33% in 2008 as increases in tuition have outpaced growth in appropriations. The System is also benefiting from increased state funding for capital needs from the Higher Education Assistance Fund (HEAF). This program is approved in 10-year cycles and the annual amount for the System rose in 2008 to $53 million from $35 million annually in the prior cycle. Moody's maintains an Aa1 general obligation rating for the State of Texas with a stable outlook. The State's credit strength is derived from a strong economy, a history of balanced budgets and low but rising debt levels. Balanced against these strengths are credit challenges including uncertainty regarding the long-term costs of the property tax relief/school finance legislation and the tax changes it made, and the spending pressures associated with a growing population, which will increase demand for essential services such as education, criminal justice, transportation, water development and environmental protection. For more information on the State of Texas, please refer to Moody's report dated May 11, The System has ambitious plans to double its research enterprise. In 2008, UHS recorded $111 million in revenue from grants and contracts, of which approximately 52% came from federal sources, 20% from the State of Texas and the remainder primarily from private and non-profit institutions. This amount grew nearly 17% in FY 2008 after being static for the previous three years. A new System Chancellor who also serves as President of the University of Houston campus maintains a goal for the main campus to become a top-tier public research institution with a focus on energy, health, the Arts, and raising the rankings of nationally visible programs. The UHS strategy calls for bringing established researchers and program clusters to the University of Houston on an aggressive timetable and also to look to the Federal and State government and private sector to contribute research funding. While we believe the System's efforts may yield results over time, we anticipate that sustained research activity could ramp up at a slower pace due to the current slowed growth in federal funding, and we expect that required investment in the research enterprise may lower the net contribution of research to the System's financial performance in the near term. BALANCE SHEET POSITION: FINANCIAL RESOURCE GROWTH PRODUCES GOOD CUSHION FOR DEBT AND OPERATIONS, BUT IS TEMPERED BY ADDITIONAL BORROWING AND LIKELY CAPITAL NEEDS At fiscal year end (FYE) 2008, financial resources totaled $972.6 million (an increase of 45% over 2004), of which $278.9 million were unrestricted and $600 million were expendable. These amounts include the resources of the University of Houston Foundation (Foundation) for FY Expendable financial resources provide a good cushion for debt and operations, with expendable financial resources covering pro-forma debt by 0.8 times and covering operations by 0.7 times. Moody's includes as pro-forma debt the full $125 million authorization of commercial paper. The cushion of expendable resources to debt reduces to 0.4 times assuming a Moody's adjustment of a 30% decrease in expendable resources to reflect investment loses and endowment spending. Another $100 million in issuance is estimated within the next twelve months, which will reduce the coverage of outstanding debt by expendable financial resources to 0.7 times. This future debt issuance is not TRB eligible. Moody's notes that the impact of the System's debt is muted by TRB reimbursement from the State, which represents approximately 40% of bonds secured by the consolidated revenue pledge. Although specific details have not yet been determined, Moody's anticipates that the System will issue additional debt in a 5 to 10 year time frame to address deferred maintenance on its campuses and to carry out a capital facilities plan on the University of Houston campus. The UHS age of plant of 17.3 years is much higher than the 11.8 years median across all of Moody's Aa3-rated public colleges and universities and slightly less than the 17.9 year median for all Texas public universities. A "framework plan" for the University of Houston campus is now being implemented, which calls for doubling the number of students housed on campus, providing for projected enrollment growth. With this issue, the Series 2009A bonds will create 1,128 new beds on the System's main campus which will help meet increasing demand. Going forward, UHS may issue bonds to assist in the financing of an addition to the optometry building, new academic business building, new engineering center and academic research center. The System reports that it may utilize a variety of funding sources including gifts and HEAF funds. Moody's believes that current capital planning efforts may require borrowing beyond amounts currently outlined, which could pressure balance sheet measures if not accompanied by commensurate growth in financial resources. In FY 2008, UHS reported a negative 5.4% investment return, while the Foundation registered a negative 5.5% return. For the three months ended March 2009, UHS returned negative 5.05% (negative 29.72% for the one year ended March 2009) and its investments were allocated across equities (42%), fixed income (15%), inflation hedge (13%), alternatives (2%), marketable alternatives (19%) and cash (9%). The Foundation investments returned negative 7.06% for the three months ended March 2009 (negative 26.6% for the one year ended March 2009). Allocation of the investments includes equities (63%), fixed income (10%), cash (22%) and alternatives (5%). Moody's notes some concentration of asset management in the UHS endowment, with two international equities managers holding approximately 10% each. At March 31, 2009, the System and Foundation investments total $357 million and $67 million, respectively. In addition to investments, the System maintains working capital balance sheet cash of $275 million as of April 30, 2009.

4 As previously noted in Moody's reports, System-wide fundraising lags peer institutions, with an average of just $47 million raised annually in the past five years. Alumni participation is quite low at only 5%. Although no single formal campaign is underway, the new administration is focused on various smaller campaigns to raise funds for such initiatives as scholarships and capital projects. The administration's goal is to develop and sustain annual giving of $100 million or more. For FY 2008, UHS raised $78 million, the largest amount of fund raising in several years. The System will not report any other post-retirement benefit liability (OPEB) on its balance sheet. Instead, the liability will be consolidated with and reported by the State. SHORT-TERM RATING RATIONALE Moody's believes that the System's self-liquidity program provides adequate coverage for the tender features of the variable-rate demand bonds and commercial paper program. Variable rate demand bonds include the Series 2004 totaling $15 million outstanding in a flexible rate mode and the commercial paper program with a total authorized amount of $125 million. System manages the CP program so that no more than $40 million matures in any five consecutive business days. The System currently maintains over $234 million of investments with same-day liquidity, including funds with AIM Money Market Fund (rated Aaa by Moody's), working cash deposits with P-1 rated banks, and approximately $73 million in highly rated fixed income holdings, predominantly US Treasuries, with same-day availability. Moody's applies its Standard Approach to the self-liquidity analysis, as detailed in our November 2006 report, "Variable Rate Debt Instruments Supported By An Issuer's Own Liquidity." Under the Standard Approach, the System's same-day liquidity investments must cover its daily and weekly liabilities. As of March 31, 2009 coverage of variable rate debt by internal liquidity and full commercial paper issuance is good at 1.68 times assuming only investments qualifying as daily liquidity. The obligation to make payments on tendered bonds that are not remarketed and to pay commercial paper at maturity is a general obligation of the System. System management has appropriate expertise and procedures in place to ensure the timely liquidation of securities to meet the purchase price in the event of a failed remarketing of variable rate demand debt. Outlook The stable outlook reflects Moody's expectation that the System will grow enrollment and invest in greater research infrastructure and capital facilities without harm to its operating performance or financial resource position as well as maintain current levels of state operating and capital support. What could change the rating-up Significant growth in financial resources to provide a stronger cushion for debt and operations What could change the rating--down Marked increase in borrowing plans without proportionate resource growth; material decline in State funding sources KEY INDICATORS (FY 2008 financial data and fall 2008 enrollment data) * Numbers included in parentheses represent the projection of a 30% decline in resource levels to reflect investment losses and endowment spending Total Enrollment: 44,349 full-time equivalent students Total Pro-Forma Direct Debt: $710 million (including CP program at full size) Expendable Financial Resources to Pro-Forma Debt: 0.8 times (0.4 times) Expendable Financial Resources to Operations: 0.7 times (0.4 times) Average Operating Margin: 4% Average Debt Service Coverage: 2.6 times Percent of Revenues from State Appropriations: 33% State of Texas Rating: Aa1

5 RATED DEBT Consolidated Revenue Bonds, Series 1999, 2009: Aa3 Consolidated Revenue Bonds, Series 2000: Aa3; National Public Finance Guarantee Corp insured (National Public Finance Guarantee Corp's current financial strength rating is Baa1 on review for possible upgrade) Consolidated Revenue Bonds, Series 2002A, 2002B, 2003, 2008: Aa3; FSA insured (FSA's current financial strength rating is Aa3 on review for possible downgrade) Consolidated Revenue Variable Rate Demand Bonds, Series 2004; Aa3/VMIG1 Consolidated Revenue Bonds, Series 2005, 2006: Aa3; Ambac insured (Ambac's current financial strength rating is Ba3 with a developing outlook) Consolidated Revenue Commercial Paper Notes, Series A: P-1 CONTACTS University of Houston System: Raymond Bartlett, Treasurer, Financial Adviser: Drew Masterson, First Southwest Company, The principal methodology used in rating this issue was the Public College and University, which can be found at in the Credit Policy & Methodologies directory, in the Ratings Methodologies subdirectory. Other methodologies and factors that may have been considered in the process of rating this issue can also be found in the Credit Policy & Methodologies directory. The last rating action with respect to the University of Houston was on March 24, 2009 when the ratings were affirmed. Analysts Leah J. Ploussiou Analyst Public Finance Group Moody's Investors Service Laura C. Sander Backup Analyst Public Finance Group Moody's Investors Service Contacts Journalists: (212) Research Clients: (212) CREDIT RATINGS ARE MOODY'S INVESTORS SERVICE, INC.'S (MIS) CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MIS DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. CREDIT RATINGS DO NOT CONSTITUTE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS ARE NOT RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. CREDIT RATINGS DO NOT COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MIS ISSUES ITS CREDIT RATINGS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. Copyright 2009, Moody's Investors Service, Inc. and/or its licensors including Moody's Assurance Company, Inc. (together, "MOODY'S"). All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED,

6 REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY'S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY'S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such information is provided "as is" without warranty of any kind and MOODY'S, in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such information. Under no circumstances shall MOODY'S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY'S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY'S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings and financial reporting analysis observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY'S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling. MOODY'S hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MOODY'S have, prior to assignment of any rating, agreed to pay to MOODY'S for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,400,000. Moody's Corporation (MCO) and its wholly-owned credit rating agency subsidiary, Moody's Investors Service (MIS), also maintain policies and procedures to address the independence of MIS's ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually on Moody's website at under the heading "Shareholder Relations - Corporate Governance - Director and Shareholder Affiliation Policy."