$29,890,000. Higher Education Revenue Bonds, Series 2006 (Ana G. Méndez University System Project)

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1 In the opinion of Squire, Sanders & Dempsey L.L.P., Bond Counsel, under existing law, (i) assuming continuing compliance with certain covenants and the accuracy of certain representations, interest on the Series 2006 Bonds is excluded from gross income for federal income tax purposes and is not an item of tax preference for purposes of the federal alternative minimum tax imposed on individuals and corporations, and (ii) the Series 2006 Bonds and the interest thereon are exempt from state, Commonwealth of Puerto Rico, and local income tax. Interest on the Series 2006 Bonds may be subject to certain federal taxes imposed only on certain corporations, including the corporate alternative minimum tax on a portion of that interest. For a more complete discussion of tax aspects, see TAX MATTERS herein. New Issue - Book Entry Only $29,890,000 Puerto Rico Industrial, Tourist, Educational, Medical and Environmental Control Facilities Financing Authority (AFICA) Higher Education Revenue Bonds, Series 2006 (Ana G. Méndez University System Project) The Series 2006 Bonds are limited obligations of Puerto Rico Industrial, Tourist, Educational, Medical and Environmental Control Facilities Financing Authority (the Authority ) and, except to the extent payable from bond proceeds and certain other moneys pledged therefor, will be payable solely from and secured by an assignment of revenues to be derived by the Authority under a loan agreement with SISTEMA UNIVERSITARIO ANA G. MENDEZ, INCORPORADO The Series 2006 Bonds will be issued as registered bonds, without coupons, in denominations of $5,000 and integral multiples thereof, initially registered in the name of Cede & Co., as nominee of The Depository Trust Company ( DTC ). Purchasers of the Series 2006 Bonds will not receive certificates representing the Series 2006 Bonds. DTC will act as securities depository for the Series 2006 Bonds. The principal of and interest on the Series 2006 Bonds are payable to DTC by U.S. Bank Trust National Association (as successor in interest to State Street Bank and Trust, N.A.), New York, New York, as Trustee. Upon receipt of payments of principal and interest, DTC will remit such payments to the DTC participants for subsequent disbursement to the beneficial owners of the Series 2006 Bonds. Interest on the Series 2006 Bonds will accrue from their date of issuance and will be payable semi-annually on each March 1 and September 1, commencing September 1, The Series 2006 Bonds will be subject to mandatory and optional redemption as described herein. The inside cover page of this Official Statement contains information with respect to the maturity schedule, interest rates and prices of the Series 2006 Bonds. The Series 2006 Bonds are being issued to provide financing for the acquisition, construction, improvement and equipping of certain educational facilities owned or to be owned by Sistema Universitario Ana G. Méndez (the University System ), including the repayment of interim loans incurred for such purpose and the reimbursement to the University System of interest paid on such interim loans, and to pay certain costs of issuance. The Series 2006 Bonds do not constitute an indebtedness of the Commonwealth of Puerto Rico or any of its political subdivisions. Neither the Commonwealth of Puerto Rico nor any of its political subdivisions is liable for payment of the Series 2006 Bonds. The Authority has no taxing power. Investing in the Series 2006 Bonds involves risks. See Bondholders Risks beginning on page 7. The Series 2006 Bonds are offered, subject to prior sale, when, as and if issued by the Authority and received by Lehman Brothers, subject to the approval of legality by Squire, Sanders & Dempsey L.L.P., Bond Counsel, and certain other conditions. Certain legal matters will be passed upon for Lehman Brothers by O Neill & Borges, San Juan, Puerto Rico. Certain legal matters will be passed upon for the University System by Fiddler González & Rodríguez, LLP, San Juan, Puerto Rico, and by José de la Cruz Skerrett, Esq., San Juan, Puerto Rico. It is expected that settlement on the Series 2006 Bonds will occur through the facilities of The Depository Trust Company on or about April 11, 2006, in New York, New York. March 30, 2006

2 $29,890,000 Puerto Rico Industrial, Tourist, Educational, Medical and Environmental Control Facilities Financing Authority (AFICA) Higher Education Revenue Bonds, Series 2006 (Ana G. Méndez University System Project) $3,015,000 Serial Bonds Maturity Date March 1, Principal Amount Interest Rate Yield CUSIP $405, , , , , , % % ED EE EF EG EH EJ9 $26,875,000 Term Bonds $2,605, % Term Bonds due March 1, 2016 price * - CUSIP EK6 $4,055, % Term Bonds due March 1, 2021 yield 4.62%** - CUSIP EL4 $5,180, % Term Bonds due March 1, yield 4.73%** - CUSIP EM2 $15,035, % Term Bonds due March 1, 2036 yield 4.86%** - CUSIP EN0 * Approximate yield 4.52% priced to September 19, 2014 average life ** Yield to March 1, 2016 call date

3 This Official Statement is delivered in connection with the offer and sale of the Series 2006 Bonds described herein and may not be reproduced or used, in whole or in part, for any other purpose. The information set forth herein has been obtained from the Authority, the University System and other sources, which are believed to be reliable but is not guaranteed as to accuracy or completeness by, and is not to be construed as a representation by, the Underwriter. The information and expressions of opinion herein are subject to change without notice, and neither the delivery of this Official Statement nor any sale made hereunder implies that there has been no change in the affairs of the University System at any time subsequent to the date hereof. No dealer, broker, salesman or any other person has been authorized by the Authority, the Underwriter or the University System to give any information or to make any representation other than those contained in this Official Statement in connection with the offering described herein and, if given or made, such other information or representation must not be relied upon as having been authorized by any of the foregoing. This Official Statement does not constitute an offer of any securities other than those described on the cover page or an offer to sell or a solicitation of an offer to buy such securities by any person in any jurisdiction in which it is unlawful for such person to make such offer, solicitation or sale. In connection with the offering of the Series 2006 Bonds, the Underwriter may effect transactions, which stabilize or maintain the market prices of the Series 2006 Bonds at a level above that which might otherwise prevail in the open market. Such stabilizing, if commenced, may be discontinued at any time. TABLE OF CONTENTS Page Summary... 5 Bondholders Risks... 7 Forward-Looking Statements... 9 Project Description... 9 Sources and Uses of Proceeds The Series 2006 Bonds General Book-Entry Only System Payments and Transfers Discontinuance of Book-Entry Only System Security for the Bonds The Debt Service Reserve Account Certain Covenants Issuance of Additional Bonds Mandatory Sinking Fund Redemption Extraordinary Mandatory Redemption Optional Redemption Extraordinary Optional Redemption Notice of Redemption Amendment Registration of Transfer and Replacement of Bonds The Ana G. Méndez University System Historical Coverage of Debt Service Page Selected Financial Information Management s Discussion and Analysis of Results of Operations Higher Education in Puerto Rico Tax Matters The Authority and Government Development Bank for Puerto Rico Legal Investment Rating Underwriting Legal Matters Continuing Disclosure Covenant Miscellaneous Appendix A - Audited Financial Statements of the University System for the fiscal years ended July 31, 2005 and A-1 Appendix B - Principal Legal Documents... B-1 Appendix C - Form of Bond Counsel Opinion... C-1

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5 SUMMARY Issuer The University System Puerto Rico Industrial, Tourist, Educational, Medical and Environmental Control Facilities Financing Authority (the Authority ), an instrumentality of the Commonwealth of Puerto Rico, will issue the Series 2006 Bonds and lend the proceeds of the sale of the Series 2006 Bonds to Sistema Universitario Ana G. Méndez, Incorporado (the University System ). The Authority is required to pay the Series 2006 Bonds only from repayments of this loan made by the University System and certain other amounts held under the Indenture described herein. Sistema Universitario Ana G. Méndez, Incorporado is a private, not-for-profit corporation that owns and operates three universities located in Puerto Rico and two public television stations. The University System is the second largest private university in Puerto Rico, with 35,974 students enrolled in the academic year. The University System s audited financial statements for the fiscal years ended July 31, 2005 and 2004 are presented in Appendix A. The Series 2006 Bonds The Series 2006 Bonds consist of Serial Bonds maturing on March 1 of each year from 2007 through 2012 and Term Bonds maturing on March 1, 2016, 2021, 2026 and Interest accrues from their date of issuance and is payable on each March 1 and September 1, commencing on September 1, The Series 2006 Bonds will be issued by the Authority pursuant to an Indenture of Trust and a Second Supplemental Indenture (the Indenture ), between the Authority and U.S. Bank Trust National Association (as successor in interest to State Street Bank and Trust, N.A.) as Trustee. The Authority will lend the proceeds of the sale of the Series 2006 Bonds to the University System pursuant to a Loan Agreement (the Loan Agreement ). In 1999, the Authority issued $41.9 million aggregate principal amount of bonds (the Series 1999 Bonds ) under the Indenture on behalf of the University System. In 2002, the Authority issued an additional $20.4 million aggregate principal amount of bonds (the Series 2002 Bonds ) under the Indenture on behalf of the University System. The Authority may issue additional series of bonds ( Additional Bonds and, together with the Series 2006 Bonds, the Series 2002 Bonds and the Series 1999 Bonds, the Bonds ) under the Indenture on behalf of the University System. Forms of the Indenture and the Loan Agreement, which include the definitions of certain terms used in this Official Statement, are set forth in Appendix B. Optional Redemption Mandatory Sinking Fund Redemption The University System may redeem some or all of the Series 2006 Bonds maturing on or after March 1, 2021, beginning on March 1, 2016, at a price equal to 100% of their principal amount, plus accrued interest to the date fixed for redemption. The University System must redeem a specified principal amount of the Term Bonds due on 2016, 2021, 2026 and 2036 at par each year beginning on 2013, 2017, 2022 and 2027, respectively, pursuant to the Indenture s sinking fund requirements. 5

6 Extraordinary Mandatory Redemption Extraordinary Optional Redemption Use of Proceeds The University System must redeem all the Series 2006 Bonds at par if the University System loses its status as a tax-exempt 501(c)(3) organization and as a result interest on the Series 2006 Bonds is no longer excluded from gross income for federal income tax purposes. The University System may redeem all or some of the Series 2006 Bonds upon the occurrence of certain events of casualty or condemnation, or certain other events described under The Series 2006 Bonds - Extraordinary Optional Redemption. The proceeds of the Series 2006 Bonds will be used, together with other available moneys, to: provide financing for the acquisition, construction, improvement, and equipping of certain educational facilities of the University System, including the repayment of interim loans incurred for such purpose and the reimbursement to the University System of capitalized interest paid on such interim loans, pay certain costs of issuing the Series 2006 Bonds, and fund a debt service reserve for the Series 2006 Bonds. Bondholders Risks An investment in the Series 2006 Bonds involves certain risks. See Bondholders Risks beginning on page 7. These risks include: dependence on federal financial aid programs to students, competition with other public and private higher education institutions, and a significant amount of debt, including some secured debt. Rating Standard & Poor s: BBB-. 6

7 BONDHOLDER S RISKS You should carefully consider the following factors and other information in this Official Statement before deciding to invest in the Series 2006 Bonds. Dependence on Student Financial Aid Approximately 88% of the University System s students receive some financial support in the form of Pell grants from the U.S. Department of Education, loans from the U.S. Department of Education under the Federal Family Educational Loan Program (FFELP), and other loans and grants sponsored by the United States and Puerto Rico governments. During the academic year, the principal sources of federal grants to students enrolled in the University System amounted to $123 million, or 74% of the University System s total revenues, of which $95.1 million were federal Pell grants. In addition, approximately 15% of the students of the University System were awarded loans under the FFELP Program in fiscal year Due to the degree to which the students of the University System rely on these financial aid programs, the University System is limited in its ability to raise tuition significantly without adversely affecting student enrollment (or the number of credit hours per student) and therefore its revenues. Any significant reduction in the availability of financial aid provided to students by the federal government (or, to a lesser extent, the Puerto Rico government) would therefore adversely affect the University System s enrollment (or the number of credit hours per student), its revenues, and consequently its capacity to pay principal and interest on the Series 2006 Bonds. Level of Debt At July 31, 2005, after making pro-forma adjustments to the balance sheet of the University System to give effect to the issuance of the Series 2006 Bonds, the repayment of certain interim loans incurred to finance the acquisition, construction and refurbishing of certain educational facilities and the reimbursement to the University System of capitalized interest paid on such loans, the long-term indebtedness of the University System (excluding debt of its subsidiary, for which the University System is not liable) would have been $119 million, consisting of the following: $29.9 million of the Series 2006 Bonds, $19.2 million of the Series 2002 Bonds, issued under the Indenture, consisting of serial bonds due through 2011 and term bonds due in 2021 and 2031, bearing interest at fixed rates, $38.1 million of the Series 1999 Bonds, issued under the Indenture, consisting of serial bonds due through 2010 and term bonds due in 2019 and 2029, bearing interest at fixed rates, $22.6 million of term bonds due in 2021, currently bearing interest at short-term rates (the Series 1998 Bonds ), and $9.2 million of other long-term indebtedness, including capital leases. The University System s total pro-forma long-term indebtedness represented approximately 44.5 % of its pro-forma total assets as of July 31, 2005.* Amount of Secured Debt The Series 2006 Bonds are not secured by any mortgage or other lien on any of the assets of the University System. However, $25.6 million aggregate principal amount of the University System s other long-term indebtedness, described above (excluding $9.9 million of secured debt of its subsidiary, AGMUS Holding Management, Inc., for which the University System is not liable), is secured by mortgages on certain of its properties, or is secured by a letter of credit issued by a financial institution that has required and obtained such mortgages. This secured indebtedness represented approximately 14.1% of the book value of the University System s net property, plant and equipment as of July 31, 2005.* *The University System is not responsible for the obligations of its subsidiary, including $9.9 million of indebtedness excluded in the above calculation. The book value of the subsidiary s net property, plant and equipment is $12.2 million. 7

8 In the event of the bankruptcy or insolvency of the University System, the holders of these secured bonds, or the financial institution that has issued a letter of credit securing these bonds, would be entitled to foreclose on the property covered by these mortgages and to be paid before the holders of the Series 2006 Bonds from the proceeds of any such foreclosure. The remaining assets of the University System may be insufficient to pay the Series 2006 Bonds. Competition with Other Higher Education Institutions Competition among higher education institutions in Puerto Rico is strong. The largest institution, the University of Puerto Rico, is a public institution which had approximately 68,000 students enrolled in the academic year, representing approximately 34% of the students enrolled in Puerto Rico higher education institutions. Because the University of Puerto Rico is a public university, its tuition costs are significantly lower than those of the University System and its financial and other resources are greater than those of the University System. The next three higher education institutions in Puerto Rico in terms of student enrollment are private universities: The Interamerican University of Puerto Rico, the University System and the Pontifical Catholic University of Puerto Rico. These three universities compete among themselves and with other private universities on the basis of cost, curriculum, quality of teaching and quality and location of facilities, among other factors. Some of these institutions may have greater financial and other resources than the University System. Other Factors Affecting the University System s Revenues The ability of the University System to comply with its obligations under the Loan Agreement depends primarily upon the level of future revenues and expenses of the University System. In addition to the factors discussed above, other factors which may influence the University System s revenues and expenses include (i) population and demographic trends and economic conditions, particularly in Puerto Rico, (ii) employee strikes, (iii) the cost and availability of energy, (iv) the cost, availability and sufficiency of insurance for risks such as property damage and general liability, and (v) the occurrence of natural disasters such as hurricanes and earthquakes. Puerto Rico is in the Caribbean, a geographic area that is subject to hurricanes and earthquakes. Limited Use of University System s Properties Certain of the University System s properties may not be suitable for purposes other than educational purposes. As a result, in the event of a default, acceleration of the Series 2006 Bonds and any resulting foreclosure sale of such property, the Trustee s remedies and the number of entities interested in purchasing these properties would be limited, and the sales price generated by these properties might thus be adversely affected. Enforceability of Certain Remedies May be Limited Under existing law, including specifically Title 11 of the United States Bankruptcy Code (the Bankruptcy Code ), the remedies specified in the Loan Agreement and the Indenture may not be readily available or may be limited. Furthermore, the remedies which will be available to the holders of the Series 2006 Bonds upon an event of default under the Loan Agreement or the Indenture will in many respects be dependent upon judicial actions, including the granting of equitable remedies, which are often subject to discretion and delay. The various legal opinions to be delivered at the closing of the sale of the Series 2006 Bonds will be qualified as to the enforceability of the Indenture, the Loan Agreement and the other legal instruments by reference to limitations imposed by bankruptcy, reorganization, insolvency, moratorium, and other similar laws affecting the rights of creditors and the availability of equitable remedies. 8

9 FORWARD-LOOKING STATEMENTS This Official Statement contains certain forward-looking statements concerning the University System s operations, performance and financial condition, including its future economic performance, plans and objectives and the likelihood of success in developing and expanding its business. These statements are based upon a number of assumptions and estimates which are subject to significant uncertainties, many of which are beyond the control of the University System. The words may, would, could, expect, anticipate, believe, intend, plan, estimate and similar expressions are meant to identify these forwardlooking statements. Actual results may differ materially from those expressed or implied by these forward-looking statements. PROJECT DESCRIPTION The proceeds of the Series 2006 Bonds will be used, together with the available moneys, for the following purposes (including through the repayment of interim financing incurred for the following purposes): construction of a new three-level 300-space parking building at the main campus of Universidad Metropolitana, expansion of the existing facilities of the Aguadilla off-campus center of Universidad Metropolitana, including the addition of six new classrooms, two labs, a gazebo, expansion of the library and the addition of parking spaces, purchase and improvements to an existent two story structure adjacent to the Aguadilla off-campus center, including parking spaces, purchase and improvements to two buildings in the Bayamón off-campus center of Universidad Metropolitana. improvements to main entrance and exit gate, enhancement to curbs, sidewalks and islands, and improvements to access to parking areas at Universidad del Turabo, paying certain cost of issuing the Series 2006 Bonds, and funding a debt service reserve for the Series 2006 Bonds. 9

10 SOURCES AND USES OF PROCEEDS Set forth below is the estimated sources and uses of the proceeds of the Series 2006 Bonds: Sources Par amount of Series 2006 Bonds $ 29,890, Original issue premium , Total Sources $ 30,450, Uses Deposit to Project Fund $ 27,920, Deposit to 2006 Debt Service Reserve Account ,949, Authority fee , Underwriter=s discount, trustee, legal and printing fees and expenses and other direct costs of issuance of the Series 2006 Bonds , Total Uses $ 30,450, THE SERIES 2006 BONDS Following is a summary of certain of the principal terms of the Series 2006 Bonds and of certain provisions of the Indenture and the Loan Agreement. Forms of the Indenture and Loan Agreement, which include the definitions of certain terms used herein, are set forth in Appendix B. General The Series 2006 Bonds will be dated their date of issuance and will mature (subject to redemption as described below) in such amounts on March 1 of such years as are set forth on the inside cover page of this Official Statement. The Series 2006 Bonds will be issued as registered bonds without coupons, in denominations of $5,000 and integral multiples thereof, initially registered in the name of Cede & Co., as nominee of The Depository Trust Company, New York, N.Y. ( DTC ). Interest on the Series 2006 Bonds will be computed on the basis of a 360-day year consisting of twelve 30-day months. Interest on the Series 2006 Bonds will accrue from their date of issuance and will be paid semi-annually on March 1 and September 1, commencing September 1, 2006, until maturity or prior redemption. Book - Entry Only System The following information concerning DTC and DTC s book-entry system has been obtained from DTC. Neither the Authority nor the Underwriters take any responsibility for the accuracy thereof. Beneficial Owners of the Bonds should confirm this information with DTC or the DTC Participants. DTC will act as securities depository for the Bonds. The Bonds will be issued as fully registered bonds in the name of Cede & Co. (DTC s partnership nominee) or such other nominee as may be requested by an authorized representative of DTC. One fully registered Bond will be issued for each maturity of each series of the Bonds in the aggregate principal amount of such maturity and will be deposited with DTC. So long as the nominee of DTC is the registered owner of the Bonds, such nominee will be 10

11 considered the sole owner or holder of the Bonds for all purposes under the Indenture and any applicable laws. Except as otherwise provided below, a Beneficial Owner (as hereinafter defined) of Bonds will not be entitled to have the Bonds registered in such owner s name, will not be entitled to receive definitive Bonds and will not be considered an owner or holder of the Bonds under the Indenture. DTC, the world s largest depository, is a limited-purpose trust company organized under the New York Banking Law, a banking organization within the meaning of the New York Banking Law, a member of the Federal Reserve System, a clearing corporation within the meaning of the New York Uniform Commercial Code, and a clearing agency registered pursuant to the provisions of Section 17A of the Securities Exchange Act of DTC holds and provides asset servicing for over 2.2 million issues of U.S. and non-u.s. equity issues, corporate and municipal debt issues, and money market instruments from over 100 countries that DTC s participants ( Direct Participants ) deposit with DTC. DTC also facilitates the post-trade settlement among Direct Participants of sales and other securities transactions in deposited securities through electronic computerized book-entry transfers and pledges between Direct Participants accounts. This eliminates the need for physical movement of securities certificates. Direct Participants include both U.S. and non-u.s. securities brokers and dealers, banks, trust companies, clearing corporations, and certain other organizations. DTC is a wholly-owned subsidiary of The Depository Trust & Clearing Corporation ( DTCC ). DTCC, in turn, is owned by a number of Direct Participants, by members of the Fixed Income Clearing Corporation and Emerging Markets Clearing Corporation, (also subsidiaries of DTCC), and by the New York Stock Exchange, Inc., the American Stock Exchange LLC, and the National Association of Securities Dealers, Inc. Access to the DTC system is also available to others, such as both U.S. and non-u.s. securities brokers and dealers, banks, trust companies, and clearing corporations that clear through or maintain a custodial relationship with a Direct Participant, either directly or indirectly ( Indirect Participants ). DTC has Standard & Poor s highest rating: AAA. The DTC rules applicable to its Participants are on file with the Securities and Exchange Commission. More information about DTC can be found at and Purchases of the Bonds under the DTC system must be made by or through Direct Participants, which will receive a credit for the Bonds on DTC s records. The ownership interest of each actual purchaser of each Bond (a Beneficial Owner ) will in turn be recorded in the Direct or Indirect Participants records. Beneficial Owners will not receive written confirmations from DTC of their purchases. Beneficial Owners, however, are expected to receive written confirmations providing details of the transaction, as well as periodic statements of their holdings, from the Direct or Indirect Participant through which the Beneficial Owner entered into the transaction. Transfers of ownership interests in the Bonds will be accomplished by entries made on the books of Direct or Indirect Participants acting on behalf of the Beneficial Owners. Beneficial Owners will not receive certificates representing their ownership interests in the Bonds except in the event that use of the book-entry system for the Bonds is discontinued. To facilitate subsequent transfers, all Bonds deposited by Direct Participants with DTC are registered in the name of DTC s partnership nominee, Cede & Co. or such other nominee as may be requested by an authorized representative of DTC. The deposit of Bonds with DTC and their registration in the name of Cede & Co. or such other DTC nominee do not effect any change in beneficial ownership. DTC has no knowledge of the actual Beneficial Owners of the Bonds; DTC s records reflect only the identity of the Direct Participants to whose accounts such Bonds are credited, which may or may not be the Beneficial Owners. The Direct and Indirect Participants will remain responsible for keeping account of their holdings on behalf of their customers. Conveyance of notices and other communications by DTC to Direct Participants, by Direct Participants to Indirect Participants, and by Direct Participants and Indirect Participants to Beneficial Owners will be governed by arrangements among them, subject to any statutory or regulatory requirements as may be in effect from time to time. Beneficial Owners of Bonds may wish to take certain steps to augment transmission to them of notices of significant events with respect to the Bonds, such as redemptions, defaults, and proposed amendments to the documents governing the Bonds. For example, Beneficial Owners of Bonds may wish to ascertain that the nominee holding the Bonds for their benefit has agreed to obtain and transmit notices to Beneficial Owners. Redemption notices will be sent to DTC. If less than all of the Bonds within a maturity are being redeemed, DTC s practice is to determine by lot the amount of the interest of each Direct Participant in the Bonds of that maturity to be redeemed. Neither DTC nor Cede & Co. (nor any other DTC nominee) will consent or vote with respect to the Bonds unless authorized by a Direct Participant in accordance with DTC s procedures. Under its usual procedures, DTC mails an Omnibus Proxy to the Authority as soon as possible after the record date. The Omnibus Proxy assigns Cede & Co. s consenting or voting rights to those Direct Participants to whose accounts the Bonds are credited on the record date (identified in a listing attached to the Omnibus Proxy). Principal and interest payments on the Bonds will be made to Cede & Co. or to such other nominee as may be requested by an authorized representative of DTC. DTC s practice is to credit Direct Participants accounts upon DTC s receipt of funds and 11

12 corresponding detail information from the Authority, the Trustee, on the payable date in accordance with their respective holdings shown on DTC s records. Payments by Participants to Beneficial Owners will be governed by standing instructions and customary practices, as is the case with securities held for the accounts of customers in bearer form or registered in street name, and will be the responsibility of such Participant and not of DTC or its nominee, the Authority, the Trustee, subject to any statutory or regulatory requirements as may be in effect from time to time. Payment of principal and interest to Cede & Co. (or such other nominee as may be requested by an authorized representative of DTC) is the responsibility of the Authority, the Trustee, disbursement of such payments to Direct Participants shall be the responsibility of DTC, and disbursement of such payments to the Beneficial Owners shall be the responsibility of Direct and Indirect Participants. Payments and Transfers No assurance can be given by the Authority that DTC will make prompt transfer of payments to the Direct Participants or that Direct Participants will make prompt transfer of payments to Indirect Participants or to Beneficial Owners. The Authority is not responsible or liable for payment by DTC or Participants or for sending transaction statements or for maintaining, supervising or reviewing records maintained by DTC or its Participants. The Authority and the Trustee will have no responsibility or obligation to Direct Participants, Indirect Participants, or the persons for whom they act as nominees with respect to the payments to or the providing of notice for the Direct Participants, the Indirect Participants, or the Beneficial Owners. Payments made to DTC or its nominee shall satisfy the obligations of the Authority to the extent of such payments. For every transfer of the Bonds, the Beneficial Owner may be charged a sum sufficient to cover any tax or other governmental charge that may be imposed in relation thereto. Discontinuance of Book-Entry Only System DTC may discontinue providing its services as securities depository with respect to the Bonds at any time by giving reasonable notice to the Authority and the Trustee. Under such circumstances, in the event that a successor securities depository is not obtained, definitive Bonds are required to be printed and delivered. The Authority may decide to discontinue the use of the system of book-entry only transfers through DTC (or a successor securities depository). In that event, definitive Bonds will be printed and delivered. In the event that such book-entry only system is discontinued for the Bonds, the following provisions will apply to the Bonds: principal of the Bonds and redemption premium, if any, will be payable in lawful money of the United States of America at the designated corporate trust office of the Trustee in New York, New York. Interest on the Bonds will be payable on each March 1 and September 1 by check mailed to the respective addresses of the registered owners thereof, as shown on the registration books of the Authority maintained by the Trustee as of the close of business on the record date therefor as set forth in the Indenture. The Bonds will be issued only as registered bonds without coupons in authorized denominations. The transfer of the Bonds will be registrable and the Bonds may be exchanged at the designated corporate trust office of the Trustee in New York, New York upon the payment of any taxes or other governmental charges required to be paid with respect to such transfer or exchange. The Authority will have no responsibility or obligation to DTC, to Direct Participants or to Indirect Participants with respect to (1) the accuracy of any records maintained by DTC, any Direct Participant, or any Indirect Participant; (2) any notice that is permitted or required to be given to the owners of the Bonds under the Indenture; (3) the selection by DTC or any Direct Participant or Indirect Participant of any person to receive payment in the event or a partial redemption of the Bonds; (4) the payment by DTC or any Direct Participant or Indirect Participant of any amount with respect to the principal or redemption premium, if any, or interest due with respect to the Bonds; or (5) any consent given or other action taken by DTC as the owner of the Bonds. 12

13 SECURITY FOR THE BONDS The Series 2006 Bonds are limited obligations of the Authority, payable solely from the following funds (the Pledged Funds ): (i) payments made by the University System pursuant to the Loan Agreement (excluding certain amounts payable to the Authority); (ii) any portion of the net proceeds from the sale of the Series 2006 Bonds or other moneys deposited with the Trustee under the Indenture (excluding the Rebate Fund); and (iii) investment earnings on amounts deposited with the Trustee under the Indenture (excluding the Rebate Fund). Pursuant to the Indenture, the Authority assigned to the Trustee all of its rights (except for certain reserved rights) under the Loan Agreement. The Series 2006 Bonds do not constitute an indebtedness of the Commonwealth of Puerto Rico or any of its political subdivisions. Neither the Commonwealth of Puerto Rico nor any of such subdivisions shall be liable thereon. The obligations of the University System under the Loan Agreement are general unsecured obligations of the University System. They are not secured by any mortgage or other lien on any assets of the University System. The Debt Service Reserve Account The Indenture provides for the creation and maintenance of a Reserve Account in an amount equal to the least of (i) the maximum Principal and Interest Requirements on account of the Outstanding Series 2006 Bonds, in the current or any subsequent Fiscal Year, (ii) 125% of the average annual Principal and Interest Requirements on account of the Outstanding Series 2006 Bonds, or (iii) 10% of the proceeds of the Series 2006 Bonds (the Reserve Requirement ). A portion of the proceeds of the sale of the Series 2006 Bonds in an amount equal to the Reserve Requirement will be deposited in the Reserve Account for the Series 2006 Bonds (the Series 2006 Reserve Account. ) Moneys in the Series 2006 Reserve Account will be used to make payments on the Series 2006 Bonds whenever and to the extent that other moneys to the credit of the Bond Fund are insufficient for such purpose. Moneys in the Series 2006 Reserve Account may not be used to pay other Bonds issued under the Indenture. Similarly, moneys held in other reserve accounts created under the Indenture for the benefit of the holders of other Bonds issued thereunder may not be used to pay the Series 2006 Bonds. Under the Indenture, there may be deposited to the credit of the Reserve Account certain insurance policies, surety bonds or letters of credit (a Reserve Account Credit Facility ) meeting the requirements of the Indenture in lieu of or in substitution for all or a portion of the moneys or securities then to the credit of the Reserve Account. The Indenture requires that the Reserve Account have on deposit an amount of cash or Investment Obligations, or a Reserve Account Credit Facility, or a combination thereof, meeting the requirements of the Indenture, equal to the Reserve Requirement. If a deficiency in this amount occurs, the Indenture requires the University System to restore such deficiency within twelve months, except where a Reserve Account Credit Facility is in effect in which case such deficiency must be restored immediately. Certain Covenants In the Loan Agreement, the University System has agreed to comply with the following covenants, among others: Rate Covenant. The University System has agreed to fix, revise, charge and collect such reasonable tuition and other fees, rentals and charges for the use and occupancy of its Facilities so that there shall inure to the University System gross cash receipts in each fiscal year that, together with other money available to the University System, are sufficient to pay its indebtedness and other obligations. Restrictions on Incurrence of Additional Indebtedness. The University System may only incur additional indebtedness under the following circumstances: (1) The University System may incur additional Senior Indebtedness constituting Long-Term Indebtedness (including Additional Bonds) if, after giving effect to the incurrence of such indebtedness, the University System s Cash Available for Debt Service, as computed from the most recent audited financial statements of the University System, is not less than 125% of the Maximum Principal and Interest Requirements on all Senior Indebtedness constituting Long- Term Indebtedness (including all Bonds) Outstanding after the incurrence of such proposed additional indebtedness. 13

14 (2) The University System may incur additional Senior Indebtedness constituting Long-Term Indebtedness (including Additional Bonds) for the purpose of refunding any Outstanding Senior Indebtedness constituting Long-Term Indebtedness if, after giving effect to the proposed refunding, the Maximum Principal and Interest Requirements on all Outstanding Senior Indebtedness constituting Long-Term Indebtedness shall not be increased. (3) The University System may incur Short-Term Indebtedness (which may constitute Senior Indebtedness) in an aggregate principal amount that shall not exceed 30% of the University System s Total Unrestricted Revenues, Gains and Other Support for its most recent fiscal year for which audited financial statements have been delivered to the Trustee; provided, however, that the University System shall have no such Short-Term Indebtedness Outstanding for a period of at least ten consecutive days during each fiscal year. (4) The University System may incur Subordinated Indebtedness upon the terms and conditions set forth in Section 3.14 of the Loan Agreement. For purposes of the above provisions, the following terms have the following meanings: Cash Available for Debt Service means the sum of (i) the change in unrestricted net assets as reflected in the most recently available audited financial statements of the University System, adjusted to reflect any increases or decreases to the University System s tuition, fees, rates and charges which have been adopted by the University System since the beginning of the fiscal year covered by such audited financial statements as if such increase or decrease had been in effect since the first day of such fiscal year, (ii) depreciation and amortization expense in such fiscal year, as reported in such audited financial statements and (iii) interest paid (including interest on capital leases) during such fiscal year, as reported in such audited financial statements. Maximum Principal and Interest Requirements means the highest annual principal and interest requirements with respect to all Outstanding Bonds and other Senior Indebtedness constituting Long-Term Indebtedness of the University System, including the indebtedness proposed to be incurred. Senior Indebtedness means indebtedness issued by or on behalf of the University System which is payable and secured on a parity with the Bonds. Long-Term Indebtedness means indebtedness having a maturity of more than one year, or renewable at the option of the University System for a period of more than one year, including (i) indebtedness for borrowed money; (ii) capital leases; (iii) installment sale or conditional sale contracts; (iv) Short-Term Indebtedness if a commitment by a financial lender exists to provide financing to retire such indebtedness and such financing would constitute Long-Term Indebtedness; and (v) the current portion of any Long-Term Indebtedness. Short-Term Indebtedness means indebtedness having a maturity of one year or less, excluding the current portion of Long-Term Indebtedness. Restrictions on Certain Liens. The University System may not create or suffer to be created by any other person any lien or charge upon any of the Facilities of the University System, or upon the rents, contributions, charges, receipts or revenues from the foregoing other than certain Permitted Encumbrances, including certain mortgages and other liens existing on the date of issuance of the Series 2006 Bonds, certain capital leases, certain statutory liens, certain utility, access and other easements and rights of way, certain other liens that do not materially affect the property affected thereby, and any future lien that secures the Series 2006 Bonds on a parity with the Senior Indebtedness or Subordinated Indebtedness in connection with which such lien is granted. Restrictions on the Sale or Other Disposition of Facilities. The University System may only sell or otherwise dispose of any portion of its Facilities under the following circumstances: (1) The University System may, subject to compliance with certain conditions, sell or dispose of any portion of its Facilities that has become obsolete. (2) The University System may sell or otherwise dispose of any portion of its Facilities if the aggregate book value of the Facilities sold or otherwise disposed of pursuant to this provision in that fiscal year does not exceed 5% of the book value of all the 14

15 Facilities of the University System, as shown on the audited financial statements of the University System for the most recently ended fiscal year. (3) The University System may sell or otherwise dispose of any portion of its Facilities if it provides the Authority and the Trustee a letter from each rating agency then rating the Series 2006 Bonds at the request of the University System to the effect that such sale or disposition will not, in and of itself, cause such rating agency to reduce or withdraw its rating currently assigned to the Series 2006 Bonds. In the event of any sale or disposition described above, if (i) the portion of the facilities sold or otherwise disposed of consists of any portion of the facilities financed with the proceeds of the Series 2006 Bonds (the 2006 Projects ), (ii) such portion of the facilities is sold or otherwise disposed of in a transaction or series of transactions involving cash consideration in excess of $10,000, and (iii) the sum of such cash consideration and all other cash consideration received by the University System during the current fiscal year on account of dispositions of assets forming part of the 2006 Projects (other than dispositions involving cash consideration of $10,000 or less) equals or exceeds $100,000, then the proceeds of such sale or other disposition shall be applied, at the option of the University System, either to the redemption of Series 2006 Bonds on the earliest date on which Series 2006 Bonds may be redeemed, or to the acquisition, construction or improvement of other educational facilities (subject to the receipt of a favorable opinion of Bond Counsel). Merger, Consolidation or Transfer of Substantially All Assets. The University System may not (i) dissolve, (ii) sell, transfer or otherwise dispose of all or substantially all of its assets, or (iii) consolidate with or merge into another person or permit any person to be merged into it unless the following conditions are met: (1) The institution surviving such merger or consolidation or acquiring such assets (i) is an educational institution duly accredited under Puerto Rico law, (ii) is a Tax-Exempt Organization, (iii) expressly assumes in writing all the obligations of the University System under the Series 2006 Bond documents and (iv) shall not have become liable for any indebtedness or liabilities that the University System would not have been permitted to become liable for under the Loan Agreement. (2) No Event of Default or event that with the passage of time or the giving of notice would constitute an Event of Default shall have occurred and be continuing. (3) No litigation meeting certain materiality qualifications shall be pending against the surviving institution. (4) Such merger, consolidation or transfer of assets shall not adversely affect the exclusion of interest on the Series 2006 Bonds from gross income for federal income tax purposes. (5) Such merger, consolidation or transfer of assets will not, in and of itself, cause a reduction in or withdrawal of the current ratings assigned by the Rating Agencies to the Series 2006 Bonds. Insurance. The University System has agreed to maintain insurance coverage with respect to the Facilities of such types, against such risks and in such amounts as is normally carried on educational facilities and other similar properties, including property insurance in an amount at least equal to the principal amount of all Senior Indebtedness from time to time outstanding, net of amounts held as debt service reserves. Issuance of Additional Bonds Subject to the restrictions described above under Certain Covenants - Restriction on Incurrence of Additional Indebtedness, one or more series of Additional Bonds may be issued under the Indenture to provide funds to pay any one or more of the following: the costs of acquisition, construction and rehabilitation by the University System of educational facilities permitted to be financed by the Authority s enabling statute; refunding to the extent permitted by law any Bonds issued and outstanding under the Indenture or otherwise issued and outstanding on behalf of the University System; and 15

16 to the extent permitted by law, the cost of issuance of the Additional Bonds and other costs reasonably related to the financing as shall be agreed upon by the University System and the Authority. Such Additional Bonds shall be payable from Pledged Funds and may be additionally secured by any Credit Enhancement Device as the University System deems desirable. As described above under Certain Covenants - Restrictions on Incurrence of Additional Indebtedness, the University System must meet certain debt service coverage requirements after giving effect to any issuance of additional Senior Indebtedness or, in the case of refunding indebtedness, the University System s maximum debt service requirements may not increase. Mandatory Sinking Fund Redemption The Term Bonds due on March 1, 2016, 2021, 2026 and 2036 shall be subject to mandatory redemption in part (to be selected by lot) on March 1, 2013, 2017, 2022 and 2027, respectively, and on the first day of each March thereafter at a redemption price equal to the principal amount to be redeemed as set forth in the table below, together with accrued interest on such principal amount to the redemption date, as follows: Redemption Date (March 1) Amount due on Bonds due 2016 Amortization Requirements for Bonds Amount due on Bonds due 2021 Amount due on Bonds due 2026 Amount due on Bonds due $605, , , , $735, , , , , $ 935, , ,035, ,085, ,140, $1,195, ,255, ,320, ,385, ,455, ,525, ,600, ,680, ,765, ,855, Maturity. 16

17 Extraordinary Mandatory Redemption The Series 2006 Bonds shall be subject to mandatory redemption in whole at the principal amount thereof, plus accrued interest to the date of redemption any time within 180 days after the University System shall lose its status as a 501(c)(3) Organization, if in the opinion of Bond Counsel such event results in the interest on the Series 2006 Bonds no longer being excluded from gross income for federal income tax purposes. For purposes of this provision, a 501(c)(3) Organization means a tax-exempt organization described in Section 150(a)(4) of the U.S. Internal Revenue Code of 1986 or any successor provision. Optional Redemption The Series 2006 Bonds maturing on or after March 1, 2021, are subject to redemption at the option of the Authority, at the direction of the University System, in whole on any date or in part on the first Business Day of any month, on or after March 1, 2016, at a redemption price equal to the principal amount of the Series 2006 Bonds to be redeemed, plus accrued interest to the date fixed for redemption. Extraordinary Optional Redemption The Series 2006 Bonds will be subject to extraordinary redemption at the option of the Authority, at the direction of the University System, on any date not later than 180 days after the time of the applicable event described below at 100% of the principal amount thereof plus accrued interest to the redemption date, but without premium, upon the occurrence of any of the following events: (1) in whole or in part, if all or a portion of the 2006 Projects shall be damaged or destroyed and the University System shall determine that it is not practicable or desirable to rebuild, repair or restore such 2006 Projects or such portion thereof; (2) in whole or in part, if all or a portion of the 2006 Projects shall be condemned, or such use or control thereof shall be taken by eminent domain as to render the 2006 Projects unsatisfactory to the University System for continued operation; (3) in whole, if unreasonable burdens or excessive liabilities shall be imposed upon the Authority or the University System with respect to the 2006 Projects or the maintenance or the operation thereof, which burdens or liabilities result in either the permanent discontinuance of maintenance or operation or termination of ownership of the University System s interest in the 2006 Projects; (4) in whole, if operation of the 2006 Projects shall be enjoined, and the University System shall decide to discontinue operation thereof; and (5) in whole, upon the occurrence of any change in the Constitution of Puerto Rico or the Constitution of the United States or any legislative or administrative action (whether local, state or federal) or any final decree, judgment or order of any court or administrative body (whether local, state or federal) which results in the Loan Agreement becoming void or unenforceable or impossible of performance in accordance with the intent and purpose of the parties expressed therein (or in part if, in the unqualified opinion of Bond Counsel, such partial redemption will render the Loan Agreement enforceable and capable of being performed in accordance with such intent and purpose). Notice of Redemption In the event any of the Series 2006 Bonds or any portion thereof are called for redemption, the University System shall give the Trustee 45 days prior notice thereof, and the Trustee shall give notice in the name of the Authority of the redemption of such Series 2006 Bonds (or such portions), which notice shall: (1) specify the Series 2006 Bonds or portions thereof to be redeemed, the redemption date, the redemption price and the place or places where amounts due upon such redemption will be payable (which shall be the principal corporate trust office of the 17

18 Paying Agent) and, if less than all of the Series 2006 Bonds or portions thereof are to be redeemed, the CUSIP identification numbers, the numbers of the Series 2006 Bonds, and the portions of Series 2006 Bonds, so to be redeemed, (2) state any condition to such redemption, and (3) state that on the redemption date, and upon the satisfaction of any such condition, the Series 2006 Bonds or portions thereof to be redeemed shall cease to bear interest. The notice of redemption may set forth any additional information relating to the redemption. The notice shall be given at least 30 days prior to the date fixed for redemption to the holders of Series 2006 Bonds to be redeemed (with copies to the Paying Agent); provided, however, that failure to give such notice to any holder, or any defect therein, shall not affect the validity of any proceedings for the redemption of any of the Series 2006 Bonds for which proper notice was given. If a notice of redemption shall be unconditional, or if the conditions contained in a notice of redemption shall have been satisfied, then upon presentation and surrender of Series 2006 Bonds so called for redemption at the place or places of payment, such Series 2006 Bonds shall be redeemed. With respect to any notice of optional redemption, unless upon the giving of such notice such Series 2006 Bonds shall be deemed to have been paid in accordance with the Indenture, such notice may state that such redemption shall be conditional upon the receipt by the Trustee on or prior to the date fixed for such redemption of moneys sufficient to pay the principal of and interest on such Series 2006 Bonds to be redeemed, and that if such moneys shall not have been so received, said notice shall be of no force and effect, and the Authority shall not be required to redeem such Series 2006 Bonds. In the event that such notice of redemption contains such a condition and such moneys are not so received, the redemption shall not be made and the Trustee shall within a reasonable time thereafter give notice, in the manner in which the notice of redemption was given, that such moneys were not so received. Amendment The Indenture and the Loan Agreement may generally be amended with the consent of holders of a majority in aggregate principal amount of the Bonds of each affected series then Outstanding, except that certain amendments may be made without the consent of any Bondholder and certain amendments may not be made without the consent of each Bondholder affected. Registration of Transfer and Replacement of Bonds The transfer of any Series 2006 Bonds is registrable at the designated corporate trust office of the Registrar (initially the Trustee) upon surrender thereof to the Registrar together with an assignment duly executed by the registered owner or his legal representative and payment of any taxes, fees or governmental charges imposed with respect thereto. Neither the Authority nor the Registrar is required to register the transfer of any Bond during the ten-day period preceding the giving notice of any redemption or after any Bond has been selected for redemption. In case any Bond shall become mutilated or be destroyed or lost or stolen, the Authority shall cause to be executed, and the Trustee or an authenticating agent shall authenticate and deliver, a new Bond of any authorized denomination in the same series and form as the mutilated, destroyed, lost or stolen Series 2006 Bonds, and at the same rate of interest and method for determination applicable to said Series 2006 Bonds in exchange and substitution for and cancellation of such mutilated Bond (but only upon surrender to the Trustee of such mutilated Bond), or in lieu of and in substitution for such Bond destroyed, lost or stolen, upon the owner or holder paying the reasonable expenses and charges of the Authority and Trustee in connection therewith and, in the case of a Bond destroyed or lost or stolen, his filing with the Trustee of evidence satisfactory to it and to the Authority that such Bond was destroyed, lost or stolen, and of his ownership thereof, and furnishing the Authority and the Trustee indemnity satisfactory to them. 18

19 THE ANA G. MENDEZ UNIVERSITY SYSTEM Sistema Universitario Ana G. Méndez, Incorporado is a private, higher education, not-for profit corporation organized under the laws of the Commonwealth of Puerto Rico. The University System, whose administration offices are located in San Juan, operates three educational institutions: Universidad Metropolitana ( UMET ), Universidad del Este ( UNE ), and Universidad del Turabo ( UT ). UMET, UNE and UT are referred to herein, collectively, as the Institutions. The University System was founded in 1949, originally as a junior college, by Mrs. Ana G. Méndez, the mother of the current President of the University System, José F. Méndez, to provide educational opportunities to those students who could not otherwise obtain an education beyond high school. The University System is non-sectarian, co-educational and does not discriminate on the basis of race, sex, origin, social class, physical or mental handicaps, religion or political or labor affiliation. In addition, the University System owns and operates two public television stations: WMTJ-TV/Channel 40, serving the San Juan area, and WQTO-TV/Channel 26, serving the Ponce area. These stations, along with the Interactive Television System (ITS), comprise the Center for Telecommunications and Distance Learning (CETED). In September 2003, the System inaugurated the Metro Orlando University Center in Orlando, Florida. The Center is dedicated to accelerated studies programs offered to adults 23 year of age or older. The Metro Orlando University Center is operated through a subsidiary, AGMUS Ventures, Inc., a private for profit organization owned by the University System (50%) and by New Ventures in Higher Education Inc. (50%), a subsidiary of Regis University in Denver, Colorado, a recognized leader in adult accelerated education in the United States. Operational and financial data in this report excludes the activity of the Metro Orlando University Center, except as indicated. The University System is committed to providing quality education that will contribute to the objective of expanding the number of well-trained Hispanics. The University System experienced strong growth in enrollment during the late 1970 s and early 1980 s. From the mid s to the mid-1990 s, enrollment stabilized, ranging between 17,000 and 17,800 students. However, in the growth pattern in enrollment resumed and headcount enrollment has consistently increased since, reaching 35,974 students in academic year Accreditation The Institutions are fully accredited by the Middle States Association of Colleges and Schools ( Middle States ) and licensed by the Puerto Rico Council on Higher Education. Accreditation for each Institution by Middle States is scheduled for review in 2012 (UMET) and in 2015 (UNE and UT). Institutional Objectives The University System s goal is to promote the cultural, social and educational well-being of Puerto Rican society through the broadening of educational opportunities for the various sectors of the communities it serves. In accordance with the parameters outlined in its By Laws, the University System has the following fundamental aims: Establish, develop, lead and supervise institutions and centers offering university programs that lead to advanced studies, in baccalaureate, master s and doctoral levels that are duly licensed and accredited by the corresponding authorities. Every institution, college, program or school established, directed and supervised by the University System will be non-sectarian, will admit both men and women, and will not permit discrimination on the basis of race, sex, color, birth, national origin or social condition, nor on the basis of political, religious or social belief. In addition to educational institutions and centers, the University System may establish auxiliary enterprises and other related activities. 19

20 Board of Directors In accordance with its certificate of incorporation and by-laws, the University System s Board of Directors is the paramount governing body. The Board is comprised of 18 distinguished professionals and civic leaders. To qualify to be a member of the Board, a person must have achieved distinction in an educational, cultural, business, or civic activity. The Board supervises the fulfillment of the University System s mission; approves its annual budget; oversees its operations; confirms its appointments; establishes financial remuneration; requests studies; oversees academic programs and long-range educational and administrative planning; and supervises the distribution of funds. The Board has six working committees: Executive Committee Finance Committee Academic and Student Affairs Committee Audit Committee Development Committee Fiduciary Committee for the Employees Pension Plan and the Savings and Investments Plan The current officers and members of the Board and their principal affiliations are as follows: Mario F. Gaztambide, Jr. Chairman of the Board Teresita Fuentes Vice Chair José F. Méndez Jorge A. Pierluisi, Jr. Antonio J. de Haro Juan Manuel García-Passalaqua Enrique M. Cardona Rita Di Martino Néstor de Jesús Pou Ivar A. Pietri Antonio J. Colorado Attorney at law. Certified public accountant; partner of Ernst & Young. President of the University System; permanent member of Board of Directors. Attorney at law; President of José Jaime Pierluisi Foundation. Former Director for Corporate Affairs and Public Relations of AT&T Puerto Rico; consultant in public relations. Attorney at law; author; newspaper columnist; political analyst; permanent member of Board of Directors. Certified public accountant; President of Cardona Irizarry & Company, P.S.C. Holds several Presidential appointments as Diplomatic ambassador to several organizations; consultant. Former Vice President, Congressional Relations and Federal Government Affairs of AT&T. Senior Vice President of Lehman Brothers. Real estate developer; President of Peregrine Development. Attorney at law; entrepreneur; partner of Colorado, Piñero & Vélez Law Offices; former Resident Commissioner and Secretary of State of Puerto Rico. * Lehman Brothers is the underwriter of the Series 2006 Bonds. 20

21 José Domingo Pérez Zoraida Fonalledas Juan R. Melecio David Rivé Power Florabel G. Mullick Víctor Hernández Félix Rodríguez Schmidt Civil engineer; entrepreneur; President of Caribe Tecno. Attorney at law. Attorney at law; retired Judge; former President of the State Elections Commission of Puerto Rico. Attorney at law, partner of O Neill & Borges.* Medical Doctor; Principal Deputy Director, Department of Defense, Center for Advanced Pathology and Toxicology, Armed Forces Institute of Pathology; member and collaborator of many educational and research institutions. Dentist in private practice for over 30 years. Medical Doctor; Pediatrics. Senior Medical Director, Advanced Medical Services, Windermere, Florida. In addition, Gloria Castillo de García has been Secretary of the Board since July, She has an MBA in Accounting and is a part-time member of the faculty in Accounting. Principal Officers The by-laws vest the authority and responsibility for the management of ordinary academic and business affairs of the University System in its officers. The President is the chief executive officer and member of the Board. He serves in various Board committees and is an ex-officio voting member of all other committees. The President is appointed by the Board and is the nominating authority, responsible for recommending to the Board the appointments of Chancellors and Vice Presidents, for the Board s approval. The President receives counsel from an advisory board, consisting of ten distinguished professionals who represent various sectors of the Puerto Rico community. The advisory members serve voluntarily for three-year terms. The advisory board s principal purpose is to serve as a link between the University System and private industry, the government and the community at large. The Central Administration is composed by the Office of the President and a supporting staff. The President s main function is to implement the mission of the University System and provide administrative and academic leadership. A Chancellor administers each of the Institutions of higher education and acts as its main academic and administrative officer. The Chancellors, as well as the Vice Presidents, are appointed by the President and ratified by the Board. The three Chancellors and all the Vice Presidents report directly to the President. The Executive Vice President responds directly to the President and coordinates the work of each vice-presidency and the institutions whenever it is deemed necessary. Following is an excerpt from the resumes of the Principal Officers of the University System: José F. Méndez has been President of the University System since He has been a Special Advisor to the President of the Senate of the Commonwealth of Puerto Rico and has served on numerous boards, commissions, and advisory committees including the Federal Judiciary Nominating Commission for the District of Puerto Rico, the District Export Council of the U.S. Secretary of Commerce, and the John F. Kennedy Performing Arts Center, to which he was appointed by President Jimmy Carter. Mr. Méndez was President of the Board of Directors of the American Red Cross in 1989 and was Chairman of the Organizing Committee of the 1983 World Master Games, held in Puerto Rico. President Méndez was the first Puerto Rican to obtain the Charles R. Drew Award from the National Red Cross, the Distinguished Service Award from the Association of Governing Boards of Universities and Colleges, the Distinguished Educator Award from the Phi Delta Kappa and the Mercury Award from the Puerto * O Neill & Borges is acting as legal counsel to Lehman Brothers in connection with the offering of the Series 2006 Bonds. 21

22 Rico Chamber of Commerce, among many other distinctions. He has been President of the Private Colleges and Universities Association of Puerto Rico, and has been member of different Boards of Directors of educational organizations such as the National Association of Independent Colleges and Universities (NAICU); the Hispanic Association of Colleges and Universities (HACU), among others. Méndez has participated as member of different governmental committees: member of the board of Trustees of the Educational Foundation; member of the Special Commission for the Convenience of a Unicameral Legislature; member of the Elementary and Higher Education Improvement Plan, and member of the Council for the Development of the Public Policy of Science and Technology. Alfonso L. Dávila has been Executive Vice President since September of 1999 and is the Acting Vice President for Financial Affairs since March of He also previously held the position of Assistant Vice President for Administrative Affairs. Prior professional engagements include being Secretary and Undersecretary for the Puerto Rico Department of Agriculture, Chancellor of the San Juan Technological College, and Secretary of Staff for the Municipality of San Juan. Mr. Dávila, who holds a Master in Education from North Carolina State University and a Bachelor s Degree in Agricultural Sciences from the Mayagüez Campus of the University of Puerto Rico has also served as member of the board of various public and private corporations, and was the first Puerto Rico delegate to the Federal Agriculture Organization of the United Nations. Federico M. Matheu has served as Chancellor of Universidad Metropolitana since He previously served as Executive Director of the General Council on Education, a governmental agency that oversees the Department of Education. His experience includes appointments as Chancellor of Inter American University, San German Campus and Director of the Humacao Campus of the University of Puerto Rico (UPR). He also held a position as Chemistry Professor at the Río Piedras Campus of UPR. He holds a Ph.D. from the University of Pittsburgh. Dennis Alicea has served as Chancellor for the UT since Has been with the University System as faculty member and in various administrative positions since His previous experience includes appointments as Vice Chancellor for Academic Affairs, Director of the Public Affairs Institute and Associate Dean of Liberal Arts. He holds a Ph.D. from Brown University. Dr. Alicea acts as President of the Advisory Board to the College Board of Puerto Rico since Also, he was designated by the Governor as President of the Board of Directors of the Puerto Rico Institute of Culture in Alberto Maldonado has served as Chancellor for UNE since He has been with the University System since 1970 as a faculty member as well as Associate Academic Dean, Dean of Students and Chairman of the Social Sciences Department of Universidad del Turabo. He holds a Juris Doctor from the University of Puerto Rico and a Masters Degree in Political Science from Ohio University. Migdalia Torres is Vicepresident and General Manager of the Telecommunications and Distance Education Center (CETED in Spanish) since October The CETED is the expanded concept of telecommunications and distance education to which the WMTJ-TV, Channels 40/26 (PBS affiliate) has evolved. Dr. Torres, who holds a PH.D. in Curriculum and Instruction with a concentration in Instructional Systems Designs from Penn State University, has been a faculty member since 1974, actually with the rank of Associate Professor. During these years she has served in several positions, including Associate Dean at the Television Studio Center, which later became Channel 40, Dean of Learning Resources at Universidad Metropolitana, and Director of the Interactive Television System of Channel 40. Jorge L. Crespo is the Acting Vice President of Academic Affairs since December 1, 2005, as well as the Vice President for Institutional Research and Planning since Previously, he was Assistant Vice President for Planning, and has held other career positions in his more than 15 years in the University System. Mr. Crespo holds a Master s Degree in Planning from the University of Puerto Rico, Río Piedras Campus. He is a Certified Planner and a member of the Puerto Rico Planners Association. Francisco J. Bartolomei has served as Vice President for Marketing and Student Affairs since His previous experience includes being Vice President for Marketing at Emory College, Vice President for Admissions at Instituto de Banca y Comercio and Assistant Vice President for Marketing and Recruitment at the University System. He holds a Bachelors Degree in Business Administration from Universidad del Turabo, and a Master s Degree in Business Administration from Universidad Metropolitana. Victoria de Jesús is Acting Vice President for Human Resources since August 1, She holds a Doctoral Degree in Education from Interamerican University. Her experience in the University System includes being Executive Assistant to the Vice President for Academic Affairs, and Executive Assistant to President José F. Méndez, since December,

23 Jesús A. Díaz was served as Vice President for Administrative Affairs since April 1, His previous experience includes being Assistant VP for Collections and Telemarketing of the System since Other experience includes managerial and financial positions at Chase Manhattan Bank, NA, Citibank, NA and Drexel Burnham Lambert Puerto Rico, Inc. He holds a Master s degree in Business Administration, with a major in Management from Universidad Metropolitana. John Navarro, is a Certified Public Accountant with many years of experience in the internal auditing field, has served as Internal Auditor since Mr. Navarro holds a Bachelor s Degree in Business Administration from the University of Puerto Rico, with a major in Accounting. Mr. Navarro is member of the CPA s Chapter, and the Internal Auditors Institute. Members of the University System Universidad del Este. Universidad del Este (UNE) developed into a comprehensive university in the Fall of 2001 when it began offering graduate level masters degree programs. The institution was founded in 1949 as a Junior College granting two-year associate degrees. Its main campus is located in Carolina and its five off-campus centers are located in the municipalities of Yauco, Utuado, Cabo Rojo, Manatí and Santa Isabel. The Carolina campus is five miles from San Juan, the capital of Puerto Rico and within easy reach of the entire eastern part of Puerto Rico. The academia of UNE is organized into the following schools: Professional Studies; Business Administration; Liberal Arts; Health, Science and Technology; Technical Studies and Continuing Education; and International Tourism and Hotel Administration. UNE offers three masters degree programs with 9 specializations, 14 baccalaureate degree programs with 30 majors and six associate degree programs with 24 majors. There are twelve postsecondary certificate programs offered in computer application, computer systems programs, medical billing, teacher assistant of early childhood education, health assistant, and marketing and sales among others. UNE has a full-time faculty of 73 professors, serving a total of 10,351 students throughout its Carolina campus and the five off-campus sites (Fall 2005) Universidad Metropolitana. Universidad Metropolitana was established in 1980 as Colegio Universitario Metropolitano. In 1985 it evolved to Universidad Metropolitana (UMET). The main campus is located in the San Juan metropolitan area, and it has three off campus centers in the municipalities of Aguadilla, Jayuya and Bayamón. The academia of UMET is organized into the following schools: Professional Studies; Business Administration; Social Sciences and Humanities; Education; Health Sciences; Environmental Studies; and Continuing Education. UMET offers diverse programs leading to Certificate, Associate, Baccalaureate and Master s and doctoral Degrees. The academic offering in the graduate area includes Doctorate Degree in Teaching and Curriculum, and Master s Degree in Education, Business Administration, and Environmental Management. UMET has a full time faculty of 99 professors, and 11,259 students (Fall 2005). UMET has a longstanding commitment in the areas of science and technology, environmental science, entrepreneurship, distance learning, adult education, and short-term technical and continuing education programs. The university hosts The Information System and Environmental Information Center, The Environmental Education Institute, The Caribbean Center for Environmental Education, The OSHA Certified Training Center and The Center of Studies for Sustainable Development. These major outreach projects are sponsored by the McArthur Foundation, the National Aeronautics and Space Administration (NASA), the Environmental Protection Agency, the Puerto Rico Electric Power Authority, the US Department of Labor and the private and public sectors. UMET is the only university in Puerto Rico and one of the six institutions of higher learning in the United States selected to receive a major grant form the National Science Foundation (NSF) under its Model Institution of Excellence Program (MIE). MIE is a collaborative agreement between NSF, NASA, and the Department of the Interior and Agriculture. The project is on its 10 th year of implementation of comprehensive services for science, engineering, and mathematics students to encourage them to pursue graduate studies. Full scholarship, and research and internship opportunities in national laboratories and universities are offered to students to create an effective pathway from pre-college through the undergraduate transition to graduate studies. NSF also sponsors The Fellows Enhancing Science and Technology Program to Improve Environmental Education (FEST) from 6 th to 12 th grades and The Course Curriculum and Development (CCLI) Project among other undergraduate research initiatives. Another initiative in environmental education that also promotes graduate studies is The Bridges to Graduate Program funded by The National Institute of Health (NIH). The Office of Sponsored Biomedical Research Associate (OSBRA), the Idea Network for Biomedical Research Excellence (INBRE) and the Roles of BAF-Like in the Nucleus (AREA) are also sponsored by NIH. 23

24 Additionally, UMET has several grants with the US Department of Education: to integrate technology into the curriculum, to enhance the teaching of English, Spanish, Biology, Chemistry, Physics, Mathematics and Special Education at K-12 levels, and to enhance the pre-college and undergraduate students services through the TRIO Programs: Talent Search and the Student Support Services and the Extended Child Care Services Program and the Family Planning Clinic Services. Universidad del Turabo. Since 1982, Universidad del Turabo (UT) has evolved into a comprehensive university with both undergraduate and graduate programs. UT has a full-time faculty of 130 professors in its eight schools. Total enrollment in the Fall of 2005 was 14,364. The academia of the university is organized into schools: Engineering, Science and Technology, Health Sciences, Education, Business Administration, and Social and Human Sciences. The university offers 44 majors at the bachelor s level, 28 specializations at the master s level and four doctoral degrees programs in Business Administration, Environmental Sciences, Education, and Psychology Counseling. UT also holds the following specialized accreditations: Accreditation by the Board for Engineering and Technology (ABET), for the Program of Mechanical Engineering; Accreditation for Dietetics Education (CADE) of the American Dietetic Association (ADA) for the Dietetics and Nutrition Program; and the Nursing Program was accredited by the commission on Collegiate Nursing Programs (AACN). UT operates a Museum and Center for Humanistic Studies, which was established to promote and create cultural programs including workshops in the plastic arts and archaeological expeditions in Puerto Rico. The main campus of UT is located in the municipalities of Caguas and Gurabo, approximately twelve miles from San Juan. UT also operates five off-campus centers at Naguabo, Cayey, Yabucoa, Isabela and Ponce. Telecommunications and Distance Education Center (CETED) / WMTJ-TV/Channel 40 and WQTO-TV/Channel 26. The University System established the Telecommunications and Distance Education Center (CETED, its Spanish acronym) in 2000 in order to integrate the resources of its two television stations (Channel 40 and Channel 26), its ITFS system (described below), and certain other resources in furtherance of its distance education strategy. The University System operates since 1985 a non-commercial public television station, WMTJ-TV/Channel 40, and a repeater station, WQTO-TV/Channel 26. As a public television station, the University System maintains an operating license with the Federal Communications Commission (FCC) and submits separate financial statements for WMTJ-TV/Channel 40 to the Corporation for Public Broadcasting. (CPB). WMTJ-TV/Channel 40 was established in 1985 as Puerto Rico s first non-governmental public television station and the first station in Puerto Rico to concentrate on educational offerings at the post-secondary level. WQTO-TV/Channel 26 was established in 1986 in Ponce, a town in the south of Puerto Rico. One of the main goals of CETED is to acquire, produce and broadcast or narrowcast local college credit television courses throughout Interactive Televised Fixed Services (ITFS). As a member of the Public Broadcasting System, WMTJ-TV/Channel 40 is also a participant in the PBS Adult Learning Service, which broadcasts college-level television courses, including those created by the Annenberg Project of the Corporation for Public Broadcasting (CPB). In 1992 a grant was obtained from the National Telecommunications and Information Agency (NTIA) to develop the first Interactive Televised Fixed Services (ITFS) this system in Puerto Rico. This system is an island-wide network of microwave transmitters that enable CETED to provide on-site training and teleconference services specially designed to target industry, business and other private or public entities. CETED also received a grant in 1995 from the NTIA to expand the ITFS system and install certain electronic classrooms at the University System s institutions. This enabled a significant increase in its coverage. To provide technological support the University System s academic endeavor, CETED selected in 2001 the Blackboard platform to develop the technical infrastructure for the offering of online courses. In 2003 CETED also integrated the ISDN technology for the offering of teleconferences. 24

25 WMTJ-TV/Channel 40 and WQTO-TV/Channel 26 obtained grants from the US Department of Commerce to assist the stations in the transition to a digital infrastructure. The transition to a digital format is in the process of implementation. Curriculum The faculty and a curriculum committee design the curriculum offered at each Institution. The undergraduate academic programs are offered to develop highly qualified professionals who also possess a general understanding of humanities and a sense of social responsibility. The graduate degree programs are designed to assist students in developing the knowledge, ability and judgment to become successful professionals in their chosen field. Curriculum design is also shaped and supported by several education joint ventures of which the University System is a member. These consortia consist of a series of bilateral or multi-institutional cooperation agreements through which participating institutions combine human, financial, and structural resources to achieve common goals. Areas of particular interest in such consortia are the creation or revision of curricula, professional development of the faculty members, the acquisition of equipment or other necessary teaching support materials, and the development of academic or scientific research. Faculty and Staff The faculty of the University System during the academic year consists of 302 full-time members. The faculty is composed of 52 professors, 92 associate professors, 80 assistant professors, and 78 instructors. Of the full time faculty, 92 (31%) are tenured, and 210 (69%) are on multi-year non-tenure contracts. Each Institution is responsible for staffing policies which include hiring, wage and salary administration and setting of tenure levels of its faculty, subject to the approval of the President and the Board. Of the full-time faculty, 73 teach in UNE, 130 at UT, and 99 at UMET. The faculty at each Institution meets in assembly at least twice a year. The various departments meet more frequently to discuss academic and administrative matters. Each department performs its main academic responsibility through committees with the participation of administrators, faculty and students. All faculty members are evaluated annually to determine their performance and suitability for reappointment based on the quality of their teaching, professional service, and scholarly and creative accomplishments. The University System s part-time faculty typically has well-established relationships with the Institutions. The following table shows the composition of the faculty divided between full and part-time and tenured and non-tenured members for each of the last five academic years: Faculty Academic Year Full-Time Part-time 1,045 1,159 1,224 1,490 1,634 Total 1,307 1,414 1,498 1,787 1,936 Tenured 36% 37% 33% 31% 31% Non-tenured 64% 63% 67% 69% 69% The table shows that the number of full-time faculty has remained stable as a result of an administrative policy that discontinued tenured positions. Instead, multi-annual contracts are offered to faculty. 25

26 The University System has approximately 1,300 employees in administrative, technical, maintenance and clerical positions. None of the employees is represented by labor unions. The administration of the University System believes that its relations with its employees are good. Admission Requirements and Standards At each Institution, candidates for admission to the freshman class must have a high school diploma or its equivalent from an institution accredited by the Puerto Rico Department of Education. Each institution has its specific requirements for admission that take into account academic grade point average and achievement test scores. Some academic programs (Engineering, Science and Nursing) have specific requirements related to the field of study. Each student must maintain the minimum grade point average required by the respective Institution. In the event that such average falls below the required level, the student is placed on academic probation, during which time the student receives special assistance to help improve academic performance. Those students who do not achieve the minimum grade point average at the end of the probation period are suspended for unsatisfactory academic progress. The following table sets forth information with respect to student enrollment in each of the following fiscal years. Student Enrollment Headcount 24,443 26,880 30,768 33,836 35,974 Full-Time 18,656 21,209 23,671 25,203 27,267 Part-Time 5,787 5,671 7,097 8,633 8,707 Full Time Equivalent 22,242 24,846 28,098 30,315 32,289 Undergraduate 20,549 22,870 25,429 27,056 28,136 Graduate 1,693 1,976 2,669 3,259 4,153 Institution Universidad del Este 8,100 8,801 9,706 10,198 10,351 Universidad del Turabo 9,323 10,527 12,256 13,408 14,364 Universidad Metropolitana 7,020 7,552 8,806 10,230 11,259 Total 24,443 26,880 30,768 33,836 35,974 The following table shows, for the academic years indicated, the number of applications for admission received by University System, the number of acceptances, and the number of students enrolled Applications 18,996 22,169 22,329 26,595 31,030 Accepted 12,354 14,388 14,768 16,892 18,693 Acceptance Rate 65.3% 64.9% 66.1% 63.5% 60.3% Enrolled 9,055 11,095 11,103 12,383 13,370 Enrollment Rate 73.3% 77.1% 75.2% 73.3% 71.6% 26

27 Tuition and Fees The Institutions charge the same tuition and fees for all academic programs with the exception of certain special programs, such as Engineering and Nursing. Tuition and fees are set in accordance with the Board s policy to maintain an affordable tuition and fee structure. Students pay tuition on the basis of credit hours enrolled, plus fees that total $295 per semester per student. In academic year , tuition for certificate programs was $123 per credit hour, tuition for undergraduate programs was $143 per credit hour and tuition for graduate programs was $170 per credit hour. The table below summarizes the undergraduate tuition costs (based on an average of 12 credit hours per semester) and cost per credit during the past five academic years. Academic Year Tuition Cost and Fees $3,530 $3,722 $3,752 $3,872 $4,022 Cost per Credit $ 130 $ 138 $ 138 $ 143 $ 143 Financial Assistance Programs The University System participates in the full range of student financial assistance programs provided by the Federal government and by the government of the Commonwealth of Puerto Rico. Due to the relatively low average family income in Puerto Rico (as compared to that of the mainland United States), a significant portion of the students enrolled at the University System are eligible to receive Pell grants, as well as additional aid under the Federal Work Study (FWS) program, the Supplemental Educational Opportunity Grant (SEOG) program, and the Scholarship for Disadvantaged Students (SDS) program. Students are also eligible to receive grants from the government of the Commonwealth of Puerto Rico. Students are also offered various oncampus work/study positions where they earn their financial aid awards while gaining work experience. In addition, loans are available to help students cover the total costs of their studies, including loans from the federal government under the FEELP Program (Federal Family Educational Loan Program). The following chart summarizes the principal sources of financial aid during the last four academic years. Student Financial Aid * 2005* Federal Pell Grants $67,825,031 $81,901,226 $91,563,696 $95,145,195 Federal Educational Opportunity Grant 1,929,053 2,193,700 2,349,948 2,474,782 College Work Study Program 2,137,034 2,673,279 2,569,056 2,449,990 Scholarship for Disadvantaged Students 528, , , ,617 Federal Loans 7,724,952 9,900,967 13,206,470 19,987,419 Puerto Rico Grants 3,484,764 3,671,284 3,670,576 4,268,953 *Includes financial aid received by students in the Metro Orlando University Center. Pell grants are the most important source of student financial aid at the University System, totaling $95 million or 77% of total aid received in year Approximately 88% of students were awarded Pell grants in fiscal year These grants are awarded by the United States Department of Education directly to students based primarily on family income. The maximum amount of the Pell grant in fiscal year was $4,050. This amount was sufficient to cover all tuition and fees payable by a student taking 24 credits (which is the average number of credits taken). In fiscal year the maximum amount remained at 27

28 $4,050, which also covers all tuition and fees payable by student taking 24 credits. Another important source of student financial aid are loans from the Federal government under the Federal Family Educational Loan Program (FFELP). Approximately 15% of students of the University System were awarded loans under the FFELP Program in Fiscal year The FEELP Program and other programs administered by the United States Department of Education under Title IV of the Higher Education Act have certain requirements that must be met by participating institutions. One of these requirements is that the default rate on NDSL and FFELP loan programs made to students attending that institution remain below specified limits. If the default rate exceeds 25% in three consecutive years, the institution may become ineligible to participate in Title IV loan programs and the Pell grant program for at least two years. If the default rate exceeds 40% in any year, the Department of Education may suspend, limit or terminate the institution from all student aid programs administered by the Department of Education under Title IV, including the Pell Grant program. In the case of the University System s educational institutions, the NDSL default rate has never exceeded 25% in three consecutive federal fiscal years, and has never exceeded 40% in any federal fiscal year. The NDSL default rate of the Universidad del Este (formerly the Colegio Universitario del Este) exceeded 25% in , and , and the NDSL default rate of the Universidad Metropolitana exceeded 25% in Set forth below is the NDSL default rate for each Institution during the last five fiscal years. Fiscal Year UNE UMET UT *Preliminary % 14.2% 6.2% % 8.3% 5.1% % 5.0% 3.0% % 3.4% 1.3% * 2.7% 2.2% 2.2% The default rate is calculated on an annual basis as the rate at which student borrowers scheduled to begin repaying their loans in the federal fiscal year default on such loans by the end of the next federal fiscal year. The University System also receives grants and contracts in support of its activities. Federal and Puerto Rico Grants and contracts support totaled $23.4 million in fiscal year and $20.2 million in fiscal year Budgeting Procedures The preparation of the University System s annual budget involves the President, the Central Administration officers, the Chancellors of the Institutions, the Deans and department heads. As a policy, the University System s budget must be at the least balanced. The budgeting process is initiated by the University System s Vice President for Planning and Institutional Research who coordinates the process of developing the plans for the year from the school and departmental level up to the institutional and systemwide level. The plans must be the basis of the budget proposals submitted by each unit, therefore providing for the integration of the planning and budget processes. The VP for Planning and Institutional Research also prepares the enrollment projections. These enrollment projections are reviewed and approved by the Chancellors of the Institutions and the Vice President for Marketing and Student Affairs. Subsequently, the Vice President for Financial Affairs, and the University System s Budget Office in coordination with managers across the Institution (deans departments, heads, directors) the Chancellors, the Vice Presidents and the President prepare the annual budget. The budget proposal is consolidated and prepared by the Budget Office and presented with the main objectives and plans for final review and approval to the Board of Directors prior to the beginning of each fiscal year. 28

29 Outstanding Indebtedness Set forth below is the outstanding long-term debt, including capital leases, of the University System (excluding its subsidiary AGMUS Holding Management, Inc., the obligations of which are not obligations of or guaranteed by the University System) as of July 31, 2005, 2004, 2003 and as of October 31, For additional information, see the financial statements of the University System included in Appendix A. Outstanding Indebtedness* Bonds As of July 31, As of October 31, Series 1998 Bonds $24,400,000 $23,500,000 $ 22,600,000 $ 21,700,000 Series 1999 Bonds 39,613,498 38,869,868 38,086,238 38,090,330 Series 2002 Bonds 19,809,384 19,506,231 19,192,642 19,194,925 Long term notes 3,680,161 11,384,863 19,783,219 31,190,403 Obligations under capital leases 4,859,082 4,824,190 5,666,656 5,121,475 Total $92,362,125 $98,085,152 $105,328,755 $115,297,133 * The outstanding indebtedness of the University System excludes any long term debt incurred by its subsidiary AGMUS Holding Management Inc., the obligations of which are not obligations of or guaranteed by the University System as of July 31, 2005, 2004, 2003 and as of October 31,

30 Property, Plant and Equipment** The following table summarizes the book value of University System s Property, Plant and Equipment: As of July 31, As of October 31, Construction in progress $ 8,258,450 $ 8,514,836 $ 17,568,093 $ 22,954,543 Land 16,280,382 18,433,010 22,241,482 25,623,426 Building and improvements 138,456, ,692, ,257, ,038,093 Equipment 53,028,874 57,924,300 61,412,635 61,989,170 Library books 7,499,394 8,561,729 9,746,536 10,119,029 Vehicles 1,441,556 1,743,614 1,831,754 1,831,754 Works of art - 557, , ,735 Software 2,431,119 2,508,665 2,995,333 3,015,358 $227,396,351 $244,936,447 $272,639,839 $291,183,108 Less Accumulated Depreciation and Amortization (70,157,413) (78,399,212) (90,453,410) (93,837,740) Property, plant and equipment net $157,238,938 $166,537,235 $182,186,429 $197,345,368 Employee Benefit Plans The University System has a defined benefit pension plan covering 291 of employees. The participating employees are required to contribute to the plan 3% to 5% of their annual compensation based on their salary range, and the University System makes all additional contributions necessary to provide the benefits under the plan. The benefits are based on years of service and the employee s average compensation during the five consecutive years of employment in which he earned the highest salaries. As of April 30, 2005, admission to the Plan was closed. As of July 31, 2005, the Plan s projected benefit obligations were $30.5 million and the market value of plan assets was $24.1 million. ** The assets of the University System do not include the assets of its subsidiary AGMUS Holding Management Inc. 30

31 Investments The following chart describes the University System s cash, cash equivalents, and investment portfolio at fair value. This portfolio includes both the Endowment Fund and operating funds. As of July 31, As of October 31, Cash and Cash Equivalents $2,120,610 $1,929,823 $1,079,544 $1,777,856 U.S. Gov. and Agency Securities 4,173,950 3,442,773 5,531,126 6,148,503 Corporate Bonds 6,838,312 6,938,793 5,076,460 4,498,770 Equity Securities 17,564,836 19,970,770 16,823,844 16,914,341 Asset-Backed Securities , ,266 Balanced Mutual Funds 2,374,467 2,737,962 3,494,845 3,516,942 Mortgage-Backed Securities 3,977,542 4,612,171 4,101,698 3,826,827 Investment in Subsidiaries 2,857,422 3,339,585 2,963,805 3,173,317 Total $39,907,139 $42,971,877 $39,698,747 $40,830,822 Professional money managers overseen by the Board and the University System s administration manage the University System s investments. The following table summarizes the balances in the Endowment Fund in each of the past three years as of July 31, 2005 and as of October 31, Endowment Fund As of July 31, As of October 31, Endowment Fund Corpus $19,531,471 $19,963,410 $21,090,071 $20,947,176 Quasi Endowment Fund 12,883,919 15,254,344 9,561,664 9,510,764 Scholarship Endowment Fund 5,462,547 7,269,774 6,751,886 6,798,240 Total $37,877,937 $42,487,528 $37,403,621 $37,256,180 The Endowment Fund Corpus consists of federal grants received from the Unites States Department of Education under the Title III program, Endowment Challenge Grant, together with matched funds provided by the Institution. The University System matches these grants dollar-for-dollar and has funded its contributions from its own operations. The federal grants and University System s contribution constitute the Endowment Fund Corpus. The University System must invest and may not expend the Endowment Fund Corpus for a period of 20 years. During the grant period, a maximum of 50% of the aggregate earned income is available for spending. The other 50% must be reinvested with the Endowment Fund Corpus. Afterwards, the moneys can be used for educational purposes. The Quasi Endowment Fund consists of moneys contributed by University System to the Endowment from its operational funds, and as such, has no restrictions. The Scholarship Endowment Fund consists of private gifts and grants invested in perpetuity. The majority of the income from these investments may be spent only for scholarships. 31

32 Insurance The University System carries general liability and other insurance policies or self-insurance covering property damage, potential liabilities and losses in amounts believed to be adequate and customary for an institution of its size and character. Buildings and its contents are insured under a Blanket Coverage including but not limited to glass, boiler and machinery, accounts receivable, valuable papers and records, fine arts including exhibitions, personal property, and general liability. To manage other responsibilities we have the following insurance, crime, malpractice liability, employment practices and professional liabilities (including Directors & Officers and School Leaders Errors & Omissions), fiduciary liability, pension and welfare liability and commercial umbrella. To cover accidents to students the Institution has an insurance coverage for all enrolled students. Litigation The University System is involved in routine claims incidental to its business. In the opinion of the University System s management and of its legal counsel, none of these proceedings should have a material effect on the University System s financial s statements. HISTORICAL COVERAGE OF DEBT SERVICE The following table, developed from information in the University System s audited consolidated financial statements for the five fiscal years ended July 31, 2005, and other sources, shows the University System s historical debt service coverage based upon its financial performance and cash available for debt service and the actual debt service requirements on the University System s long-term indebtedness. The table excludes all financial data related to the subsidiary of the University System for which the University System is not legally responsible. The change in unrestricted net assets for the fiscal years ended July 31, 2001 and 2002 include a net depreciation in the market value of investments of $4.0 million in 2001 and $5.0 million in 2002, attributable principally to conditions in the stock market. This reduction had a significant impact on the debt service coverage ratio shown for such fiscal years. The change in unrestricted net assets for the fiscal years ended July 31, 2005 and 2004 includes a minimum pension liability adjustment related to a defined benefit pension plan the institution maintains for certain of its employees. The adjustment reflects the difference between the plan s accumulated benefit obligations and the plan s assets. For the years ended July 31, Change in unrestricted net assets $(4,745,211) $(4,906,399) $ 4,729,119 $(1,794,826) $3,425,090 Extraordinary loss on extinguishment of debt 594,863 Depreciation and amortization 7,665,027 8,741,272 9,941,705 11,016,330 12,880,013 Interest expense 5,055,236 4,551,404 4,668,617 4,336,391 5,035,528 Cash available for debt service $7,975,052 $8,981,140 $19,339,441 $13,557,895 $21,340,631 Historical debt service requirement $8,742,231 $9,274,853 $9,515,470 $9,121,168 $9,646,590 Historical debt service coverage

33 SELECTED FINANCIAL INFORMATION The following table sets forth selected consolidated financial information for the University System and its subsidiary. The financial information for the fiscal years ended July 31, 2005, 2004 and 2003 is derived from the audited consolidated financial statements of the University System. The University System s audited consolidated financial statements for the fiscal year ended July 31, 2005 and 2004 are included in Appendix A. The financial information for the three-month periods ended October 31, 2005 and 2004 is derived from unaudited financial statements. Statements of Activities Fiscal Year ended July 31, Three-Month Period Ended October 31, Unrestricted Revenues, gains and other support: Tuition and fees $105,036,985 $118,884,357 $133,150,642 $39,009,310 $42,735,752 Less scholarships 7,505,582 6,582,488 8,786,904 2,490,565 4,304,671 Net tuition and fees 97,531, ,301, ,363,738 36,518,745 38,431,081 Grants and contracts 21,363,142 20,204,529 22,978,595 4,767,089 7,772,620 Private gifts and grants 443, , ,797 34,582 58,021 Investment income 668, , , , ,614 Net appreciation (depreciation) of investments 1,344,983 1,304,159 2,330, ,610 (262,942) Auxiliary enterprises 3,968,135 4,664,739 5,105,999 1,759,447 1,680,137 Other sources 8,827,105 7,102,209 6,052,594 1,448,439 2,528,743 Net assets released from restrictions 1,000, ,000 3,642,941 2,409,574 1,630,549 Total revenues, gains and other support 135,147, ,067, ,772,005 48,018,507 52,125,823 Expenses and other deductions: Education and general expenses: Instruction 63,563,453 74,363,425 80,490,586 20,149,424 20,854,302 Research - 199, , , ,670 Public Service 9,891,011 9,344,258 10,482,823 1,957,018 4,125,108 Academic Support 12,470,463 12,100,567 13,549,029 3,325,247 3,419,247 Student Services 15,526,970 17,899,400 18,836,939 5,493,520 5,456,401 Institutional Support 25,274, ,087 33,090,815 8,271,793 9,081,357 Total educational and general expenses 126,726, ,490, ,325,115 39,360,498 43,108,085 Auxiliary enterprises expenses 3,599,530 4,239,124 5,088,044 1,386,848 1,553,311 Total expenses and other deductions 130,326, ,729, ,413,159 40,747,346 44,661,396 Change in net assets before minimum pension liability adjustment 4,821,139 1,337,911 3,358,846 7,271,161 7,464,427 Minimum pension liability adjustment - (3,048,469) (431,401) - - Change in Unrestricted Net Assets 4,821,139 (1,710,558) 2,927,445 7,271,161 7,464,427 Temporary Restricted Revenues Assets released from restrictions (1,000,000) (310,000) (3,642,941) (2,409,574) (1,630,549) Investment income 355, , ,534 78,582 86,501 Net appreciation (depreciation) of investments 296, , , ,446 (157,948) Change in Temporarily Restricted Net Assets (347,685) 377,378 (3,079,609) (2,205,546) (1,701,996) Change in Permanently Restricted Net Assets Net assets released from restrictions - (200,000) Private gifts and grants 721, ,600 1,677,831 1,372, ,462 Change in Permanently Restricted Net Assets 721, ,600 1,677,831 1,372, ,462 Change in Net Assets $ 5,194,919 $(1,004,580) $ 1,525,667 $ 6,438,446 $5,982,893 Statement of Financial Accounting Standards No. 117, Financial Statements of Not-for-Profit Organizations (SFAS 117), establishes standards for general purpose external financial statements by a not-for-profit organization. SFAS 117 requires that three classes of net assets - permanently restricted, temporarily restricted and unrestricted - be displayed in a statement of financial position and that the amount of change in each of those classes of net assets be displayed in a statement of activities. SFAS 117 also requires the inclusion of a statement of cash flows in the financial statements of the organization. 33

34 The net assets of the University System and changes therein are classified as follows: Unrestricted net assets - Net assets that are not subject to donor-imposed stipulations. Temporarily restricted net assets - Net assets subject to donor-imposed stipulations that may or will be met either by actions of the University System and/or the passage of time. Permanently restricted net assets - Net assets subject to donor-imposed stipulations that must be maintained permanently by the University System. Generally, the donors of these assets permit the University System to use all or part of the income earned on related investments for general or specific purposes. Net assets released from restrictions - Permanently or temporary revenues that with the passage of time or the meeting of donor imposed restrictions are reclassified as unrestricted revenues. MANAGEMENT S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS The following discussion is based on the audited consolidated financial statements of the University System and its subsidiary for the fiscal years ended July 31, 2005, 2004, 2003 and the unaudited consolidated financial statements of the University System and its subsidiary for the three-month periods ended on October 31, 2005 and Three-Month Period ended on October 31, 2005 Compared with Three-Month Period ended on October 31, 2004 The increase in unrestricted net assets for 2005 (references to a year mean the three months ended on October 31 of that year) was a net gain of $7.5 million, while the change in unrestricted net assets for 2004 was a net gain of $7.3 million. Total unrestricted revenues, gains and other support were 8.5% higher in 2005 than in 2004, increasing from $48 million to $52.1 million. Total expenses and other deductions, on the other hand, were 9.8% higher in 2005 than in 2004, increasing from $40.7 million to $44.7 million. The increase in unrestricted revenues, gains and other support resulted principally from an increase in net tuition and fees of 5.2%, from $36.5 million in 2004 to $38.4 million in The increase in tuition and other fees was primarily the result of an increase in student enrollment. Headcount increased by 6.3% in the academic year, from 33,836 in to 35,974 in , while the number of full-time equivalent students increased by 6.5% in , from 30,315 in to 32,289 in Grants and contracts increased by 62.5% from $4.8 million in 2004 to $7.8 million in Other sources increased by 78.6% from $1.4 million in 2004 to $2.5 million in Also, the University System experienced a net depreciation in the value of its investments of $0.3 million in 2005, compared to a net appreciation of $0.8 million in On the expense side, the University System classifies its expenses as either instruction, research, public service, academic support, student services, and institutional support. Instruction expenses include faculty salaries and other expenses related to teaching. Research expenses include the expenses related with research projects developed in the University. Public service expenses include the expenses of the public television stations and community services. Academic support expenses include salaries and other expenses related to instruction, such as libraries, audiovisual services and others. Student services expenses include the salaries and expenses of admissions personnel, expenses related to the provision of direct services to students and marketing expenses. Institutional support expenses include the salaries of administrative personnel and other expenses such as legal services, bad debt and bank charges, among others. In addition, certain expenses are allocated among each of these categories. These include interest, depreciation and amortization, and plant maintenance expenses. Expenses for instruction increased by 3.5%, from $20.1 million in 2004 to $20.8 million in Since July 2004 expenses for research were disclosed in a separate line item. In past years the research classification was included as part of public service expenses. Expenses for public services increased by 105% from $2.0 million in 2004 to $4.1 million in Academic support expenses increased by 3%, from $3.3 million in 2004 to $3.4 million in Student service expenses were similar in the period, totaling $5.5 million in 2004 and Expenses for institutional support increased by 9.6% from $8.3 million in 2004 to $9.1 million in

35 2005 Compared with 2004 The increase in unrestricted net assets for 2005 (references to a year mean the fiscal year ended on July 31 of that calendar year) was a net gain of $2.9 million, while the change in unrestricted net assets for 2004 was a loss of $1.7 million. Total unrestricted revenues, gains and other support were 12.9% higher in 2005 than in 2004, increasing from $147 million to $166 million. Total expenses and other deductions, on the other hand, were 10.9% higher in 2005 than in 2004, increasing from $146 million to $162 million. The increase in unrestricted revenues, gains and other support resulted principally from an increase in net tuition and fees of 10.7%, from $112 million in 2004 to $124 million in The increase in net tuition and other fees was partially the result of an increase in student enrollment and partially the result of an increase in tuition fees. Headcount increased by 10.0% in the academic year, from 30,768 in to 33,836 in , while the number of full-time equivalent students increased by 7.9% in , from 28,098 in to 30,315 in Average undergraduate tuition costs increased by 3.2% in , from $3,752 in to $3,872 in On the other hand, investment income was 28.6% higher in fiscal year 2005 than in 2004, increasing from $0.7 million in 2004 to $0.9 million in Also, the University System experienced an unrestricted net appreciation in the value of its investments of $2.3 million in 2005, compared to $1.3 million in Expenses for instruction increased by 8.2%, from $74.4 million in 2004 to $ 80.5 million in Said increase was due mainly to the increase in enrollments which produced and increase in faculty salaries and other expenses related to instruction. Expenses for research increased 339.7% from $199 thousands in 2004 to $875 thousands in 2005 due to an increase in different research projects in the Institution. Expenses for public services increased by 12.9%, from $9.3 million in 2004 to $10.5 million in Expenses for academic support increased by 11.6%, from $12.1 million in 2004 to $13.5 million in Expenses for student services increased by 5.0%, from $17.9 million in 2004 to $18.8 million in 2005, also due to increase in salaries and new positions to serve the student population. Expenses for institutional support increased by 19.9%, from $27.6 million in 2004 to $33.1 million in This increase is mainly due to salaries increases, operational leases and other expenses. Auxiliary enterprises expenses increased by 21.4%, from $4.2 million in 2004 to $5.1 million in 2005 corresponding to an increase in salaries and volume of operations Compared with 2003 The decrease in unrestricted net assets for 2004 (references to a year mean the fiscal year ended on July 31 of that calendar year) was $1.7 million, which represents a net loss, while the change in unrestricted net assets for 2003 was a benefit of $4.8 million. The decrease resulted mainly from a minimum pension liability adjustment of $3 million related with the University System s defined benefit Pension Plan. The adjustment reflects the difference between the plan s accumulated benefit obligations and the plan s assets. This difference came principally about due to a reduction in the discount rate used to determine the plan s accumulated benefit obligations. Total unrestricted revenues, gains and other support were 8.9% higher in 2004 than in 2003, increasing from $135.1 million to $147.1 million. Total expenses and other deductions, on the other hand, were 11.8% higher in 2004 than in 2003, increasing from $130.3 million to $145.7 million. The increase in unrestricted revenues, gains and other support resulted principally from an increase in net tuition and fees of 15.2%, from $97.5 million in 2003 to $112.3 million in Also, from an increase in auxiliary enterprises of 17.5%, from $4.0 million in 2003 to $4.7 million in The increase in net tuition and other fees was partially the result of an increase in student enrollment and partially the result of an increase in tuition fees. Headcount increased by 14.5% in the academic year, from 26,880 in to 30,768 in , while the number of full-time equivalent students increased by 13.0% in , from 24,846 in to 28,098 in Average undergraduate tuition costs increased by.8% in , from $3,722 in to $3,752 in Also, the University System experienced a net appreciation in the value of its unrestricted investments of $1.3 million in 2004, similar to Expenses for instruction increased by 17.0%, from $63.6 million in 2003 to $ 74.4 million in Said increase was due mainly to the increase in enrollments which produced and increase in faculty salaries and other expenses related to instruction. 35

36 Expenses for public services decreased by 6.0%, from $9.9 million in 2003 to $9.3 million in Expenses for academic support decreased by 3.2%, from $12.5 million in 2003 to $12.1 million in Expenses for student services increased by 15.5%, from $15.5 million in 2003 to $17.9 million in 2004, also due to increase in salaries because of new positions to serve the student population. Expenses for institutional support increased by 9.1%, from $25.3 million in 2003 to $27.6 million in This increase is mainly due to salaries increases and other related to normal business operation. Auxiliary enterprises expenses increased by 16.7%, from $3.6 million in 2003 to $4.2 million in 2004 corresponding to an increase in salaries and volume of operations. HIGHER EDUCATION IN PUERTO RICO During the past four decades, Puerto Rico has made significant advances in the field of education, particularly at the undergraduate and graduate levels. The transformation of Puerto Rico during the 1950s and 1960s from an agricultural economy to an industrial economy brought about an increased demand for education at all levels. Since 1970, the manufacturing sector has attracted high technology industries in Puerto Rico. This has resulted in an increased demand for workers having a higher level of education in general and, in particular, greater expertise in various technical fields. During the same period, enrollment at institutions of higher learning have risen very rapidly. Although this growth trend has slowed down with respect to the college age population due mainly to demographic factors, the increasing proportion of college attendance by the college age population and adults returning to college for advanced training, retraining or to obtain degrees has stabilized the enrollment levels. The following table presents comparative data for Puerto Rico and the United States with respect to college age population and percentage of such population attending institutions of higher learning. Commonwealth of Puerto Rico Trend in College Enrollment Commonwealth of Puerto Rico Mainland United States Population Higher Population Higher Academic Years Education Years Education Year of Age (2) Enrollment Percent (1) of Age (2) Enrollment Percent (1) ,448 57, % 23,714,000 8,580, % , , % 30,022,000 12,096, % , , % 26,961,000 13,621, % , , % 27,143,455 15,312, % , , % 27,968,162 15,928, % , , % 28,442,293 16,612, % , , % 28,923,731 16,910, % , , % 29,245,102 17,095, % (1) Number of persons of all ages enrolled in higher education as a percent of population of years of age. (2) Estimated. Source: United States Census Bureau (Mainland United States Population), United States National Center for Education Statistics, Planning Board (Puerto Rico Population) and Council on Higher Education of Puerto Rico. 36

37 Private Higher Education in Puerto Rico Private institutions, along with public institutions, provide academic programs in liberal arts, education, business, natural sciences, technology, secretarial and computer sciences, nursing, medicine and law. Degrees are offered by these institutions at the associate, bachelor, master s and doctorate levels. Since the early 1970s, enrollment at the private higher education institutions has increased and in recent years has represented between 57% and 65% of all students attending higher education institutions in Puerto Rico. Nevertheless, in the last few years the percentage of students enrolled at public institutions has risen considerably as a result of a relaxation in the admission policy of the University of Puerto Rico (UPR). The UPR is a public institution and is the largest and most selective in Puerto Rico. The following table presents data on college and university enrollment in Puerto Rico since Higher Education Enrollment in Puerto Rico Enrollment Enrollment Academic in Public in Private College Year Total Institutions and Universities ,015 73, , ,229 74, , ,552 73, , ,842 74, , ,791 74, ,735 Source: Puerto Rico Planning Board and Council on Higher Education. The University System s Market Share The following table reflects the data (academic year ) published by the Puerto Rico Council on Higher Education in terms of enrollment for the largest higher education institutions. The enrollment data for the University System includes students attending the Orlando, Florida campus, which are not included in previous enrollment figures for the University System. Three of the top four institutions are private universities, and when combined, represent approximately 40% of the students attending higher education institutions. Institution Affiliation Enrollment Market Share University of Puerto Rico Public 68, % Interamerican University of Puerto Rico Private 43, % Ana G. Méndez University System Private 31, % Pontifical Catholic University of Puerto Rico Private 10, % Source: Puerto Rico Planning Board and Council on Higher Education. 37

38 TAX MATTERS In the opinion of Squire, Sanders & Dempsey L.L.P., Bond Counsel, under existing law, (i) interest on the Series 2006 Bonds is excluded from gross income for federal income tax purposes under Section 103 of the Internal Revenue Code of 1986, as amended (the Code ), and is not an item of tax preference for purpose of the federal alternative minimum tax imposed on individuals and corporations, and (ii) the Series 2006 Bonds and the interest thereon are exempt from state, Commonwealth of Puerto Rico and local income tax. An opinion to those effects will be included in the legal opinion of Bond Counsel (the form of opinion to be delivered by Bond Counsel is set forth in Appendix C to this Official Statement). Bond Counsel will express no opinion as to any other tax consequences regarding the Series 2006 Bonds. The opinion on federal tax matters will be based on and will assume the accuracy of certain representations and certifications, and continuing compliance with certain covenants of the University System and the Authority to be contained in the transcript of proceedings and that are intended to evidence and assure the foregoing, including that the Series 2006 Bonds are and will remain obligations the interest on which is excluded from gross income for federal income tax purposes. Bond Counsel will also rely on the opinion of José de la Cruz Skerrett, Esq., counsel for the University System, as to all matters concerning the status of the University System as an organization described in Section 501(c)(3) of the Code and exempt from federal income tax under Section 501(a) of the Code. Bond Counsel will not independently verify the accuracy of those certifications and representations, that compliance or the opinion of counsel for the University System. The Code prescribes a number of qualifications and conditions for the interest on state and local government obligations to be and to remain excluded from gross income for federal income tax purposes, some of which require future or continued compliance after issuance of the obligations in order for the interest to be and to continue to be so excluded from the date of issuance. Noncompliance with these requirements by the University System or the Authority may cause the interest on the Series 2006 Bonds to be included in gross income for federal income tax purposes and thus to be subject to federal income tax retroactively to the date of issuance of the Series 2006 Bonds. The University System and, subject to certain limitations, the Authority have each covenanted to take the actions required of it for the interest on the Series 2006 Bonds to be and to remain excluded from gross income for federal income tax purposes, and not to take any action that would adversely affect the exclusion. A portion of the interest on the Series 2006 Bonds may be subject to a federal corporate alternative minimum tax. In addition, interest on the Series 2006 Bonds may be subject to a federal branch profits tax imposed on certain foreign corporations doing business in the United States and to a federal tax imposed on excess net passive income of certain S corporations. Under the Code, the exclusion of interest from gross income for federal income tax purposes may have certain adverse federal income tax consequences on items of income, deduction or credit for certain taxpayers, including financial institutions, certain insurance companies, recipients of Social Security and Railroad Retirement benefits, those that are deemed to incur or continue indebtedness to acquire or carry tax-exempt obligations, and individuals otherwise eligible for the earned income tax credit. The applicability and extent of these or other tax consequences depends upon the particular tax status or other tax items of the owner of the Series 2006 Bonds. Bond Counsel will express no opinion regarding such consequences. Ownership of tax-exempt obligations, including the Series 2006 Bonds, may also result in collateral income tax consequences under Puerto Rico law to financial institutions doing business in Puerto Rico. Purchasers of the Series 2006 Bonds at other than their original issuance at their respective prices indicated on the inside cover of this Official Statement should consult their own tax advisors regarding other tax considerations such as the consequences of market discount. Original Issue Premium The Series 2006 Bonds were offered and sold to the public at a price in excess of their stated redemption price (the principal amount) at maturity. That excess constitutes bond premium. For federal income tax purposes, bond premium is amortized over the period to maturity of a Series 2006 Bond, based on the yield to maturity of that Series 2006 Bond (or, in the case of a Series 2006 Bond callable prior to its stated maturity, the amortization period and yield may be required to be determined on the basis of an earlier call date that results in the lowest yield on that Series 2006 Bond), compounded semiannually. No portion of that bond premium is deductible by the owner of a Series 2006 Bond. For purposes of determining the owner s gain or loss on the sale, redemption (including redemption at maturity) or other disposition of a Series 2006 Bond, the owner s tax basis in the Series

39 Bond is reduced by the amount of bond premium that accrues during the period of ownership. As a result, an owner may realize taxable gain for federal income tax purposes from the sale or other disposition of a Series 2006 Bond for an amount equal to or less than the amount paid by that owner for that Series 2006 Bond. A purchaser of a Series 2006 Bond in the initial public offering at the price for that Series 2006 Bond stated on the inside cover of this Official Statement who holds that Bond to maturity (or, in the case of a callable Series 2006 Bond, to its earlier call date that results in the lowest yield on that Series 2006 Bond) will realize no gain or loss upon the retirement of that Series 2006 Bond. Owners of Series 2006 Bonds should consult their own tax advisers as to the determination for federal income tax purposes of the amount of bond premium properly accruable in any period with respect to the Series 2006 Bonds and as to other federal tax consequences and the treatment of bond premium for state and local taxes on, or based on, income. The Authority THE AUTHORITY AND GOVERNMENT DEVELOPMENT BANK FOR PUERTO RICO The Authority is a body corporate and politic constituting a public corporation and governmental instrumentality of Puerto Rico. The Legislature of Puerto Rico determined that the development and expansion of commerce, industry, health services and education within Puerto Rico are essential to the economic growth of Puerto Rico and to attain full employment and preserve the health, welfare, safety and prosperity of all its citizens. The Legislature also determined that adequate higher educational facilities were needed for the academic training and improvement of the citizens of Puerto Rico. The Authority was created under Act No. 121 of the Legislature of Puerto Rico, approved on June 27, 1977, as amended (the Act ), for the purpose of promoting the economic development, health, welfare and safety of the citizens of Puerto Rico. The Authority is authorized to borrow money through the issuance of revenue bonds and to loan the proceeds thereof to finance the acquisition, construction and equipping of industrial, tourist, medical, educational, pollution control and solid waste disposal facilities. Any such bonds, other than Additional Bonds issued on behalf of the University System, would be issued pursuant to trust agreements or resolutions separate from and unrelated to the Indenture and would be payable from sources other than payments under the Loan Agreement. The Authority has no taxing power. The offices of the Authority are located at Government Development Bank for Puerto Rico, Minillas Government Center, De Diego Avenue, Stop 22, San Juan, Puerto Rico The Authority s telephone number is (787)

40 Governing Board of the Authority The Act provides that the governing board of the Authority (the Governing Board ) shall consist of seven members. The President of Government Development Bank for Puerto Rico ( GDB ), the Executive Director of the Puerto Rico Industrial Development Company, the Executive Director of Puerto Rico Infrastructure Financing Authority, the President of the Puerto Rico Environmental Quality Board and the Executive Director of the Puerto Rico Tourism Company are each ex officio members of the Governing Board. The remaining two members of the Governing Board are appointed by the Governor of Puerto Rico for terms of four years. There are currently two vacancies on the Governing Board. The following individuals are the current members of the Governing Board: Name Position Term Occupation Alfredo Salazar Chairperson Indefinite Acting President, Government Development Bank for Puerto Rico Carlos W. López Member Indefinite President, Puerto Rico Environmental Quality Board Terestella González Denton Member Indefinite Executive Director, Puerto Rico Tourism Company Jorge P. Silva-Puras Member Indefinite Executive Director, Puerto Rico Industrial Development Company Guillermo M. Riera Member Indefinite Executive Director, Puerto Rico Infrastructure Financing Authority The Act provides that the affirmative vote of four members is sufficient for any action taken by the Governing Board. The following individuals are currently officers of AFICA: Jorge Irizarry, Executive Director of AFICA, is also Executive Vice President of GDB. He was appointed to these positions in Mr. Irizarry has over 30 years of experience in banking, investments, and consulting, which he acquired while working at Chase Manhattan, Booz Allen Hamilton, Inc., Banco Mercantil, Banco de Ponce, PaineWebber, Inc., and Sandoval Associates. Mr. Irizarry has a Bachelor s degree in finance from New York University and holds a Master s in Business Administration from Harvard Business School. Minia González Alvarez, Assistant Executive Director of AFICA, is also Senior Vice President and the Director of the Compliance Department at GDB, a position she assumed in Prior to that, Ms. González was the Executive Director of the Puerto Rico Housing Finance Corporation, a subsidiary of GDB, where she held various positions since Ms. González received a law degree from the Inter-American University of Puerto Rico in Olga Ortiz, Assistant Secretary of AFICA, is also Secretary of the Board of Directors of GDB. Outstanding Revenue Bonds and Notes of the Authority As of December 31, 2005, the Authority had revenue bonds and notes issued and outstanding in the principal amount of approximately $1.7 billion. All such bond and note issues, other than the Series 1999 Bonds, have been authorized and issued pursuant to trust agreements or resolutions separate from and unrelated to the Indenture and the Series 2002 Bonds and are payable from sources other than the payments under the Loan Agreement. 40

41 Under the Act, the Authority may issue additional bonds and notes from time to time to finance industrial, tourist, educational, medical, pollution control or solid waste facilities. However, any such bonds and notes (other than any Additional Bonds issued on behalf of the University System) would be authorized and issued pursuant to other trust agreements or resolutions separate from and unrelated to the Indenture and would be payable from sources other than the payments under the Loan Agreement. Government Development Bank for Puerto Rico As required by Act No. 272 of the Legislature of Puerto Rico, approved May 15, 1945, as amended, GDB has acted as financial advisor to the Authority in connection with the issuance and sale of the Series 2006 Bonds. GDB is a public corporation with varied governmental financial functions. Its principal functions are to act as financial advisor to, and fiscal agent for Puerto Rico, its instrumentalities, its municipalities and its public corporations in connection with the issuance of bonds and notes, to make advances to public corporations and to make loans to private enterprises that will aid in the economic development of Puerto Rico. The Underwriter has been selected by GDB to serve from time to time as underwriter of its obligations and the obligations of Puerto Rico, its instrumentalities and public corporations. The Underwriter or its affiliates also participate in other financial transactions with GDB. LEGAL INVESTMENT The Series 2006 Bonds will be eligible for deposit by banks in Puerto Rico to secure public funds and will be approved investments for insurance companies to qualify them to do business in Puerto Rico as required by law. RATING The Series 2006 Bonds have been assigned a rating of BBB- by Standard & Poor s Ratings Services, a division of The McGraw-Hill Companies, Inc. ( S&P ). The rating reflects only the opinion of S&P. Any explanation of the significance of the rating must be obtained from S&P. There is no assurance that the rating will continue for any given period of time or will not be revised downward or withdrawn entirely by S&P. Any such downward revision or withdrawal of the rating could have an adverse effect on the market prices of the Series 2006 Bonds. UNDERWRITING Under a Purchase Contract, the Underwriter has agreed, subject to certain conditions, to purchase the Series 2006 Bonds from the Authority at an aggregate discount of $209,230 from the initial public offering price set forth on the inside cover page hereof. If any of the Series 2006 Bonds are taken and paid for by the Underwriter, the Underwriter must take and pay for all of the Series 2006 Bonds. The Purchase Contract referred to above provides for the indemnification by the University System of the Authority and the Underwriter against certain civil liabilities. The offering price may be changed from time to time by the Underwriter. The Underwriter may offer and sell the Series 2006 Bonds to certain dealers (including dealers depositing the Series 2006 Bonds into investment trusts) and others at prices lower than the offering price stated on the inside cover page of this Official Statement. LEGAL MATTERS The validity of the obligations of the University System under the Loan Agreement and certain other documents will be passed upon by Fiddler González & Rodríguez, LLP, San Juan, Puerto Rico. In addition, José de la Cruz Skerrett will give an opinion as to certain litigation and other matters. Legal matters incident to the authorization, issuance and sale by the Authority of the Series 2006 Bonds are subject to the unqualified approving opinion of Squire, Sanders & Dempsey L.L.P., Bond Counsel. Certain legal matters will be passed upon for the Underwriter by O Neill & Borges, San Juan, Puerto Rico. 41

42 CONTINUING DISCLOSURE COVENANT The University System will enter into a Continuing Disclosure Agreement with the Trustee wherein the University System will covenant for the benefit of the Bondholders and the Beneficial Owners of the Series 2006 Bonds to file within 150 days after the end of each fiscal year, with each nationally recognized municipal securities information repository ( NRMSIR ) and with any Puerto Rico state information depository ( SID ), core financial information and operating data for such fiscal year, including (i) audited financial statements prepared in accordance with generally accepted accounting principles in effect from time to time, and (ii) operating data and data relating to its revenues, expenditures, financial operations and indebtedness of the type generally found in this Official Statement. The University System will covenant also to file in a timely manner, with each NRMSIR or with the Municipal Securities Rulemaking Board ( MSRB ), and with any Puerto Rico SID, notice of any of the following events with respect to the Series 2006 Bonds, if material: $ principal and interest payment delinquencies; $ non-payment related defaults; $ unscheduled draws on debt service reserves reflecting financial difficulties; $ unscheduled draws on credit enhancements reflecting financial difficulties; $ substitution of credit or liquidity providers, or their failure to perform; $ adverse tax opinions or events affecting the tax-exempt status of the Series 2006 Bonds; $ modifications to rights of holders of the Series 2006 Bonds; $ bond calls; $ defeasances; $ release, substitution, or sale of property securing repayment of the Series 2006 Bonds; and $ rating changes. The University System will also covenant to file in a timely manner with each NRMSIR and with any Puerto Rico SID notice of a failure by the University System to provide the required annual financial information on or before the specified date. These covenants have been made in order to assist the Underwriter in complying with paragraph (b)(5) of Rule 15c2-12 (the Rule ) promulgated by the Securities and Exchange Commission. The University System does not undertake to provide the above-described event notice of a scheduled redemption, not otherwise contingent upon the occurrence of an event, if the terms, dates and amounts of redemption are set forth in detail in this Official Statement. The University System expects to provide the core financial information and operating data described above by delivering its audited financial statements prepared in accordance with generally accepted accounting principles for the applicable fiscal year and a supplemental report containing the other core financial information and operating data described above by such deadline. As of the date of this Official Statement, there was no Puerto Rico SID, and the nationally recognized municipal securities information repositories are: Bloomberg Municipal Repository, 100 Business Park Drive, Skillman, New Jersey 08558; FT Interactive Data, Attention: NRMSIR, 100 William Street, 15 th Floor, New York, New York 10038; Standard & Poor s Securities Evaluations, Inc., 55 Water Street, 45 th Floor, New York, New York 10041; Thompson Financial - Munistatements, 395 Hudson Street, Third Floor, New York, New York 10004, Attn: Municipal Disclosure; and DPC Data Inc., One Executive Drive, Fort Lee, New Jersey The University System may from time to time choose to provide notice of the occurrence of certain other events in addition to those listed above if, in its judgment, such other events are material with respect to the Series 2006 Bonds, but the University System does not undertake to provide any such notice of the occurrence of any material event except those events listed above. The University System acknowledges that its undertakings pursuant to the Rule described above are intended to be for the benefit of the Bondholders, and shall be enforceable by any such Bondholders; provided that the right to enforce the provisions of its undertaking shall be limited to a right to obtain specific enforcement of its obligations thereunder. Failure by the University System to comply with the undertaking will not constitute an event of default under the Loan Agreement, the Indenture or the 42

43 Series 2006 Bonds. Failure by the University System to comply with the undertaking must be reported in accordance with the Rule and must be considered by any broker, dealer or municipal securities dealer before recommending the purchase or sale of the Series 2006 Bonds in the secondary market. Consequently, any such failure may adversely affect the transferability and liquidity of the Series 2006 Bonds and their market prices. No Bondholder may institute any suit, action or proceeding at law or in equity for the enforcement of the foregoing covenants or for any remedy for breach thereof, unless such Bondholder shall have filed with the University System written notice of a request to cure such breach, and the University System shall have refused to comply within a reasonable time. All such proceedings shall be instituted only as specified in the Continuing Disclosure Agreement in any Federal or Puerto Rico court located in the Municipality of San Juan, and for the equal benefit of all bondholders benefited by the same or a substantially similar covenant, and no remedy shall be sought or granted other than specific performance by the University System of the covenant at issue. Notwithstanding the foregoing, no challenge to the adequacy of the information provided in accordance with the filings mentioned above may be prosecuted by any Bondholder except in compliance with the remedial and enforcement provisions contained in the Indenture. The above covenants may only be amended or waived if: (1) the amendment or waiver is made in connection with a change in circumstances that arises from a change in legal requirements, change in law, or change in the identity, nature or status of the University System; the covenants, as amended, or the provision as waived, would have complied with the requirements of the Rule at the time of award of the Series 2006 Bonds, after taking into account any amendments or change in circumstances; and the amendment does not materially impair the interests of the Bondholders, as determined by parties unaffiliated with the University System; or (2) all or any part of the Rule, as interpreted by the staff of the Securities and Exchange Commission at the date of the adoption of such interpretation, ceases to be in effect for any reason, and the University System elects that the above covenants shall be deemed amended accordingly. above. Any assertion of beneficial ownership must be filed, with full documentary support, as part of the written request described 43

44 MISCELLANEOUS There are appended to this Official Statement the financial statements of the University System as of and for the fiscal years ended July 31, 2005 and 2004, together with the independent auditor s report of Deloitte & Touche LLP for said years, forms of the Loan Agreement and the Indenture, and the form of opinion of Squire, Sanders & Dempsey L.L.P., Bond Counsel. The financial statements of Sistema Universitario Ana G. Méndez Incoporado and AGMUS Holding Management Inc., as of and for the years ended July 31, 2005 and 2004, included in Appendix A to this Official Statement have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report appearing therein. The execution and delivery of this Official Statement by its Assistant Executive Director has been duly authorized by the Authority, and this Official Statement has been approved by the University System. PUERTO RICO INDUSTRIAL, TOURIST, EDUCATIONAL, MEDICAL AND ENVIRONMENTAL CONTROL FACILITIES FINANCING AUTHORITY By: /s/ Minia González Alvarez Assistant Executive Director APPROVED: SISTEMA UNIVERSITARIO ANA G. MENDEZ, INCORPORADO By: /s/ José F. Méndez President 44

45 APPENDIX A Sistema Universitario Ana G. Méndez Incorporado and AGMUS Holding Management, Inc. Consolidated Financial Statements as of and for the Years Ended July 31, 2005 and 2004, Consolidating Schedules as of and for the Year Ended July 31, 2005, and Independent Auditors Report A-1

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48 A-4

49 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ, INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Consolidated Statement of Activities For the Year Ended July 31, 2005 Revenues, gains and other support: Temporarily Permanently Unrestricted Restricted Restricted Total Tuition and fees $ 133,150,642 $ - $ - $ 133,150,642 Less scholarships 8,786,904 8,786,904 Net tuition and fees 124,363, ,363,738 Contributions 1,279,431 1,279,431 Grants and contracts 23,378,392 23,378,392 Private gifts and grants 398, ,400 Investment income 897, ,534 1,238,026 Net appreciation of investments 2,330, ,798 2,553,647 Auxiliary enterprises 5,105,999 5,105,999 Other sources 6,052,594 6,052,594 Net assets released from restrictions 3,642,941 (3,642,941) Total revenues, gains and other support 165,772,005 (3,079,609) 1,677, ,370,227 Expenses and other deductions: Educational and general expenses: Instruction 80,490,586 80,490,586 Research 874, ,923 Public service 10,482,823 10,482,823 Academic support 13,549,029 13,549,029 Student services 18,836,939 18,836,939 Institutional support 33,090,815 33,090,815 Total educational and general expenses 157,325, ,325,115 Auxiliary enterprises 5,088,044 5,088,044 Total expenses and other deductions 162,413, ,413,159 Change in net assets before minimum pension liability adjustment 3,358,846 (3,079,609) 1,677,831 1,957,068 Minimum pension liability adjustment (431,401) (431,401) Change in net assets 2,927,445 (3,079,609) 1,677,831 1,525,667 Net assets at beginning of year 76,190,051 11,228,268 4,150,940 91,569,259 Net assets at end of year $ 79,117,496 $ 8,148,659 $ 5,828,771 $ 93,094,926 See notes to consolidated financial statements. A-5

50 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ, INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Consolidated Statement of Activities For the Year Ended July 31, 2004 Temporarily Permanently Unrestricted Restricted Restricted Total Revenues, gains and other support: Tuition and fees $ 118,884,357 $ - $ - $ 118,884,357 Less scholarships 6,582,488 6,582,488 Net tuition and fees 112,301, ,301,869 Contributions 528, ,600 Grants and contracts 20,204,529 20,204,529 Private gifts and grants 263, ,342 Investment income 717, ,093 1,031,108 Net appreciation of investments 1,304, ,285 1,677,444 Auxiliary enterprises 4,664,739 4,664,739 Other sources 7,102,209 7,102,209 Net assets released from restrictions 510,000 (310,000) (200,000) Total revenues, gains and other support 147,067, , , ,773,840 Expenses and other deductions: Educational and general expenses: Instruction 74,363,425 74,363,425 Research 199, ,090 Public service 9,344,258 9,344,258 Academic support 12,100,567 12,100,567 Student services 17,899,400 17,899,400 Institutional support 27,584,087 27,584,087 Total educational and general expenses 141,490, ,490,827 Auxiliary enterprises 4,239,124 4,239,124 Total expenses and other deductions 145,729, ,729,951 Change in net assets before minimum pension liability adjustment 1,337, , ,600 2,043,889 Minimum pension liability adjustment (3,048,469) (3,048,469) Change in net assets (1,710,558) 377, ,600 (1,004,580) Net assets at beginning of year 77,900,609 10,850,890 3,822,340 92,573,839 Net assets at end of year $ 76,190,051 $ 11,228,268 $ 4,150,940 $ 91,569,259 See notes to consolidated financial statements. A-6

51 SISTEMA UNIVERSITARIO ANA G. MENDEZ, INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Consolidated Statements of Cash Flows For the Years Ended July 31, 2005 and Cash flows from operating activities: Change in net assets $ 1,525,667 $ (1,004,580) Adjustments to reconcile change in net assets to net cash provided by operating activities: Private gifts and grants received for investments (398,400) (528,600) Depreciation and amortization of property, plant and equipment 12,964,827 11,081,465 Contribution of property, plant and equipment (1,279,431) (37,433) Net appreciation of investments (2,553,647) (1,677,444) Amortization of original issue discount 27,781 23,216 Amortization of debt issue costs 83,664 80,486 Impairment of property, plant and equipment 135,143 Loss on disposal and expropriation of property, plant and equipment 582,145 Minimum pension liability adjustment 592,276 2,947,759 Participation in (income) loss of unconsolidated subsidiary (121,865) 102,106 Changes in: Receivables (3,823,727) (3,339,564) Inventories (285,400) (198,200) Prepaid expenses and deferred charges (89,581) (464,739) Intangible asset 118,212 (630,626) Accounts payable and other liabilities 4,102,931 3,105,661 Total adjustments 10,054,928 10,464,087 Net cash provided by operating activities 11,580,595 9,459,507 Cash flows from investing activities: Purchase of property, plant and equipment (24,606,928) (18,025,143) Proceeds from expropriation of property, plant and equipment 113,500 Decrease (increase) in restricted cash 2,439 (1,647) Investment in unconsolidated subsidiary (500,000) Purchase of investments (41,840,602) (32,677,324) Proceeds from sales and redemptions of investments 46,441,320 31,581,406 Change in loans receivable (111,061) 8,623 Decrease in deposits held in trust 546, ,226 Net cash used in investing activities (19,455,006) (19,445,859) Cash flows from financing activities: Proceeds from gifts and grants received for investments 398, ,600 Payments of loans and notes payable (73,912,674) (67,844,721) Proceeds from loans and notes payable 82,736,015 79,368,872 Increase in advances from federal government for student loans 77,506 1,463 Payments of debt issue costs (68,695) Payments of obligations under capital leases (2,275,115) (2,189,954) Net cash provided by financing activities 7,024,132 9,795,565 Net decrease in cash and cash equivalents (850,279) (190,787) Cash and cash equivalents at beginning of year 1,929,823 2,120,610 Cash and cash equivalents at end of year $ 1,079,544 $ 1,929,823 Supplemental disclosure of cash flow information: Cash paid for interest $ 5,314,174 $ 4,578,052 Property, plant, and equipment acquired through capital leases $ 3,117,581 $ 2,155,062 Property, plant, and equipment acquired through long-term debt $ 3,298,291 $ - See notes to consolidated financial statements. A-7

52 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements As of and for the Years Ended July 31, 2005 and 2004 (1) Organization and Summary of Significant Accounting Policies Sistema Universitario Ana G. Méndez, Incorporado (the Institution or SUAGM ) is a private, nonprofit, educational institution incorporated under the laws of the Commonwealth of Puerto Rico. The Institution operates three educational institutions in Puerto Rico and a noncommercial public television station: Universidad Metropolitana; Universidad del Este; Universidad del Turabo; and WMJT, Channel 40. The Institution, as a nonprofit organization, is exempt from the payment of income taxes under Federal and Commonwealth of Puerto Rico laws and from taxes on property devoted to education.. AGMUS Holding Management, Inc. ( AGMUS ) is a wholly owned subsidiary of the Institution. Plaza Metropolitana, Inc. ( Plaza ), a wholly owned subsidiary of AGMUS, is engaged in real estate management and generates unrelated business income. AGMUS and Plaza, for profit corporations, elected to be treated as a special partnership for income tax purposes and therefore, are not subject to tax. Instead, the partners report their distributive share of the earnings or losses of AGMUS and Plaza in their individual income tax returns. AGMUS Ventures, Inc. ( AVI ) is a Delaware for profit corporation that was created for the development of selected accelerated adult degree bilingual academic programs and for the delivery of those programs to adult learners initially in the Orlando, Florida area, through the SUAGM institutions. AVI is a 50% owned subsidiary of SUAGM. The other 50% owner is New Ventures in Higher Education, Inc. (NV), a Colorado non profit corporation that has developed a proprietary learning system for the creation and delivery of credit generating, accelerated academic degree and non degree programs for adult learners. The significant accounting policies followed by the Institution are set forth below: (a) Principles of Consolidation The consolidated financial statements include the accounts of the Institution, and it s wholly owned subsidiary AGMUS. All material intercompany balances and transactions have been eliminated in consolidation. (b) Accrual Basis The consolidated financial statements of the Institution have been prepared on the accrual basis of accounting. A-8

53 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements (c) Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements and revenues and expenses recognized during the reporting period. Actual results could differ from those estimates. (d) Basis of Presentation Net assets and revenues, expenses, gains, and losses are classified based on the existence or absence of donor-imposed restrictions. Accordingly, net assets of the Institution and changes therein are classified as follows: Unrestricted net assets Net assets that are not subject to donor-imposed stipulations. Temporarily restricted net assets Net assets subject to donor-imposed stipulations that may or will be met either by actions of the Institution and/or the passage of time. Permanently restricted net assets Net assets subject to donor-imposed stipulations that must be maintained permanently by the Institution. Generally, the donors of these assets permit the Institution to use all or part of the income earned on related investments for general or specific purposes. Revenues from sources other than contributions are reported as increases in unrestricted net assets. Contributions are reported as increases in the appropriate category of net assets, except contributions that impose restrictions that are met in the same fiscal year they are received, which are included in unrestricted revenues. Expenses are reported as decreases in unrestricted net assets. Gains and losses on investments are reported as increases or decreases in unrestricted net assets unless their use is restricted by explicit donor stipulation or by law. Expirations of temporary restrictions recognized on net assets (i.e., the donor stipulated purpose has been fulfilled and/or the stipulated time period has elapsed) are reported as reclassifications from temporarily restricted net assets to unrestricted net assets. Temporary restrictions on gifts to acquire long-lived assets are considered met in the period in which the assets are acquired or placed in service. (e) Cash Equivalents The Institution considers all highly liquid instruments purchased with an original maturity of three months or less from the date of acquisition to be cash equivalents. A-9

54 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements (f) Contributions Contributions, including unconditional promises to give, are recorded as revenue in the period received. Contributions received with donor-imposed restrictions that are met in the same fiscal year are reported as revenue from unrestricted net assets. Conditional promises to give are not recognized as revenue until they become unconditional, that is, when the conditions on which they depend are substantially met. Contributions of assets other than cash are recorded at their estimated fair value at the date of gift. Contributions to be received after one year are discounted, if practicable, at an appropriate discount rate commensurate with the risk involved. An allowance for uncollectible contributions receivable is provided, if necessary, based upon management s judgment including factors such as prior collection history, type of contribution and nature of fund-raising activity. (g) Inventories Inventories, which consist principally of books and other merchandise for resale, are stated at the lower of average cost or market. (h) Investments The Institution accounts for its investments under the provisions of Statement of Financial Accounting Standards No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, which requires that the investments in equity securities with readily determinable fair values and all investments in debt securities be stated at fair value with unrealized gains and losses, as applicable, included in the statement of activities. Fair value of marketable debt and equity securities is determined by quoted market prices of such securities at the consolidated statement of financial position date. (i) Discount on Loans Payable and Debt Issue Costs Discount on loans payable and debt issue costs are deferred and amortized over the term of the debt using a method which approximates the interest method. (j) Property, Plant and Equipment Property, plant and equipment are stated at cost at date of acquisition or fair value at date of donation in the case of gifts. A-10

55 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements Depreciation and amortization are provided using the straight-line method over the estimated useful life of the respective assets as follows: Useful life Buildings Building improvements Equipment including computers Library books Vehicles Software 50 years 15 years 5 years 5 years 5 years 7 years Equipment held under capital leases is amortized over a period of 10 years or the lease term, whichever is shorter. All construction in progress is carried in a temporary account until the construction is completed, at which time a transfer is made to the appropriate property, plant or equipment account. (k) Broadcasting Costs Costs associated with license agreements for program materials broadcasted by WMTJ, Channel 40 are deferred and included as prepaid expenses and deferred charges. These costs are generally amortized over the license period or usage of the programs. Barter transactions are reported at the estimated fair value of the products or services received. Barter revenue is recorded when merchandise or services are received or used. (l) United States Government Grants and Contracts Revenue Revenue from United States government grants and contracts is recognized as it is spent in accordance with the grant agreements. Funds received for student financial assistance (principally Pell Grant and Direct Loans) that are awarded directly to students are excluded from revenues and expenses. (m) Refundable Advances from the United States Government Advances from the federal government under the Perkins loan program are distributable to the federal government upon liquidation of the fund and, thus, the corresponding balances are reflected as a liability in the accompanying consolidated statements of financial position. A-11

56 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements (n) Functional Expense Allocation Expenses are reported in the consolidated statements of activities in categories recommended by the National Association of College and University Business Officers (NACUBO). The Institution s primary program services are instruction and public service. Expenses reported as academic support, student services, and auxiliary enterprises are incurred in support of the Institution s primary program. Institutional support mainly includes management and general expenses. Certain expenses such as operation and maintenance of plant, depreciation, and interest costs, which are related to more than one category, are allocated among the appropriate categories based primarily on equipment usage and building square footage. (o) Reclassifications Certain reclassifications have been made to the 2004 financial statements to conform them to the current year presentation. (2) Receivables Accounts receivable at July 31, 2005 and 2004 consist of the following: Student accounts receivable $ 6,112,873 $ 5,500,028 Contributions receivable 1,176,694 1,197,818 Loan receivable 156,007 44,946 Other receivables (grants) 13,088,173 9,841,865 Less allowance for doubtful accounts 20,533,747 16,584, , ,810 Receivables, net $ 19,645,635 $ 15,710,847 (3) Investments The fair value of investments as of July 31, 2005 and 2004 is as follows: U.S. government securities $ 5,531,126 $ 3,442,773 Corporate bonds 5,076,460 6,938,793 Equity securities 16,823,844 19,970,770 Mortgage backed securities 4,101,698 4,612,171 Asset backed securities 627,425 Shares of registered investment companies (mutual funds) 3,494,845 2,737,962 $ 35,655,398 $ 37,702,469 A-12

57 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements The composition of total investment return for the years ended July 31, 2005 and 2004 is as follows: Interest $ 1,113,919 $ 1,021,480 Dividends 476, ,606 Investment expenses (352,891) (303,978) 1,238,026 1,031,108 Net appreciation ofinvestments 2,553,647 1,677,444 Totalinvestment return $ 3,791,673 $ 2,708,552 (4) Property, Plant and Equipment Property, plant, and equipment at July 31, 2005 and 2004 are summarized as follows: Land $ 29,874,005 $ 24,468,010 Buildings andimprovements 161,480, ,332,413 Equipment 61,412,635 57,924,300 Library books 9,746,536 8,561,729 Vehicles 1,831,754 1,743,614 Software 2,995,333 2,508,665 Works of art 586, ,835 Construction in progress 17,568,093 8,649,979 Less accumulated depreciation and amortization 285,495, ,746,545 91,154,915 78,912,200 Property, plant, and equipment, net $ 194,340,961 $ 175,834,345 (5) Impairment of long-lived assets In connection with the expropriation described in Note 13, during the year ended July 31, 2005 Plaza evaluated the recoverability of its long-lived assets and recorded a loss of $135,143 because it was determined that the carrying value of certain assets within property, plant and equipment will not be recoverable. Such amount was recorded within the auxiliary enterprise expenses in the accompanying 2005 consolidated statement of activities. (6) Leases The Institution is obligated under various capital leases for equipment that expire at various dates during the next five years. A-13

58 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements At July 31, 2005 and 2004, the gross amount of equipment and the related accumulated amortization recorded under capital leases and included in property, plant and equipment in the accompanying consolidated statements of financial positions follows: Equipment $ 9,175,211 $ 9,339,257 Less accumulated amortization 3,658,292 4,526,369 Equipment, net $ 5,516,919 $ 4,812,888 Amortization of equipment under capital leases is included in depreciation and amortization expense. Future minimum capital lease payments as of July 31, 2005 are as follows: Year ending July 31, Amount 2006 $ 2,427, ,873, ,167, , ,685 Total minimum lease payments 6,272,605 Less amount representing interest (at rates ranging from 5.50% to 9.10%) 605,949 Net minimum capital lease payments $ 5,666,656 A-14

59 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements (7) Notes Payable Notes payable as of July 31, 2005 and 2004 consist of the following: Credit agreement with commercial bank permitting borrowings up to $10,000,000, bearing interest at 1.75% over 3 month LIBOR (3.69% and 1.69% at July 31, 2005 and 2004, respectively), and due on demand. $ 8,700,000 $ 10,000,000 Credit agreement with commercial bank permitting borrowings up to $10,000,000, bearing interest at 1.75% over 3 month LIBOR (3.69% and 1.69% at July 31, 2005 and 2004, respectively), and due on demand. 7,300,000 7,500,000 Unsecured revolving credit agreement with commercial bank permitting borrowings up to $10,000,000, bearing interest at rates ranging from 5.02% through 5.15% and due on demand. 8,400,000 5,500,000 Credit agreement with commercial bank permitting borrowings up to $5,000,000, bearing interest at 1.75% over 3 month LIBOR (1.69% at July 31, 2004), and due on demand. 4,000,000 Credit agreement with commercial bank permitting borrowings up to $5,000,000, bearing interest at 1.75% over 3 month LIBOR (3.69% at July 31, 2005), and due on demand. 5,000,000 Notes payable to the U.S. Department of Agriculture's Farmers Home Administration, bearing interest at 5%, payable in aggregate semiannual installments of $146,600, including interest through 2021, and secured with first mortgages on two properties. 2,950,207 3,090,404 Notes payable to a commercial bank, permitting borrowings up to $9,000,000, payable in eighty-four (84) monthlyprincipal installments, computed on the basis of a 25 year amortization schedule, beginning on September 1, 2004, plus interest at 2.25% over 3 month LIBOR (3.69% and 1.69% at July 31, 2005 and 2004, respectively) and a lump-sum payment for the then outstanding balance on August 1, 2011, and collateralized with first and second mortgages over real estate properties and a certificate of deposit of $175,000. 6,394,978 6,520,237 Note payable to a commercial bank, payable in seventy nine (79) monthlyprincipal installments, computed on the basis of a 25 year amortization schedule, beginning on March 1, 2005, plus interest at 2.25% over 3 month LIBOR (3.69% at July 31, 2005) and a lump sum payment for the then outstanding balance on September 1, 2011, and collateralized with first and second mortgages over real estate properties and a certificate of deposit of $175,000. 3,473,535 Note payable to a commercial bank, bearing interest at 1.75% over 3 month LIBOR (3.69% and 1.69% at July 31, 2005 and 2004, respectively), payable on the first day of each month, and due no later than June 24, ,367,336 3,849,136 A-15

60 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements Note payable to a commercial bank, bearing interest at 2.00% over 3 month LIBOR (3.69% and 1.69% at July 31, 2005 and 2004, respectively), payable in full or in par, and due no later than December, ,901,494 3,710,388 Note payable to a commercial bank, payable in thirty-five (35) monthly installments of $6,667 plus interest at.5 over prime rate (6.25% and 4.25% at July 31, 2005 and 2004, respectively), commencing on December 1, 2003, and a final installment of $166,666 in December 2006, and secured by equipment. 273, ,333 Note payable to a commercial bank, payable in fifty-nine (59) monthly principal installments of $6,166 plus interest at 2.00% over 3 month LIBOR (3.69% and 1.69% at July 31, 2005 and 2004, respectively), commencing on June 2, 2004, and a final installment of $6,206 plus interest on May 2, , ,668 Note payable to a commercial bank, payable in monthly installments, bearing interest at 6.25%, maturing in January 2006, and secured by equipment. 7,173 23,934 Total $ 59,051,732 $ 44,905,100 The Institution has available $10,600,000 of unused lines of credit for its operations at July 31, Aggregate maturities on notes payable as of July 31, 2005, are summarized as follows: Year ending July 31, Amount 2006 $ 46,170, , , , ,952 Thereafter 11,066,150 Total $ 59,051,732 (8) Loans Payable The Institution has entered into various loan agreements with the Puerto Rico Industrial, Tourist, Educational, Medical and Environmental Control Financing Authority ( AFICA ). The net proceeds of these loans were used to acquire, construct and improve the facilities and equipment of the Institution, to refinance certain outstanding indebtedness, to create certain reserve accounts, and to pay for bond issuance costs. A-16

61 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements In July 1998, the Institution entered into a loan agreement with AFICA under which AFICA issued $26,700,000 in Higher Education Revenue Bonds ( AFICA 1998 ). The proceeds of these bonds were loaned to the Institution by AFICA under the loan agreement. The net proceeds from these bonds have been and are being used to: a) refund, on a current basis, $9,100,000 principal amount of the AFICA 1991 bond issuance (issued in the original amount of $14,100,000), which represents all of the series bonds outstanding on the date of issuance of the new bonds; b) finance the cost of acquisition, construction, remodeling, improvement and equipping of certain educational facilities owned or to be owned by the Institution, c) deposit moneys to the credit of the Reserve Account in the amount of the Reserve Requirement for the bonds; and d) pay certain expenses of the offering of the bonds. The interest rate on the loans related to the AFICA 1998 bonds is subject to determination periodically by the remarketing agent. The average rate related to the AFICA 1998 bonds was approximately 2.72% and 2.33% at July 31, 2005 and 2004, respectively. The AFICA 1998 bonds are secured by an irrevocable letter of credit totaling $25,604,708 issued by a commercial bank. Effective October 14, 2003 the irrevocable letter of credit was extended to October 15, The face amount of the letter of credit was amended to $24,766,000. All other terms and conditions remain unchanged. During 1999, the Institution entered into a loan agreement with AFICA in connection with the issuance of Higher Education Revenue Bonds in July 1999 amounting to $41,870,000 ( AFICA 1999 ). The net proceeds from this loan have been and are being used to: (a) redeem the $22,700,000 principal amount of the AFICA 1995 bond issuance, which represents all of the series bonds outstanding on the date of issuance of the bonds; (b) finance part of the acquisition, construction, remodeling, improving and equipping of certain educational facilities of the Institution; (c) deposit monies to the credit of the Reserve Account; (d) pay capitalized interest on a portion of AFICA 1999 bonds; and (e) pay certain expenses of the offering of the bonds. The AFICA 1999 consists of $8,055,000 serial bonds, $11,945,000 term bonds due February 1, 2019, and $21,870,000 term bonds due February 1, The proceeds from the sale of the bonds were lent to the Institution by AFICA under the loan agreement. Interest rate on the loan ranges from 5% to 5.38% based on the fixed rates established for each year of the bond series or term. The maturity dates and interest rates of these bonds are as follows: 5.00% due February 1, 2000 through February 1, 2010 $ 8,055, % due February 1, 2011 through February 1, ,815,000 $ 41,870,000 A-17

62 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements During 2002, the Institution entered into a loan agreement with AFICA in connection with the issuance of Higher Education Revenue Bonds in February 1, 2002 amounting to $20,365,000 ( AFICA 2002 ). The net proceeds from this loan have been and are being used to: (a) redeem the $16,337,512 principal amount of AFICA 1985, which represents all of the series bonds outstanding on the date of issuance of the bonds; (b) pay a note payable to a commercial bank; (c) deposit monies to the credit of the Reserve Account; and (d) pay certain expenses of the offering of the bonds. The maturity dates and interest rates of these bonds are as follows: 4.000% due December 1, 2002 through December 1, 2004 $ 935, % due December 1, 2005 through December 1, ,065, % due December 1, 2008 through December 1, ,225, % due December 1, 2011 through December 1, ,575, % due December 1, 2022 through December 1, ,565,000 $ 20,365,000 All of the AFICA bonds are solely payable from revenues derived by AFICA under the loan agreement with the Institution and from other moneys pledged for payment under the trust indenture. Under the trust agreement, the Institution is required to maintain construction and reserve fund accounts with the trustee that holds the proceeds from the issuance. The funds deposited with the trustee are restricted and, currently, are reserved for debt service (principal and interest). As of July 31, 2005 and 2004, the funds held in the reserve accounts are presented as deposits held in trust in the accompanying consolidated statements of financial position and are as follows: Interest bearing deposits United States Treasury Bills bonds, notes and strips $ 4,285,738 $ 4,832,064 1,848,000 1,848,000 $ 6,133,738 $ 6,680,064 A-18

63 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements Aggregate maturities of the loan agreements and unamortized original issue discount as of July 31, 2005 follow: Period ending AFICA AFICA AFICA July 31, Total 2006 $ 900,000 $ 830,000 $ 340,000 $ 2,070, ,000, , ,000 2,230, ,000, , ,000 2,295, ,100, , ,000 2,460, ,100,000 1,015, ,000 2,520,000 Thereafter 17,500,000 33,815,000 17,570,000 68,885,000 22,600,000 38,430,000 19,430,000 80,460,000 Unamortized original issue discount - (343,762) (237,358) (581,120) $ 22,600,000 $ 38,086,238 $ 19,192,642 $ 79,878,880 The loan, letter of credit and reimbursement agreements contain various covenants, which, among other things, require the Institution to comply with certain affirmative and negative covenants. (9) Employee Benefit Plans The Institution has a contributory defined benefit pension plan covering substantially all its employees. The plan covers, on a voluntary basis, employees over 21 years of age, with at least one year as a regular employee. The participating employees are required to contribute to the plan 3% to 5% of their annual compensation based on their salary range, and the Institution makes all additional contributions necessary to provide the benefits under the plan. The benefits are based on years of service and the employee s average compensation during the last five years of employment Projected benefit obligation at July 31 $ 30,521,254 $ 26,764,526 Fair value of plan assets at July 31 24,132,516 21,435,406 Funded status $ (6,388,738) $ (5,329,120) Amounts recognized in the consolidated statements of financial position consist of: Intangible asset $ 512,414 $ 630,626 Prepaid pension cost 452, ,336 Additional minimum liability (3,992,284) (3,679,095) Net amount recognized in the consolidated statements of financial position $ (3,027,621) $ (2,317,133) A-19

64 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements The accumulated benefit obligation at July 31, 2005 and 2004 amounted to $27,672,551 and $25,111,683, respectively. Weighted average assumptions as of July 31: Discount rate 6.4 % 7.0 % Expected return on plan assets 7.5 % 7.5 % Rate of compensation 5.0 % 4.5 % The benefit cost, employer contribution, participant contribution, and benefits paid for fiscal years 2005 and 2004 were as follows: Benefit cost $ 1,821,097 $ 1,119,211 Employer contribution $ 1,000,000 $ 1,835,823 Plan participant's contribution $ 542,010 $ 482,280 Benefits paid $ 908,373 $ 714,487 The Institution expects to contribute approximately $1.4 million for the plan year ending July 31, As of July 31, 2005, the following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: Year ending July 31, Amount 2006 $ 1,186, ,253, ,336, ,407, ,593,972 Years 2011 to ,368,803 The Institution also sponsors a defined contribution savings and investment plan in which every employee is eligible on or after the date the employee completes one year of service. Each participant may elect to contribute up to 10% of his/her compensation. The Institution contributes an amount equal to 35% of each participant s contribution, not to exceed 1% of the participant s compensation. The Institution recognized $219,436 and $215,566, during the years ended July 31, 2005 and 2004, respectively, as expense under the savings and investment plan. A-20

65 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements (10) Temporarily and Permanently Restricted Net Assets Temporarily restricted net assets mainly consist of federal grants received from the U.S. Department of Education under the Title III Program, Endowment Challenge Grant together with the income earned on that amount. The Institution matches these grants dollar for dollar. The federal grants and the Institution s contribution constitute the Endowment Fund Corpus. The Institution must invest and shall not expend the Endowment Fund Corpus for a period of 20 years. Afterwards, the Endowment Fund Corpus can be used for any educational purpose. Permanently restricted net assets consist of private gifts and grants invested in perpetuity. The majority of the income from these investments is expendable for scholarships. The temporarily restricted net assets as of July 31, 2005 and 2004 are divided as follows: Federal contributions ( grant years) $ 3,500,000 $ 4,250,000 Other contributions 111, ,000 Investment income 4,537,659 6,867,268 $ 8,148,659 $ 11,228,268 (11) Fair Value of Financial Instruments The fair value of financial instruments is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair values can vary from period to period based on changes in a wide range of assumptions and factors, including interest and market perceptions of values and as existing assets and liabilities run off and new items are generated. Management, using appropriate market information and other available information, has determined the estimated fair value amounts of the Institution s financial instruments. Considerable judgment is required to develop the estimated fair values; thus, the estimates provided herein are not necessarily indicative of the amounts that could be realized in the current market exchange. A-21

66 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements The following table presents the carrying amounts and estimated fair values of the Institution s financial instruments at July 31, 2005 and 2004: Carrying Estimated Carrying Estimated Financial Assets: Amount Fair Value Amount Fair Value Cash and cash equivalents $ 1,079,544 $ 1,080,000 $ 1,929,823 $ 1,930,000 Restricted cash 177, , , ,000 Net receivables (including loans receivables) 19,645,635 19,646,000 15,710,847 15,711,000 Investments 35,655,398 35,655,000 37,702,469 37,702,000 Deposits held in trust 6,133,738 6,134,000 6,680,064 6,680,000 Financial Liabilities: Accounts payable and other liabilities $ 22,414,797 $ 22,415,000 $ 18,311,866 $ 18,312,000 Obligations under capital leases 5,666,656 5,667,000 4,824,190 4,824,000 Notes payable 59,051,732 59,052,000 44,905,100 44,905,000 Loans payable 79,878,880 79,879,000 81,876,099 81,876,000 A reasonable estimate of the fair value of loans to students could not be made because these loans, which fall under the government loan program, are not saleable and can only be assigned to the United States government or its designee. The following methods and assumptions were used to estimate the fair value of each class of financial instruments. Cash and Cash Equivalents, Receivables (excluding loans), Deposits Held in Trust and Accounts Payable and Other Liabilities. The fair value of these instruments approximates their carrying amounts because of the shortterm maturity of these instruments. Investments The fair value of investment securities is estimated based on quoted market prices for those or similar investments. Notes Payable The carrying amount of notes payable approximates fair value because these financial instruments bear interest at variable rates, which approximates current market rates for indebtedness with similar maturities and credit quality. It is not practicable to estimate the fair value of loans payable because of the inability to estimate fair value without incurring excessive costs. However, management of the Institution believes that the fair value of such loans payables is not materially different from its corresponding carrying value. A-22

67 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements (12) Significant Group Concentration of Credit Risk Approximately 90% of the Institution s students participate in student financial assistance programs under Title IV of the Higher Education Act of 1965, as amended, ( Title IV Programs ) of the U.S. Department of Education. Financial instruments, which potentially expose the Institution to concentrations of credit risk, consist primarily of cash and cash equivalents, investments in marketable equity and debt securities, and receivables. The Institution s cash and cash equivalents and investment in securities are placed with a wide array of institutions with high credit ratings. The investment portfolio is diversified and includes high quality securities. Concentration of credit risk with respect to receivables is limited because a substantial portion of these balances is due from U.S. Federal and Puerto Rico government agencies. Regarding student accounts receivable, this consists of a large volume of small balances. The Institution has provided an allowance for doubtful accounts for expected losses, based on historical trends and other information. Management believes that the above concentrations of credit risk do not represent a material risk of loss with respect to its financial position as of July 31, 2005 and (13) Contingencies During 2002 the Puerto Rico Highway and Transportation Authority (the Authority ) requested through eminent domain square meters of the Plaza s property in Monacillos Ward, San Juan, consisting of 10,302 square meters and deposited with the court $113,500 to compensate for the taking of the property. On April 27, 2004, the Authority s Exhibit A was amended to extent the taking up to 2, square meters (the Expropriated Property ) and adjusted the compensation amount deposited with the court. During the year ended July 31, 2005, Plaza requested the withdrawal of the amended Exhibit A to effectively reduce the expropriation to the original square meters and recognized a loss of $28,370 as a result of the original expropriation. In connection with the amendment of Exhibit A, management has decided to reflect this transaction in the financial statements when this matter is resolved and accordingly, the accompanying consolidated financial statements do no reflect any adjustment resulting from this matter. Management is of the opinion that the fair value of the Expropriated Property exceeds both the compensation deposited with the court and its carrying value. Accordingly, Plaza has filed a claim against the Authority sustaining that the amount deposited with the court does not represent fair compensation. Based on consultation with legal counsel, management is of the opinion that the amount to be received in any event will represent a fair compensation which will be in close proximity to the carrying value. A-23

68 SISTEMA UNIVERSITARIO ANA G. MÉNDEZ INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. Notes to Consolidated Financial Statements Law No. 206 of August 18, 2003 created the Corredor Ecológico de San Juan (the Ecological Corridor). The Ecological Corridor comprehends approximately 1,000 cuerdas or approximately four million square meters in the immediate vicinity of and including the rental properties. The law instructs governmental agencies to stall any ongoing consideration of construction permits and prohibits future permits within the boundaries of the Ecological Corridor. Furthermore, this law empowers the Department of Natural and Environmental Resources ( DNRA ) to obtain control of all privately owned properties within the Ecological Corridor through the available legal means, including expropriation, conservation easements, etc. After discussions with counsel, management is currently evaluating different courses of action which will ensure that the carrying value of the rental properties is not adversely affected by this law and the current development limitations it places, and in the case the rental properties are expropriated, management is of the opinion that Plaza will receive fair compensation which will not be less than its carrying value. In both instances, after discussions with counsel, it is the opinion of management that the outcome of these matters will not have a material adverse impact on the financial position, results of operations or cash flows of Plaza. The Institution participates in various federally funded programs of the U.S. Department of Education including Title IV Programs. These financial assistance programs are routinely subject to financial and compliance audits in accordance with the provisions of the Office of Management and Budget Circular A-133 or to compliance audits by the guaranty and/or Federal agency. The reports on the audits of these programs, which are conducted pursuant to regulatory requirements by the external auditors of the Institution, are required to be submitted to both the Institution and the U.S. Department of Education. Such Federal agency has the authority to determine liabilities as well as to limit, suspend, or terminate Federal student financial assistance programs. Other federal programs are also subject to audit. Such audits could result in claims against the resources of the Institution. No provision has been made for any liability, which may arise from such audits since the amounts, if any, cannot be determined at this date. In addition, the Institution is a defendant in various lawsuits arising from its normal operations. It is management s opinion, after consulting with its legal counsel, that losses, if any, resulting from these lawsuits, will not have a material effect on the Institution s financial position and results of operations. (14) Commitments The Institution has incurred commitments to develop a capital improvement program with the purpose of acquiring, constructing, improving and equipping their educational facilities. Commitments for construction under the program as of July 31, 2005 amounted to approximately $1,628,834 and sources of funding have been retained. A-24

69 SISTEMA UNIVERSITARIO ANA G. MENDEZ, INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. CONSOLIDATING STATEMENT OF FINANCIAL POSITION INFORMATION As of July 31, 2005 A-25 SISTEMA UNIVERSITARIO AGMUS HOLDING CONSOLIDATING ANA G MENDEZ, INC. MANAGEMENT, INC. ENTRIES CONSOLIDATED Assets Cash and cash equivalents $ 965,782 $ 113,762 $ - $ 1,079,544 Restricted cash 177, ,491 Receivables, net 19,704, ,922 (253,612) 19,645,635 Inventories 2,087,896 2,087,896 Prepaid expenses and deferred charges 1,954,700 56,926 2,011,626 Investments 35,655,398 35,655,398 Investment in AGMUS Holding Management, Inc. 2,444,046 (2,444,046) - Investment in unconsolidated subsidiary 519, ,759 Deposits held in trust 6,133,738 6,133,738 Debt issue costs 1,569,403 46,454 1,615,857 Property, plant and equipment, net 182,186,429 12,154, ,340,961 Intangible asset 512, ,414 Total assets $253,733,890 $ 12,744,087 ($2,697,658) $263,780,319 Liabilities and Net Assets Accounts payable and other liabilities $ 22,236,881 $ 235,404 $ (57,488) $ 22,414,797 Obligations under capital leases 5,666,656 5,666,656 Due to Parent Company 196,124 (196,124) - Notes payable 49,183,219 9,868,513 59,051,732 Loans payable 79,878,880 79,878,880 Advances from federal government for student loans 133, ,293 Minimum pension liability 3,540,035 3,540,035 Total liabilities 160,638,964 10,300,041 (253,612) 170,685,393 Net assets: Unrestricted 79,117,496 2,444,046 (2,444,046) 79,117,496 Temporarily restricted 8,148,659 8,148,659 Permanently restricted 5,828,771 5,828,771 Total net assets 93,094,926 2,444,046 (2,444,046) 93,094,926 Total liabilities and net assets $ 253,733,890 $ 12,744,087 $ (2,697,658) $ 263,780,319

70 SISTEMA UNIVERSITARIO ANA G. MENDEZ, INCORPORADO AND AGMUS HOLDING MANAGEMENT, INC. CONSOLIDATING STATEMENT OF ACTIVITIES INFORMATION FOR THE YEAR ENDED JULY 31, 2005 SISTEMA UNIVERSITARIO AGMUS HOLDING CONSOLIDATING ANA G MENDEZ, INC. MANAGEMENT, INC. ENTRIES CONSOLIDATED Revenues, gains and other support: Tuition and fees $ 133,150,642 $ - $ - $ 133,150,642 Less scholarships 8,786,904 8,786,904 Net tuition and fees 124,363, ,363,738 Contributions 1,279,431 1,279,431 Grants and contracts 23,378,392 23,378,392 Private gifts and grants 398, ,400 Investment income 1,238,026 1,238,026 Net appreciation of investments 2,553,647 2,553,647 Auxiliary enterprises 4,381, , ,870 5,105,999 Other sources 6,052,594 6,052,594 Total revenues, gains and other support 163,645, , , ,370,227 A-26 Expenses and other deductions: Educational and general expenses: Instruction 80,648,557 (157,971) 80,490,586 Research 874, ,923 Public service 10,505,257 (22,434) 10,482,823 Academic support 13,575,761 (26,732) 13,549,029 Student services 18,873,825 (36,886) 18,836,939 Institutional support 33,155,567 (64,752) 33,090,815 Total educational and general expenses 157,633,890 (308,775) 157,325,115 Auxiliary enterprises 4,054,733 1,033,311 5,088,044 Total expenses and other deductions 161,688,623 1,033,311 (308,775) 162,413,159 Change in net assets before minimum pension liability adjustment 1,957,068 (497,645) 497,645 1,957,068 Minimum pension liability adjustment (431,401) (431,401) Change in net assets 1,525,667 (497,645) 497,645 1,525,667 Net assets at beginning of year 91,569,259 2,941,691 (2,941,691) 91,569,259 Net assets at end of year $ 93,094,926 $ 2,444,046 $ (2,444,046) $ 93,094,926

71 B-1 APPENDIX B

72 B-2

73 B-3

74 B-4

75 B-5

76 B-6

77 B-7

78 B-8

79 B-9

80 B-10

81 B-11

82 B-12

83 B-13

84 B-14

85 B-15

86 B-16

87 B-17

88 B-18

89 B-19

90 B-20

91 B-21

92 B-22

93 B-23