$224,145,000 REGENTS OF THE UNIVERSITY OF MICHIGAN General Revenue Bonds

Transcription

1 NEW ISSUE RATINGS BOOK-ENTRY-ONLY Moody s: Aaa/VMIG 1 Standard & Poor s: AAA/A-1+ In the opinion of Miller, Canfield, Paddock and Stone, P.L.C., Bond Counsel, subject to compliance with certain covenants, under existing law as presently interpreted, while the Bonds bear interest at the Daily Rate or the Weekly Rate (i) interest on the Bonds is excluded from gross income for federal income tax purposes, (ii) interest on the Bonds is not an item of tax preference for purposes of the federal alternative minimum tax imposed on individuals and corporations, and (iii) the Bonds and the interest thereon are exempt from all taxation in the State of Michigan, except inheritance and estate taxes, taxes on gains realized from the sale, payment or other disposition thereof and except as described herein with respect to certain taxpayers under the Michigan Business Tax Act. See TAX MATTERS herein and Appendix C hereto. $224,145,000 REGENTS OF THE UNIVERSITY OF MICHIGAN General Revenue Bonds $105,810,000 Series 2008A Due: April 1, 2038 CUSIP: HD5 $118,335,000 Series 2008B Due: April 1, 2028 CUSIP: HE3 Dated: Date of Delivery Price: 100% Unless converted, interest on the Regents of the University of Michigan General Revenue Bonds, Series 2008A (the Series 2008A Bonds ) will bear interest at the Daily Rate determined by the Remarketing Agent on each Business Day, payable in arrears, on the first Business Day of each month, commencing April 1, 2008, as more fully described herein. Unless converted, interest on the Regents of the University of Michigan General Revenue Bonds, Series 2008B (the Series 2008B Bonds, together with the Series 2008A Bonds, referred to hereinafter as the Bonds ) will bear interest at the Weekly Rate determined by the Remarketing Agent on the Business Day immediately preceding the first day of each Weekly Rate Period, payable in arrears, on the first Business Day of each month, commencing April 1, 2008, as more fully described herein. The initial interest rates on the Bonds will be determined by the Underwriter on or about March 5, The Bonds are being issued pursuant to a Trust Agreement, dated as of March 1, 2008 (the Trust Agreement ), between the Regents of the University of Michigan (the Issuer ) and U.S. Bank National Association, as trustee (the Trustee ), for the purpose of (a) paying costs of certain capital projects of the Issuer, (b) refunding certain outstanding indebtedness of the Issuer, and (c) paying costs incidental to the issuance of the Bonds and the refunding. While bearing interest at the Daily Rate or Weekly Rate, the Bonds may be tendered for purchase at par plus accrued interest at the election of the beneficial owner on any Business Day in accordance with the procedures specified in the Trust Agreement. The Bonds are subject to mandatory tender for purchase at par upon conversion from one interest rate period to another and upon certain other circumstances, as more fully described herein. The Bonds are available in denominations of $100,000 or any integral multiple of $5,000 in excess thereof. The Bonds will be issued as fully registered bonds and will be registered in the name of Cede & Co., as registered owner and nominee for The Depository Trust Company, New York, New York ( DTC ). DTC will act as securities depository for the Bonds. Purchases of Bonds will be made in book-entry-only form. Beneficial Owners (hereinafter defined) will not receive certificates representing their interests in the Bonds purchased. Payments of principal of and interest and premium, if any, on the Bonds will be made by the Trustee to DTC and will be made to Beneficial Owners by DTC Participants or Indirect Participants. The Bonds are subject to optional redemption, mandatory redemption and optional and mandatory tender for purchase prior to maturity as more fully described herein. The Bonds are limited obligations of the Issuer, payable from and secured solely by an irrevocable pledge of General Revenues as provided in the Trust Agreement on a parity basis with the pledge of General Revenues securing certain outstanding indebtedness of the Issuer. The Issuer has outstanding certain Senior Lien Indebtedness which is secured by a pledge of certain portions of General Revenues, the lien of which pledge is senior to the pledge on General Revenues securing the Bonds. The obligation of the Issuer to pay the purchase price of Bonds tendered for purchase and not remarketed is a limited obligation payable solely from the sources described herein. The Bonds do not constitute a general obligation debt of the Issuer, the State of Michigan or any political subdivision of the State and neither the credit nor the taxing power of the State or any political subdivision of the State is pledged for the payment of the Bonds. The Bonds are offered when, as and if issued by the Issuer and received by the Underwriter, subject to withdrawal or modification of the offer without notice and to the approval of legality by Miller, Canfield, Paddock and Stone, P.L.C. Detroit, Michigan, Bond Counsel. Certain matters will be passed on for the Underwriter by its counsel, Hawkins Delafield & Wood LLP, New York, New York. It is expected that the Bonds in definitive form will be available for delivery through DTC on or about March 6, UBS Investment Bank The date of this Official Statement is February 25, 2008

2 Regents of the University of Michigan Julia Donovan Darlow, Ann Arbor Andrew C. Richner, Grosse Pointe Park Laurence B. Deitch, Bingham Farms S. Martin Taylor, Grosse Pointe Farms Olivia P. Maynard, Goodrich Katherine E. White, Ann Arbor Rebecca McGowan, Ann Arbor Mary Sue Coleman, ex officio Andrea Fischer Newman, Ann Arbor Executive Officers Mary Sue Coleman, President David R. Lampe, Vice President for Communications Sally J. Churchill, Vice President and Secretary of the University Daniel E. Little, Chancellor, University of Michigan-Dearborn Stephen R. Forrest, Vice President for Research Jerry A. May, Vice President for Development Gloria A. Hage, Interim Vice President and General Counsel Timothy P. Slottow, Executive Vice President and Chief Financial Officer E. Royster Harper, Vice President for Student Teresa A. Sullivan, Provost and Executive Vice Affairs President for Academic Affairs Jack Kay, Acting Chancellor, University of Michigan - Flint Cynthia H. Wilbanks, Vice President for Government Relations Robert P. Kelch, M.D., Executive Vice President for Medical Affairs Business and Financial Staff Henry D. Baier, Associate Vice President for Carol F. Senneff, CMA, CIA, Executive Director of Facilities and Operations University Audits L. Erik Lundberg, CFA, Chief Investment Officer Cheryl L. Soper, CPA, Controller and Director of Financial Operations Margaret E. Norgren, Associate Vice President for Gregory J. Tewksbury, CTP, Treasurer Finance Laura M. Patterson, Associate Vice President for Laurita E. Thomas, Associate Vice President and Michigan Administrative Information Systems Chief Human Resource Officer Trustee U.S. Bank National Association Detroit, Michigan Bond Counsel Miller, Canfield, Paddock and Stone, P.L.C., Detroit, Michigan

3 The information in this Official Statement has been obtained from the Regents of the University of Michigan and other sources which are believed to be reliable, but it is not guaranteed as to accuracy or completeness. No dealer, salesperson or any other person has been authorized to give any information or to make any representation other than those contained in this Official Statement, and if given or made, such information or representations must not be relied upon as having been authorized by the Regents of the University of Michigan or the Underwriter. Any information or expressions of opinion herein are subject to change without notice and neither the delivery of this Official Statement nor any sale hereunder shall under any circumstances create an implication that there has been no change as to the affairs of the Regents of the University of Michigan since the date hereof. This Official Statement does not constitute an offer to sell the Bonds in any jurisdiction to any person to whom it is unlawful to make such offer in such jurisdiction. The Underwriter has reviewed the information in this Official Statement in accordance with, and as part of, its responsibilities to investors under the Federal securities laws as applied to the facts and circumstances of this transaction, but the Underwriter does not guarantee the accuracy or completeness of such information. CUSIP numbers appearing on the cover of this Official Statement are provided by Standard & Poor s CUSIP Service Bureau, a division of The McGraw-Hill Companies, Inc. The Issuer is not responsible for the selection of CUSIP numbers and no representation is made as to their correctness on the Bonds or as set forth on the cover of this Official Statement. IN CONNECTION WITH THE OFFERING OF THE BONDS, THE UNDERWRITER MAY OVER-ALLOT OR EFFECT TRANSACTIONS THAT STABILIZE OR MAINTAIN THE MARKET PRICES OF SUCH BONDS AT LEVELS ABOVE THOSE WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. IN MAKING AN INVESTMENT DECISION INVESTORS MUST RELY ON THEIR OWN EXAMINATION OF THE ISSUER AND THE TERMS OF THE OFFERING, INCLUDING THE MERITS AND RISKS INVOLVED. THESE SECURITIES HAVE NOT BEEN RECOMMENDED BY ANY FEDERAL OR STATE SECURITIES COMMISSION OR REGULATORY AUTHORITY. FURTHERMORE, THE FOREGOING AUTHORITIES HAVE NOT CONFIRMED THE ACCURACY OR DETERMINED THE ADEQUACY OF THIS DOCUMENT. This Official Statement contains forward-looking statements, which can be identified by the use of the future tense or other forward-looking terms such as may, intend, will, expect, anticipate, plan, management believes, estimate, continue, should, strategy, or position or the negatives of those terms or other variations on them or by comparable terminology. In particular, any statements, express or implied, concerning future operating results or the ability to generate General Revenues or cash flow to service indebtedness are forwardlooking statements. Investors are cautioned that reliance on any of those forward-looking statements involves risks and uncertainties and that, although the Issuer s management believes that the assumptions on which those forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate. As a result, the forward-looking statements based on those assumptions also could be incorrect, and actual results may differ materially from any results indicated or suggested by those assumptions. In light of these and other uncertainties, the inclusion of a forward-looking statement in this Official Statement should not be regarded as a representation by the Issuer that its plans and objectives will be achieved. All forward-looking statements are expressly qualified by the cautionary statements contained in this paragraph. The Issuer undertakes no duty to update any forward-looking statements.

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5 TABLE OF CONTENTS Page INTRODUCTION... 1 THE BONDS... 2 Description of the Bonds... 2 Redemption Provisions Book-Entry Only System Transfer of the Bonds SECURITY FOR THE BONDS General Revenues Senior Lien Indebtedness and Parity Bonds ESTIMATED ANNUAL DEBT SERVICE REQUIREMENTS THE PROJECTS PLAN OF REFUNDING SOURCES AND USES OF FUNDS THE UNIVERSITY OF MICHIGAN General Accreditations and Memberships Regents of the University Facilities - Ann Arbor Campus Faculty and Staff Student Enrollment Student Admissions Student Tuition and Fees Financial Operations of the University State of Michigan Finances Student Financial Aid Gifts, Grants, Contracts and Research Expenditures Private Sector Campaigns Endowment and Other Invested Funds Physical Plant and New Construction Other Indebtedness of the University Capital Programs and Additional Financing in Fiscal Years 2008 and Retirement Plan Postemployment Benefits Legal Claims TAX MATTERS General Future Developments Information Reporting and Backup Withholding LITIGATION CREDIT RATINGS UNDERWRITING CERTAIN LEGAL MATTERS EXEMPTION FROM ONGOING DISCLOSURE INDEPENDENT ACCOUNTANTS MISCELLANEOUS APPENDIX A - AUDITED FINANCIAL STATEMENTS OF THE UNIVERSITY APPENDIX B - SUMMARY OF CERTAIN PROVISIONS OF THE TRUST AGREEMENT APPENDIX C - FORM OF BOND COUNSEL OPINION -i -

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7 OFFICIAL STATEMENT $224,145,000 REGENTS OF THE UNIVERSITY OF MICHIGAN General Revenue Bonds $105,810,000 Series 2008A $118,335,000 Series 2008B INTRODUCTION This Official Statement, including the cover page and the Appendices, is furnished by the Regents of the University of Michigan (the Issuer ) to provide information concerning the offering of its $105,810,000 General Revenue Bonds, Series 2008A (the Series 2008A Bonds ) and $118,335,000 General Revenue Bonds, Series 2008B (the Series 2008B Bonds, and together with the Series 2008A Bonds, the Bonds ). The Issuer is established under Article VIII, Section 5 of the Michigan Constitution of 1963 and is granted the general supervision of The University of Michigan (the University ) and control and direction of all expenditures of University funds. The Bonds are authorized and will be issued pursuant to a resolution adopted by the Issuer on January 17, 2008 (the Resolution ), and a Trust Agreement, dated as of March 1, 2008 (the Trust Agreement ), between the Issuer and U.S. Bank National Association, as trustee (the Trustee ), for the purpose of (a) paying a portion of the cost of certain capital projects of the Issuer, (b) refunding certain outstanding indebtedness of the Issuer, and (c) paying costs incidental to the issuance of the Bonds and the refunding. See THE PROJECT and PLAN OF REFUNDING herein. The Bonds are a limited obligation of the Issuer secured solely by and payable from an irrevocable pledge of General Revenues of the Issuer on a parity basis with certain outstanding debt of the Issuer and on a subordinated basis with certain Senior Lien Indebtedness of the Issuer. See SECURITY FOR THE BONDS for further information. The obligation of the Issuer to pay the purchase price of Bonds tendered for purchase and not remarketed is a limited obligation payable from Available Investments. See THE BONDS Description of the Bonds Limited Source of Payment of Purchase Price for further information. The Bonds are not a general obligation of the Issuer, the State of Michigan or any political subdivision of the State and neither the credit nor the taxing power of the State or any political subdivision of the State is pledged for the payment of the Bonds. The information contained in this Official Statement is provided for use in connection with the initial sale of the Bonds. The summaries of and references to all documents, statutes, reports and other instruments referred to in this Official Statement do not purport to be complete and are qualified in their entirety by reference to each document, statute, report or instrument. For a more detailed description of certain provisions of the Trust Agreement, see Appendix B Summary of Certain Provisions of the Trust Agreement. Most capitalized words and terms used in this Official Statement are defined in the Trust Agreement and such words and terms are used herein as so defined. Certain words and terms are defined in this Official Statement in abbreviated form for convenience only and all such definitions are subject to the complete definitions set forth in the Trust Agreement. See Appendix B Summary of Certain Provisions of the Trust Agreement.

8 Unless otherwise set forth herein, the descriptions of the Bonds and the related documents included herein generally relate only to the terms and provisions which are applicable while the Bonds bear interest in the Daily Rate Mode, the Weekly Rate Mode, the Commercial Paper Mode, the Term Rate Mode and the Fixed Rate Mode, are registered in book-entry-only form in the name of a nominee of DTC, and while no Liquidity Facility is in place with respect to the Bonds. Description of the Bonds THE BONDS General The Bonds shall be issued in two series. The Series 2008A Bonds shall be issued in the principal amount of One Hundred Five Million Eight Hundred Ten Thousand Dollars ($105,810,000), will be dated the date of their delivery and will mature on April 1, The Series 2008B Bonds shall be issued in the principal amount of One Hundred Eighteen Million Three Hundred Thirty-Five Thousand Dollars ($118,335,000), will be dated the date of their delivery and will mature on April 1, The Series 2008A Bonds will bear interest in the Daily Rate Mode (payable on the first Business Day of each month) unless and until the Series 2008A Bonds are converted to another Rate Mode. The Series 2008B Bonds will bear interest in the Weekly Rate Mode (payable on the first Business Day of each month) unless and until the Series 2008B Bonds are converted to another Rate Mode. The Bonds will be issued in denominations of $100,000 or any integral multiple of $5,000 in excess thereof during any Daily Rate Period, Weekly Rate Period or Commercial Paper Rate Period and in denominations of $5,000 or any integral multiple thereof during any Term Rate Period or the Fixed Rate Period. Interest on the Bonds will be payable on each Interest Payment Date to each registered owner of the Bonds as of the applicable Record Date. So long as the Bonds are registered in book-entry-only form in the name of Cede & Co., as nominee of The Depository Trust Company, New York, New York ( DTC ), interest on the Bonds will be payable by wire transfer in immediately available funds to Cede & Co., which will, in turn, remit such payment to the Direct Participants of DTC for subsequent disbursement to the Beneficial Owners of the Bonds. The Record Date means, with respect to any Interest Payment Date, (i) during any Daily Rate Period, any Weekly Rate Period or any Commercial Paper Rate Period, the close of business on the Business Day immediately preceding each Interest Payment Date, and (ii) during any Term Rate Period or the Fixed Rate Period, the close of business on the fifteenth (15 th ) day of the calendar month immediately preceding any calendar month in which there occurs an Interest Payment Date, regardless of whether such day is a Business Day. Interest Payment Dates for Bonds Interest on the Bonds will be paid April 1, 2008 and on the first Business Day of each month thereafter, until converted to another Rate Mode. Interest on the Bonds will be computed during any Daily Rate Period, Weekly Rate Period or Commercial Paper Rate Period on the basis of a 365-day or 366-day year, as appropriate, for the actual number of days elapsed. Interest on the Bonds will be computed during any Term Rate Period or the Fixed Rate Period on the basis of a 360-day year of twelve thirty (30) day months. Rate Periods Under the Trust Agreement, the Bonds may operate in one or more of six Rate Periods, provided that the requirements of the Trust Agreement, certain of which are described below, for entering into such Rate Period or Rate Periods have been satisfied. The Rate Periods of operation are the Daily Rate Period, the Weekly Rate Period, the Commercial Paper Rate Period, the Term Rate Period, the Fixed Rate Period and the ARS Rate Period. Generally, the Rate Periods have different operating features, including different demand features, purchase features, redemption provisions and Interest Payment Dates. This -2-

9 Official Statement is intended to be used only for Bonds that bear interest in the Daily Rate Mode, the Weekly Rate Mode, the Commercial Paper Mode, the Term Rate Mode and the Fixed Rate Mode, are registered in book-entry-only form in the name of a nominee of DTC, and while no Liquidity Facility is in place with respect to the Bonds. Daily Rate Periods The Series 2008A Bonds will initially be issued in the Daily Rate Mode. The initial Daily Rate Period begins on the date of issuance of the Series 2008A Bonds and will continue to, but will not include, the next Business Day. The initial Daily Rate will be established by UBS Securities LLC, as Underwriter, prior to the date of delivery of the Series 2008A Bonds. Beginning on the Business Day next following the date of issuance of the Series 2008A Bonds, the Series 2008A Bonds will bear interest at Daily Rates for successive Daily Rate Periods until converted to another Rate Mode. Each Daily Rate Period will begin on a Business Day and extend to, but not include, the next succeeding Business Day. Establishment of Daily Rates Each Daily Rate will be the rate of interest that, in the judgment of UBS Securities LLC, as remarketing agent (the Remarketing Agent ), having due regard for the prevailing financial market conditions for bonds or other securities the interest on which is excludable from gross income for federal income tax purposes of the same general nature as the Bonds and which are comparable to the Bonds as to credit and maturity or tender dates, would be the lowest interest rate which would enable the Bonds to be sold at a price of par, plus accrued interest, if any, on the day of the applicable Daily Rate Period. In no event may the interest rate on any Bond for any Rate Period exceed the Maximum Rate. Each Daily Rate is to be determined by 10:00 a.m., New York City time, on each Business Day. If for any reason the Daily Rate for any Daily Rate Period is not established, no Remarketing Agent is serving under the Trust Agreement or the Daily Rate is held to be invalid or unenforceable, then the Daily Rate for such Daily Rate Period will be the SIFMA Municipal Index on the date such Daily Rate was to have been determined by the Remarketing Agent. Weekly Rate Periods The Series 2008B Bonds will initially be issued in the Weekly Rate Mode. The initial Weekly Rate Period begins on the date of issuance of the Series 2008B Bonds and will continue to and including the Wednesday following the date of issue. The initial Weekly Rate for the initial Weekly Rate Period will be established by UBS Securities LLC, as Underwriter, prior to the date of delivery of the Series 2008B Bonds. Beginning on the Thursday next following the initial Weekly Rate Period, the Series 2008B Bonds will bear interest at Weekly Rates for successive Weekly Rate Periods until converted to another Rate Mode. Each Weekly Rate Period will begin on a Thursday and end on Wednesday of the following week. Establishment of Weekly Rates Each Weekly Rate will be the rate of interest that, in the Remarketing Agent's judgment, having due regard for the prevailing financial market conditions for bonds or other securities the interest on which is excludable from gross income for federal income tax purposes of the same general nature as the Bonds and which are comparable to the Bonds as to credit and maturity or tender dates, would be the lowest interest rate which would enable the Bonds to be sold at a price of par, plus accrued interest, if any, on the first day of the Rate Period. In no event may the interest rate on any Bond for any Rate Period exceed the Maximum Rate. Each Weekly Rate is to be determined no later than 4:00 p.m., New York City time, on the Business Day next preceding each Weekly Rate Period. -3-

10 If for any reason the Weekly Rate for any Weekly Rate Period is not established, no Remarketing Agent is serving under the Trust Agreement or the Weekly Rate is held to be invalid or unenforceable, then the Weekly Rate for such Weekly Rate Period will be the SIFMA Municipal Index on the date such Weekly Rate was to have been determined by the Remarketing Agent. Commercial Paper Rate Periods Each Commercial Paper Rate Period shall begin on a Commercial Paper Rate Conversion Date or the Reset Date, which is the day immediately following the final day of the prior Commercial Paper Rate Period for that Bond. The Commercial Paper Rate Period for and Commercial Paper Rate on each Bond in a Commercial Paper Mode (other than a Purchased Bond) shall be determined by the Remarketing Agent for such Bond on or before 11:30 A.M., New York City time, on the first day of each Commercial Paper Rate Period; provided, however, that if the Remarketing Agent fails to specify the next succeeding Commercial Paper Rate Period for a Bond, such Commercial Paper Rate Period for such Bond shall be the shorter of (i) seven (7) days or (ii) the period remaining to and including the final maturity date of the Bond. Establishment of Commercial Paper Rates The interest rate for each Bond in a Commercial Paper Mode to take effect on such day shall be determined by the Remarketing Agent to be the rate of interest that, if borne by such Bond for its Commercial Paper Rate Period, in the judgment of the Remarketing Agent, having due regard for the prevailing financial market conditions for bonds or other securities the interest on which is excludable from gross income for federal income tax purposes of the same general nature as such Bond and which are comparable as to credit and maturity or tender dates with the credit and maturity or tender dates of such Bond, would be the lowest interest rate that would enable such Bond to be sold on the first day of the applicable Commercial Paper Rate Period at a price of par, plus accrued interest, if any. Each Bond in a Commercial Paper Mode (other than Purchased Bonds) shall bear interest during a particular Commercial Paper Rate Period at a rate per annum equal to the interest rate determined above corresponding to the Commercial Paper Rate Period. A Bond can have a Commercial Paper Rate Period, and bear interest at a Commercial Paper Rate, different from other Bonds in the Commercial Paper Mode. The Remarketing Agent shall notify the Trustee, the Tender Agent and the Issuer by facsimile transmission, transmission or other similar electronic means of communication of the term or terms of and the interest rate or rates borne by the Bonds in the Commercial Paper Mode on the first day of each Commercial Paper Rate Period. If for any reason the Commercial Paper Rate for a Commercial Paper Rate Period is not established as aforesaid, no Remarketing Agent is serving under the Trust Agreement, the Rate so established is held to be invalid or unenforceable with respect to a Commercial Paper Rate Period or pursuant to the Remarketing Agreement the Remarketing Agent is not then required to establish a Commercial Paper Rate, then the Commercial Paper Rate for such Commercial Paper Rate Period shall be the SIFMA Municipal Index on the date such Commercial Paper Rate was to have been determined by the Remarketing Agent. Term Rate Periods Each Bond in a Term Rate Mode (other than a Purchased Bond) will bear interest at the Term Rate. Not less than twenty (20) Business Days prior to the end of each Term Rate Period for a Bond, the Issuer shall deliver to the Trustee and the Remarketing Agent for such Bond written notice of the Issuer s determination of the next succeeding Term Rate Period, which Term Rate Period shall end on a Business Day and shall not be the maturity date of such Bonds; provided, however, that if the Issuer fails to specify the next succeeding Term Rate Period, such Term Rate Period shall be the shorter of (i) the same period -4-

11 as the immediately preceding Term Rate Period, or (ii) the period remaining to and including the final maturity date of such Bond. The Term Rate shall be the interest rate determined by the Remarketing Agent not later than a date two (2) Business Days prior to the Term Rate Conversion Date or the next Reset Date. The interest rate applicable to a Bond in the Term Rate Mode shall be the lowest rate which, in the judgment of the Remarketing Agent for such Bond, having due regard for the prevailing financial market conditions for bonds or other securities the interest on which is excludable from gross income for federal income tax purposes of the same general nature as such Bonds and which are comparable as to credit and maturity or tender dates with the credit and maturity or tender dates of such Bond, would be the lowest interest rate that would enable such Bond to be sold on the Term Rate Conversion Date or the Reset Date at a price of par, plus accrued interest, if any. The interest rate on the Bonds in the Term Rate Mode will not be reset on any Reset Date unless at least five (5) Business Days prior to such Reset Date and again on such Reset Date, the Trustee, the Issuer and the affected Remarketing Agent receive an Opinion of Bond Counsel; provided, however, that such Opinion of Bond Counsel shall not be required if the duration of the new Term Rate Period is the same as the immediately preceding Term Rate Period. If for any reason, the interest rate for a Bond in the Term Rate Mode is not or cannot be determined by the Remarketing Agent for such Bond in the manner specified above, the interest rate on such Bond shall be equal to MMD as of the date such interest rate was to have been determined by the Remarketing Agent, plus or minus a spread equal to the spread between MMD and the interest rate in effect for such Bond for the immediately preceding Term Rate Period. Fixed Rate Period Each Bond in the Fixed Rate Mode (other than Purchased Bonds) will bear interest at a Fixed Rate. The Fixed Rate for each such Bond shall be determined by the Remarketing Agent or other investment banking firm or firms with which the Issuer has entered into an agreement for the purchase, as underwriters, of such Bond to be converted to the Fixed Rate Mode on the Fixed Rate Conversion Date as agreed to by the Issuer. The Fixed Rate shall be either (i) the lowest rate which, in the judgment of the Remarketing Agent or such other investment banking firm or firms, having due regard for prevailing financial market conditions for bonds or other securities the interest on which is excludable from gross income for federal income tax purposes of the same general nature as such Bonds and which are comparable as to credit and maturity with the credit and maturity of such Bonds, would be the lowest interest rate that would enable such Bonds to be sold on the Fixed Rate Conversion Date at a price of par, plus accrued interest, if any, or (ii) if the Issuer and the Remarketing Agent shall have received an Opinion of Bond Counsel, such other rate of interest as the Issuer shall determine. If for any reason the Fixed Rate is not determined as aforesaid, then the Rate Mode shall on the Fixed Rate Conversion Date convert to a Weekly Rate Mode unless (i) the Issuer elects another Rate Mode for such Bonds, exercised by filing a certificate to such effect with the Trustee, and (ii) on or prior to the Conversion Date an Opinion of Bond Counsel is delivered to the Trustee whereupon the Rate to be borne by such Bonds shall be a Rate for such other Rate Mode determined as described above. Conversion to Another Rate Mode The Issuer, subject to certain conditions set forth in the Trust Agreement, may convert all or a portion of the Bonds among the Daily Rate Mode, the Weekly Rate Mode, the Commercial Paper Mode, the Term Rate Mode, the Fixed Rate Mode and the Auction Rate Mode. The Conversion Date for any Bond in a Daily Rate Mode, a Weekly Rate Mode or a Commercial Paper Mode shall be an Interest Payment Date for the Bonds to be converted. The Conversion Date for any Bond in a Term Rate Mode or -5-

12 the Fixed Rate Mode shall be an Interest Payment Date or a Reset Date on which such Bond could be redeemed at the option of the Issuer. If any Bonds are to be converted from one Rate Mode to another Rate Mode, the Issuer shall deliver to the Remarketing Agent, DTC (for delivery to the Holders of the Bonds), the Trustee and the Tender Agent, not less than twenty (20) days prior to any Conversion Date (or such shorter period as DTC will permit), a Conversion Notice specifying (a) the Bonds to be converted, (b) the Conversion Date and (c) the Rate Mode or Rate Modes that will be effective upon such conversion. Together with such Conversion Notice (except in the case of a conversion from the Weekly Rate Mode to the Daily Rate Mode or from the Daily Rate Mode to the Weekly Rate Mode), the Issuer shall receive the form of opinion that Bond Counsel expects to be able to give on the Conversion Date to the effect that the conversion of the Bonds to the new Rate Mode is authorized by the Trust Agreement and will not cause the interest on the Bonds to be includable in gross income of the owners of such Bonds for purposes of federal income taxation. No such conversion shall become effective unless, on the Conversion Date, the Issuer shall deliver to the Remarketing Agent, the Trustee and the Tender Agent the foregoing Opinion of Bond Counsel. As soon as practicable after receipt of a Conversion Notice, but in any event not more than three (3) days after the date such Conversion Notice is received, the Tender Agent shall give notice of such conversion to the Holders of such Bonds by first class mail stating that on the Conversion Date, the Bonds to be converted shall be subject to mandatory tender for purchase. If on the proposed Conversion Date, the conditions required for a change to another Rate Mode have not been met, the Bonds will continue to be subject to mandatory tender on the proposed Conversion Date, will not convert to the other Rate Mode, and will remain in the existing Rate Mode. The interest rate on the Bonds will be determined on the date the Bonds were to have converted to the other Rate Mode in the manner set forth in the Trust Agreement. On the Conversion Date for any Bonds, such Bonds shall be subject to mandatory tender and purchase at a Purchase Price equal to 100% of the principal amount thereof, plus accrued interest to the date of purchase; provided, however, that the Purchase Price for Bonds subject to mandatory tender upon conversion from the Term Rate Mode or the Fixed Rate Mode shall be equal to the redemption price that would be payable if such Bonds had been called for redemption on the Conversion Date. The Purchase Price of Bonds so tendered shall be payable from the proceeds of the remarketing of such Bonds or, if such Bonds have not been remarketed, solely from the Issuer s Available Investments, as described below. Optional Tender of Bonds The Holders of Bonds in the Daily Rate Mode and the Weekly Rate Mode only may elect to tender their Bonds (or portions thereof in Authorized Denominations) for purchase at a Purchase Price equal to 100% of the principal amount thereof, plus accrued interest thereon, on any Business Day (an Optional Tender Date ). To exercise the tender option, a Bondholder must deliver to the Remarketing Agent and Tender Agent at their principal offices, an irrevocable telephonic notice (subsequently confirmed in writing the same day) or written notice which states (i) the aggregate principal amount in an Authorized Denomination of each Bond to be purchased and (ii) that each such Bond (or portion thereof in an Authorized Denomination) is to be purchased on the Optional Tender Date. Such notice shall be delivered, in the case of Bonds bearing interest at a Daily Rate, not later than 11:00 a.m., New York City time, on the Optional Tender Date and, in case of Bonds bearing interest at a Weekly Rate, not later than 3:00 p.m., New York City time, on the seventh calendar day preceding the Optional Tender Date. -6-

13 As long as the Bonds are registered in the name of Cede & Co., as nominee of DTC, the tender option may only be exercised by a DTC Participant (as hereinafter defined) on behalf of a Beneficial Owner (as hereinafter defined) of Bonds by giving written notice of its election to tender at the times and in the manner described above. An election to tender a Bond for purchase is irrevocable and binding on the Holder or DTC Participant making such election, the Beneficial Owner on whose behalf the notice was given and on any transferee thereof. Mandatory Tender of Bonds The Bonds are subject to mandatory tender and purchase at a Purchase Price equal to 100% of the principal amount thereof, plus accrued interest thereon, on the following dates (each a Mandatory Tender Date ): (i) on each Conversion Date, but only with respect to that portion of the Bonds proposed to be converted to another Rate Mode; (ii) on each Reset Date for the Bonds in the Commercial Paper Mode or Term Rate Mode; and (iii) on the effective date of a Liquidity Facility delivered by the Issuer, in its sole discretion, for the payment of the Purchase Price of Tendered Bonds. Delivery of Tendered Bonds If on an Optional Tender Date or Mandatory Tender Date there is on deposit with the Tender Agent sufficient moneys to pay the Purchase Price of the Tendered Bonds, such Bonds will be deemed tendered without physical delivery to the Trustee and the Holders or DTC Participants and Beneficial Owners of such Bonds will have no further rights thereunder other than the right to the payment of the Purchase Price. The Purchase Price for Tendered Bonds is payable solely out of the moneys derived from the remarketing of such Bonds and the moneys made available by the Issuer, but only from the sources and up to the amounts described herein. See THE BONDS Limited Source of Payment of Purchase Price herein. Remarketing and Purchase of Bonds The Remarketing Agent is required to use its best efforts to remarket the Tendered Bonds. However, the Remarketing Agent is not required to remarket, and may immediately suspend its remarketing efforts of, any Tendered Bonds under certain circumstances, including, among others (i) if an Event of Default with respect to the Bonds has occurred and is continuing under the Trust Agreement, (ii) the Remarketing Agent determines that any applicable disclosure document or undertaking required in connection with the remarketing of the Bonds is either unavailable or not satisfactory to the Remarketing Agent or (iii) the Remarketing Agent has received an Opinion of Bond Counsel that the exclusion from gross income of interest on the Bonds for federal income tax purposes, or the exemption from registration under the Securities Act of 1933, or the exemption from qualification of the Trust Agreement under the Trust Indenture Act of 1939, can be challenged. In addition, the Issuer may direct the Remarketing Agent to discontinue or suspend the remarketing of the Bonds. Tendered Bonds will be purchased from the Holders on the Tender Date at the Purchase Price. Interest on Tendered Bonds to be purchased after the Record Date for an Interest Payment Date will be paid to the registered owner of the Tendered Bonds on the Record Date. The Purchase Price is to be paid from the proceeds of the remarketing of Tendered Bonds or from moneys provided by the Issuer. There will be no Liquidity Facility in effect upon the issuance of the Bonds. No Bond tendered for purchase at the option of the Holder which does not strictly conform to the description contained in the notice of tender will be purchased from its Holder. -7-

14 Limited Source of Payment of Purchase Price The Issuer s obligation to pay the Purchase Price of Bonds tendered or deemed tendered which have not been remarketed is a limited obligation, payable solely from the Issuer s Available Investments. Available Investments means any and all cash and investments of the Issuer held at any time that may be legally used by the Issuer to pay principal of and interest on and the Purchase Price of the Bonds, but shall not include (a) any cash or investments restricted, by contract or otherwise, to a use inconsistent with the payment of principal of and interest on and the Purchase Price of the Bonds, or (b) any cash or investments (including any amount deemed to be proceeds of State appropriations) the use of which for the payment of principal of or interest on or the Purchase Price of the Bonds would result in the Bonds being construed as indebtedness of the State of Michigan under the Michigan Constitution of 1963, as amended. The following table sets forth Available Investments of the Issuer as of June 30 of the years 2005 through Available Investments* (in Millions) $2,278 $2,512 $3,100 * Based on market value of investments and excludes assets that are restricted or the use of which is limited by other debt issues. On December 31, 2007, the Issuer had $503 million in cash and cash-equivalent securities, $153 million of commercial paper and other short term investments, and $690 million of U.S. Treasury and Agency securities. Any of these assets can be allocated to Available Investments and therefore provide liquidity for the payment of the Purchase Price of Tendered Bonds that are not remarketed. The Issuer also has $450 million in lines of credit to facilitate the liquidity of its variable rate indebtedness. The Issuer anticipates adding an additional $200 million line of credit for such purpose on or prior to the date of delivery of the Bonds. The Issuer is not obligated to continue or maintain the lines of credit and may, at its option, amend or terminate the lines of credit without notice to, or the consent of, any party. -8-

15 Daily and Weekly Rate Period Table The following tables are provided for the convenience of the Holder. The information contained in the tables is not intended to be comprehensive. Reference is made to the above description and to the Trust Agreement for a more complete description. Daily Rate Period Table Duration of Rate Period Interest Payment Dates Interest Rate Determination Dates Optional Tender Date Bondholder Notice of Tender Due Begins on a Business Day and extends to, but not including, the next succeeding Business Day The first Business Day of each month By 10:00 a.m. New York City time on each Business Day Any Business Day No later than 11:00 a.m. New York City time on the Optional Tender Date Weekly Rate Period Table Duration of Rate Period Interest Payment Dates Interest Rate Determination Dates Optional Tender Date Bondholder Notice of Tender Due Seven days beginning on a Thursday to and including the following Wednesday The first Business Day of each month By 4:00 p.m. New York City time on the Business Day prior to the first day of the Weekly Rate Period Any Business Day No later than 3:00 p.m. New York City time on the seventh day preceding the Optional Tender Date -9-

16 Commercial Paper Rate Period Table The following Commercial Paper Rate Period Table is provided for the convenience of the Holder. The information contained in the table is not intended to be comprehensive. Reference is made to the above description and to the Trust Agreement for a more complete description. Commercial Paper Rate Period Table Duration of Rate Period One to two hundred seventy days beginning on a Commercial Paper Rate Conversion Date or a Reset Date to and including the last day of the specified Rate Period for each Bond Interest Payment Dates Interest Rate Determination Dates Optional Tender Date Mandatory Tender Date The next succeeding Reset Date and each Conversion Date By 11:30 A.M. New York City time on the first day of the Rate Period None Each Reset Date Redemption Provisions The Bonds are subject to optional and mandatory redemption as described below. Optional Redemption below. The Bonds shall be subject to redemption prior to maturity at the option of the Issuer as set forth (i) The Bonds in the Daily Rate Mode, Weekly Rate Mode and Commercial Paper Mode are subject to redemption prior to maturity at the election of the Issuer, in whole or in part, on any date in the case of Bonds in the Daily Rate Mode or the Weekly Rate Mode or on any Interest Payment Date that is a Reset Date in the case of Bonds in the Commercial Paper Mode, at a redemption price equal to one hundred per centum (100%) of the principal amount of each Bond or portion thereof to be redeemed, plus accrued interest to the redemption date. (ii) The Bonds in the Term Rate Mode or the Fixed Rate Mode shall be subject to redemption prior to maturity at the election of the Issuer: (A) in whole or in part on any Reset Date in the case of Bonds in the Term Rate Mode, at a redemption price equal to one hundred per centum (100%) of the principal amount of each Bond or portion thereof to be redeemed, plus accrued interest, if any, to the day of redemption, or (B) in whole or in part on any date, at a redemption price equal to the percentages of the principal amount of each Bond or portion thereof to be redeemed set forth below, plus accrued interest, if any, to the date of redemption. -10-

17 Number of Years Remaining to Maturity at the Date of Conversion Redemption Prices 10 years or more 100% Less than 10 years Not Subject to Redemption At the time Bonds are converted from another Rate Mode to the Term Rate Mode or the Fixed Rate Mode, the Issuer may revise the foregoing dates and redemption prices at which such Bonds may be redeemed at the option of the Issuer, without the approval of the registered owners of the Bonds to reflect then-prevailing market conditions, upon receipt of an Opinion of Bond Counsel to the effect that any revisions pursuant to this subsection (ii), either by itself or in conjunction with the establishment of the Term Rate, are made in accordance with the Trust Agreement and are authorized by all necessary action on the part of the Issuer and will not have an adverse effect on the exclusion of interest on the Bonds from gross income for federal income tax purposes. Mandatory Redemption Series 2008A Bonds The Series 2008A Bonds are subject to mandatory redemption on April 1 of each year at the principal amount thereof plus accrued interest, if any, without premium, as follows (provided, however, that while any Series 2008A Bonds to be redeemed bear interest at the Daily Rate or Weekly Rate, if such April 1 is not a Business Day, the redemption shall occur on the next succeeding Business Day): Mandatory Redemption Date (April 1) Mandatory Redemption Date (April 1) Mandatory Redemption Principal Amount 2029 $ 8,920, $11,085, ,310, ,565, ,735, ,995, ,160, ,885, ,600, ,555,000 Mandatory Redemption Principal Amount The principal amount of Series 2008A Bonds to be redeemed pursuant to mandatory redemptions shall be reduced, in the order determined by the Issuer, by the principal amount of Series 2008A Bonds which have been previously redeemed or called for redemption, other than pursuant to mandatory redemptions, or purchased or acquired by the Issuer and delivered to the Trustee for cancellation. -11-

18 Series 2008B Bonds The Series 2008B Bonds are subject to mandatory redemption on April 1 of each year at the principal amount thereof plus accrued interest, if any, without premium, as follows (provided, however, that while any Series 2008B Bonds to be redeemed bear interest at the Daily Rate or Weekly Rate, if such April 1 is not a Business Day, the redemption shall occur on the next succeeding Business Day): Mandatory Redemption Date (April 1) Mandatory Redemption Date (April 1) Mandatory Redemption Principal Amount 2009 $1,535, $5,775, ,595, ,035, ,340, ,320, ,200, ,600, ,425, ,865, ,635, ,175, ,880, ,520, ,135, ,840, ,405, ,170, ,340, ,545,000 Mandatory Redemption Principal Amount The principal amount of Series 2008B Bonds to be redeemed pursuant to mandatory redemptions shall be reduced, in the order determined by the Issuer, by the principal amount of Series 2008B Bonds which have been previously redeemed or called for redemption, other than pursuant to mandatory redemptions, or purchased or acquired by the Issuer and delivered to the Trustee for cancellation. Selection of Bonds to be Redeemed If fewer than all of the Bonds are to be redeemed and the Bonds have different maturity dates or bear interest in more than one Rate Mode, the Issuer shall designate the maturities and Rate Modes from which the Bonds are to be redeemed. Within the same Rate Mode and maturity date, the Trustee shall select from the Bonds to be redeemed, or portions thereof in amounts equal to the lowest Authorized Denomination or any integral multiple thereof, by lot in any manner that the Trustee may determine; provided, however, that Purchased Bonds shall be selected for redemption (and redeemed) prior to the selection for redemption (and redemption) of Bonds that are not Purchased Bonds. In the case of a partial redemption of Bonds by lot when Bonds of denominations greater than the lowest Authorized Denomination are then outstanding, each unit of face value of principal thereof equal to the lowest Authorized Denomination shall be treated as though it were a separate Bond of such lowest Authorized Denomination. Notwithstanding anything in the Trust Agreement to the contrary, Bonds shall be selected for redemption such that following such redemption only Bonds in Authorized Denominations remain outstanding. Notice of Redemption In the event any of the Bonds are to be called for redemption, the Trustee shall give notice, in the name of the Issuer, of the redemption of such Bonds. Each notice shall (i) specify the Bonds to be redeemed by CUSIP number, registration number, date of issue, interest rate, maturity date, 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 office of the Trustee) and, if less than all of the Bonds are to be redeemed, the registration numbers or portions of such Bonds to be redeemed and, in the case of Bonds in a denomination other than the minimum Authorized Denomination, portions of the Bonds which are to be redeemed in part, -12-

19 and (ii) state that on the redemption date (if moneys are then available to pay the redemption price thereof) the Bonds or portions thereof to be redeemed shall cease to bear interest. Such notice may set forth any additional information relating to the redemption. Such notice shall be given by certified mail, return receipt requested, not less than thirty (30) days prior to the date fixed for redemption, to DTC and the Owners of Bonds or portions of Bonds to be redeemed at the addresses shown on the registration books of the Trustee as of the third day next preceding the date on which notice by mail is given, or, if any such day is not a Business Day, the Business Day next preceding such day. The Trustee shall send notices, if applicable, to DTC in such manner that the notice will be received by DTC at least two (2) days before the date of general publication or release to the public. The failure to give notice by mail to any owner of any Bonds to be redeemed, or any defect therein, shall not affect the validity of the proceedings for redemption of any other Bonds for which notice to the owners was properly given. The failure to give notice by mail to DTC, or any defect therein, shall not affect the validity of the proceedings for redemption of any Bonds. Bonds called for redemption shall be redeemed upon presentation and surrender of such Bonds at the place or places of payment. The Trustee shall use its best efforts to mail, by the same means as the first notice, a second notice to Owners of Bonds who have not presented their Bonds for redemption within sixty (60) days after the date fixed for redemption. For a more complete description of the redemption and other provisions relating to the Bonds, see Appendix B - Summary of Certain Provisions of the Trust Agreement. Book-Entry Only System The information in this subsection has been furnished by The Depository Trust Company, New York, New York ( DTC ). No representation is made by the Issuer, the Trustee or the Underwriter as to the completeness or accuracy of such information or as to the absence of material adverse changes in such information subsequent to the date hereof. No attempt has been made by the Issuer, the Trustee or the Underwriter to determine whether DTC is or will be financially or otherwise capable of fulfilling its obligations. Neither the Issuer nor the Trustee will have any responsibility or obligation to Direct Participants, Indirect Participants (both as defined below) or the persons for which they act as nominees with respect to the Bonds, or for any principal, premium, if any, or interest payment thereof. DTC will act as securities depository for the Bonds. The Bonds will be issued as fully-registered securities registered in the name of Cede & Co. (DTC s partnership nominee) or such other name as may be requested by an authorized representative of DTC. One fully-registered Bond will be issued for each maturity of the Bonds, in the aggregate principal amount of such maturity, and will be deposited with DTC. 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 of DTC and Members of the National Securities Clearing Corporation, Fixed Income Clearing Corporation and Emerging Markets Clearing Corporation, (NSCC, FICC and -13-

20 EMCC, also subsidiaries of DTCC), as well as 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 ( Beneficial Owner ) is in turn to be recorded on the Direct and Indirect Participants records. Beneficial Owners will not receive written confirmation from DTC of their purchase. Beneficial Owners are, however, 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 are to be accomplished by entries made on the books of Direct and Indirect Participants acting on behalf of Beneficial Owners. Beneficial Owners will not receive certificates representing their ownership interest 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 name 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 the 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, tenders, defaults, and proposed amendments to the security documents. 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. In the alternative, Beneficial Owners may wish to provide their names and addresses to the registrar and request that copies of the notices be provided directly to them. Redemption notices shall be sent to DTC. If less than all of the Bonds within an issue are being redeemed, DTC s practice is to determine by lot the amount of the interest of each Direct Participant in such 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 Issuer 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 such other nominee as may be requested by an authorized representative of DTC. DTC s practice is to credit Direct -14-

21 Participant s accounts upon DTC s receipt of funds and corresponding detail information from the Trustee, on payable dates 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, the Issuer or the Trustee, subject to any statutory or regulatory requirements as may be in effect from time to time. Payments of redemption proceeds, distributions, and dividend payments to Cede & Co. (or such other nominee as may be requested by an authorized representative of DTC) is the responsibility of the Trustee, disbursement of such payments to Direct Participants will be the responsibility of DTC, and disbursement of such payments to the Beneficial Owners will be the responsibility of Direct and Indirect Participants. A Beneficial Owner shall give notice to elect to have its Bond tendered for purchase, through its Participant, to the Tender Agent and the Remarketing Agent, and shall effect delivery of such Bond by causing the Direct Participant to transfer the Participant's interest in the Bond, on DTC's records, to the Tender Agent. The requirement for physical delivery of Bonds in accordance with an optional tender for purchase will be deemed satisfied when the ownership rights in the Bonds are transferred by Direct Participants on DTC's records and followed by a book-entry credit of tendered Bonds to the Tender Agent's DTC account. DTC may discontinue providing its services as depository with respect to the Bonds at any time by giving reasonable notice to the Issuer or the Trustee. Under such circumstances, in the event that a successor securities depository is not obtained, Bond certificates are required to be printed and delivered. The Issuer may decide to discontinue use of the system of book-entry transfers through DTC (or a successor securities depository). In that event, Bond certificates will be printed and delivered. So long as Cede & Co. is the registered owner of the Bonds, as nominee for DTC, references herein and in the Trust Agreement to the Bondholders, Registered owners or owners (or similar terms) of the Bonds shall mean Cede & Co., as aforesaid, and shall not mean the Beneficial Owners of the Bonds. THE INFORMATION SET FORTH ABOVE IN THIS SUB-SECTION DTC; BOOK-ENTRY- ONLY SYSTEM HAS BEEN TAKEN FROM INFORMATION FURNISHED BY DTC. NO REPRESENTATION IS MADE BY THE ISSUER, THE TRUSTEE OR THE UNDERWRITER AS TO THE COMPLETENESS OR ACCURACY OF SUCH INFORMATION OR AS TO THE ABSENCE OF MATERIAL ADVERSE CHANGES IN SUCH INFORMATION SUBSEQUENT TO THE DATE HEREOF. NO ATTEMPT HAS BEEN MADE BY THE ISSUER, THE TRUSTEE OR THE UNDERWRITER TO DETERMINE WHETHER DTC IS OR WILL BE FINANCIALLY OR OTHERWISE CAPABLE OF FULFILLING ITS OBLIGATIONS. NEITHER THE ISSUER NOR THE TRUSTEE WILL HAVE ANY RESPONSIBILITY OR OBLIGATION TO DTC PARTICIPANTS, INDIRECT PARTICIPANTS OR THE PERSONS FOR WHICH THEY ACT AS NOMINEES WITH RESPECT TO THE BONDS, OR FOR ANY PRINCIPAL OF, PREMIUM, IF ANY, OR INTEREST PAYMENT THEREON. The Issuer and the Trustee may treat DTC (or its nominee) as the sole and exclusive registered owner of the Bonds registered in its name for the purposes of payment of the principal and redemption premium, if any, of, or interest on, the Bonds, giving any notice permitted or required to be given to registered owners under the Trust Agreement, registering the transfer of the Bonds, or other action to be taken by registered owners and for all other purposes whatsoever. The Issuer and the Trustee shall not have any responsibility or obligation to any Direct or Indirect Participant, any person claiming a beneficial ownership interest in the Bonds under or through DTC or any Direct or Indirect Participant, or any other person which is not shown on the registration books of the Issuer (kept by the Trustee) as being a registered owner, with respect to the accuracy of any records maintained by DTC or any Direct or -15-

22 Indirect Participant; the payment by DTC or any Direct or Indirect Participant of any amount in respect of the principal, redemption premium, if any, or interest on the Bonds; any notice which is permitted or required to be given to registered owners thereunder or under the conditions to transfers or exchanges adopted by the Issuer; or other action taken by DTC as registered owner. Interest, redemption premium, if any, and principal will be paid by the Trustee to DTC, or its nominee. Disbursement of such payments to the Direct or Indirect Participants is the responsibility of DTC and disbursement of such payments to the Beneficial Owners is the responsibility of the Direct or Indirect Participants. So long as Cede & Co. is the registered owner of the Bonds, as nominee for DTC, references herein to the Bondholders or registered owners of the Bonds shall mean Cede & Co., as aforesaid, and shall not mean the Beneficial Owners of the Bonds. Transfer of the Bonds So long as Cede & Co., as nominee for DTC, is the Registered Owner of the Bonds, beneficial ownership interests in the Bonds may be transferred only through a DTC Participant or Indirect Participant and recorded on the book-entry-only system operated by DTC. SECURITY FOR THE BONDS The Bonds are limited obligations of the Issuer, payable from and secured solely by an irrevocable pledge of General Revenues and a security interest in and a lien on amounts in the Bond Payment Fund established by the Trust Agreement. The pledge of General Revenues constitutes a first lien thereon, on a parity basis with the lien thereon securing (i) the outstanding notes of the Issuer's $150,000,000 aggregate maximum principal amount of Commercial Paper Notes, Series E (Taxable) and Series G (collectively, the CP Notes ), (ii) the outstanding bonds of the Issuer s $140,000,000 General Revenue Bonds, Series 2002 (the 2002 Bonds ), $58,205,000 General Revenue Refunding Bonds, Series 2003 (the 2003 Bonds ), $37,745,000 General Revenue Bonds, Series 2005A (the Series 2005A Bonds ) and $48,020,000 General Revenue Bonds, Series 2005B (the Series 2005B Bonds, and together with the Series 2002 Bonds, the Series 2003 Bonds and the Series 2005A Bonds, the Prior Bonds ), and (iii) the Issuer s obligations under three separate lines of credit in the aggregate maximum available amount of $450,000,000 and under a fourth line of credit expected to be obtained on or prior to the date of delivery of the Bonds in the maximum available amount of $200,000,000 (collectively, the Lines of Credit ), subject in each case to the prior and superior lien on various portions of the General Revenues securing Senior Lien Indebtedness (as described below under Senior Lien Indebtedness and Parity Bonds ). The Issuer has also entered into an interest rate swap agreement (the Existing Swap Agreement ) with Morgan Stanley Capital Services Inc. (the Existing Swap Counterparty ) with respect to the variable rate debt service on a portion of the Series 2002 Bonds. Under the Existing Swap Agreement, the Issuer is required to pay the Existing Swap Counterparty a fixed rate of interest and the Existing Swap Counterparty is required to pay the Issuer a LIBOR based variable rate of interest. The total notional amount of the Existing Swap Agreement as of December 31, 2007 was $58,215,000. The Existing Swap Agreement is subject to termination prior to maturity by either party thereto upon certain circumstances, subject to payment of early termination payments as stated therein. The Issuer s obligations under the Existing Swap Agreement are secured by General Revenues on a parity basis with the Bonds, the CP Notes, the Prior Bonds and the Lines of Credit. In connection with the issuance of the Series 2008B Bonds, the Issuer intends to enter into a floating to fixed rate interest rate swap agreement with respect to a portion of the Series 2008B Bonds (the 2008 Swap Agreement ). Under the 2008 Swap Agreement, the Issuer will be required to pay the counterparty thereto a fixed rate on the hedged portion of the Series 2008B Bonds and the counterparty will be required to pay the Issuer a variable rate on the hedged portion of the Series 2008B Bonds based -16-

23 on a percentage of one-month LIBOR. The 2008 Swap Agreement is expected to be subject to termination prior to maturity by either party thereto upon certain circumstances, subject to payment of early termination payments as stated therein. The Issuer s obligations under the 2008 Swap Agreement will be secured by General Revenues on a parity basis with the Bonds, the CP Notes, the Prior Bonds, the Lines of Credit and the Existing Swap Agreement. The Bonds, the CP Notes, the Prior Bonds, the Lines of Credit, the Existing Swap Agreement, the 2008 Swap Agreement and any additional parity obligations of the Issuer are herein called Parity Bonds. THE BONDS ARE NOT GENERAL OBLIGATIONS OF THE ISSUER, THE STATE OF MICHIGAN OR ANY POLITICAL SUBDIVISION OF THE STATE AND NEITHER THE CREDIT NOR THE TAXING POWER OF THE STATE OR ANY POLITICAL SUBDIVISION OF THE STATE IS PLEDGED FOR THE PAYMENT OF THE BONDS. General Revenues General Revenues constitute all receipts from fees, charges, and income from all or any part of the students of the University, whether tuition, instructional fees, tuition surcharges, activity fees, general fees, health fees or other special purpose fees (before allowances for scholarships); all gross income, revenues and receipts from the ownership, operation and control of the housing, dining and auxiliary systems of the University (before allowances for scholarships); all unrestricted revenues from departmental activities; all patient service or medical service plan revenues; all unrestricted grants, gifts, donations and pledges, and receipts therefrom (including but not limited to indirect cost recoveries allocated to general operations); and unrestricted investment income; but excluding all of the following: (a) any deposits required by law or contract to be held in escrow; (b) appropriations from the State Legislature; (c) Hospital Gross Revenues as defined in the Master Indenture, dated as of May 1, 1986 between the Regents of the University of Michigan and U.S. Bank National Association (successor to Comerica Bank-Detroit), as Master Trustee; and (d) revenues from The Veritas Insurance Corporation and Michigan Health Corporation. The lien of such pledge is valid against all parties having claims of any kind (except for the holders of any Senior Lien Indebtedness or Parity Bonds), regardless of notice, and is valid and binding without physical delivery or further act by the Issuer. On or before each Interest Payment Date and each other date on which principal of, premium, if any, or interest on the Bonds is due and payable, the Issuer will pay to the Trustee for deposit in the Bond Payment Fund, from General Revenues, an amount sufficient to pay the principal of, premium, if any, and interest due on the Bonds on such Interest Payment Date or other date. The Issuer has covenanted and agreed in the Trust Agreement that to the extent that on any date the Issuer has failed to pay any amounts due under the Trust Agreement, the Issuer shall pay to the Trustee (for deposit in the Bond Payment Fund) and to the trustee or trustees for all other issues of Parity Bonds then outstanding (for deposit in the respective bond payment funds for such Parity Bonds) all General Revenues thereafter received by the Issuer (which payments shall be made promptly upon receipt of such General Revenues) until all amounts payable by the Issuer in respect of debt service on all Parity Bonds have been paid in full; provided, however, that in paying General Revenues as aforesaid, the amount of General Revenues so paid in each Fiscal Year shall be shared among the respective issues of the Parity Bonds then outstanding pro rata, based upon the respective amounts of debt service payable on each such issue of Parity Bonds during such Fiscal Year (without regard to the existence of any debt service reserve fund established for any issue of Parity Bonds); provided, further, however, that portions of General Revenues subject to a superior lien in favor of any Senior Lien Indebtedness shall not be paid over if the Issuer is not in compliance with any and all requirements for payment or funding of any amounts with respect to such Senior Lien Indebtedness or otherwise is in default with respect thereto. Subject to the above -17-

24 requirements, the Issuer shall have and retain the full right and ability to receive, collect, expend, invest, use or otherwise hold or dispose of General Revenues as the Issuer deems appropriate. The rights and remedies of the holders of the Bonds may be affected by bankruptcy, insolvency, fraudulent conveyance or other laws affecting creditors rights generally, now existing or hereafter enacted, and by the application of general principles of equity, including those related to equitable subordination. General Revenues of the Issuer for the Fiscal Years ended June 30, 2005, 2006, and 2007 are as follows: General Revenues Fiscal Year Ended June 30 (in thousands) Student tuition and fees* $ 765,201 $ 834,365 $ 891,634 Unrestricted federal, state, and local grants and contracts 1,033 1, Unrestricted sales and services of educational departments 107, , ,910 Unrestricted revenues of auxiliary enterprises: Non-hospital patient care revenues** 338, , ,689 Student residence fees*** 81,055 85,918 85,945 Other auxiliary revenues 113, , ,151 Indirect cost recoveries 163, , ,807 Unrestricted private gifts Unrestricted income from investments**** 218, , ,733 Total General Revenues $1,789,360 $1,900,755 $2,167,401 * Before allowances for scholarships of $146,226 in 2005, $158,659 in 2006 and $172,952 in ** Excluding patient care revenues included in Hospital Gross Revenues, which are pledged for hospital bonds. *** Before allowances for scholarships of $14,801 in 2005, $15,689 in 2006 and $15,690 in **** Includes realized and unrealized investment gains/losses. Senior Lien Indebtedness and Parity Bonds As of December 31, 2007, the Issuer had Senior Lien Indebtedness secured by a pledge of portions of General Revenues outstanding in the amount of $93,547,246. Of this amount outstanding, the Issuer had $91,244,244 secured by a pledge of medical service plan revenues and $2,303,002 secured by other revenue streams, and in some cases additionally payable from other legally available funds. All the Senior Lien Indebtedness secured by a senior lien on portions of the General Revenues mature by The Issuer has covenanted in the Trust Agreement that so long as any Bonds are Outstanding under the Trust Agreement and so long as the Trust Agreement has not been discharged, it shall not issue any new Senior Lien Indebtedness, but existing Senior Lien Indebtedness (including indebtedness under variable rate demand programs and bond related interest rate swap transactions) may continue to remain outstanding and to benefit from the superior lien on the respective portion of General Revenues, pledged as security therefor. The Issuer had outstanding on December 31, 2007 $250,515,000 of General Revenue Bonds, secured on a parity basis with the Bonds. Also outstanding on December 31, 2007 and secured by General Revenues were the CP Notes in the aggregate principal amount of $150,000,

25 The Issuer has reserved the right to authorize by resolution, issue and deliver, without limitation, additional Parity Bonds, as fixed rate indebtedness, variable rate indebtedness, other loan, debt or guarantee obligations, interest rate swaps, hedges or similar arrangements for any lawful purpose, secured by a lien on General Revenues on a parity basis with the lien thereon securing the Bonds, and to authorize by resolution, issue and deliver obligations secured by a subordinated lien on General Revenues on any portion thereof. The Trust Agreement does not limit the Issuer s ability to issue debt payable from sources other than General Revenues. -19-

26 ESTIMATED ANNUAL DEBT SERVICE REQUIREMENTS The following table sets forth, for each fiscal year ending June 30, the amounts required for the payment of principal at maturity or by mandatory redemption of the Bonds and the payment of estimated interest on the Bonds, together with the estimated amounts required for the payment of debt service on the outstanding Parity Bonds (excluding the CP Notes) and debt service on the Senior Lien Indebtedness. The Bonds Fiscal Year Ending June 30 Principal Interest (1) Total Prior Bonds Debt Service (2) Total Annual Debt Service (3) Senior Lien Indebtedness (4) 2008 $ - $1,864,813 $1,864,813 $28,345,379 $30,210,192 $6,596, ,535,000 7,823,529 9,358,529 27,441,100 36,799,630 6,671, ,595,000 7,782,020 9,377,020 26,301,375 35,678,396 6,647, ,340,000 7,715,988 11,055,988 26,103,440 37,159,428 6,624, ,200,000 7,600,496 12,800,496 24,112,578 36,913,074 6,707, ,425,000 7,392,980 12,817,980 24,255,167 37,073,146 6,695, ,635,000 7,213,789 12,848,789 19,363,945 32,212,734 6,685, ,880,000 7,015,131 12,895,131 19,078,133 31,973,264 6,759, ,135,000 6,818,901 12,953,901 14,367,997 27,321,898 6,737, ,405,000 6,580,916 12,985,916 14,436,561 27,422,477 6,809, ,340,000 6,367,740 12,707,740 14,617,412 27,325,152 6,789, ,775,000 6,149,145 11,924,145 12,462,448 24,386,594 6,764, ,035,000 5,955,177 11,990,177 12,026,011 24,016,187 6,836, ,320,000 5,723,365 12,043,365 10,005,882 22,049,247 6,806, ,600,000 5,509,770 12,109,770 8,736,489 20,846,258 6,673, ,865,000 5,277,219 12,142,219 7,503,709 19,645,928 6,716, ,175,000 5,043,379 12,218,379 6,511,824 18,730,203 6,820, ,520,000 4,774,257 12,294,257 5,496,418 17,790,675 6,909, ,840,000 4,516,916 12,356,916 4,446,708 16,803,624 6,991, ,170,000 4,240,586 12,410,586 4,490,517 16,901,104 7,062, ,545,000 3,958,991 12,503,991 4,554,725 17,058,716 7,122, ,920,000 3,645,242 12,565,242 4,598,657 17,163, ,310,000 3,336,693 12,646,693 4,654,613 17,301, ,735,000 3,008,357 12,743,357 4,707,668 17,451, ,160,000 2,669,673 12,829,673 4,788,937 17,618, ,600,000 2,303,177 12,903, ,887 13,544, ,085,000 1,933,135 13,018, ,733 13,568, ,565,000 1,542,353 13,107, ,972 13,565, ,995,000 1,137,185 13,132,185 13,132, ,885, ,623 12,599,623 12,599, ,555, ,685 10,862,685 10,862,685 (1) Interest on the Bonds is calculated at an assumed rate of 3.5%. (2) Interest on the hedged portion of the Prior Bonds is calculated at the fixed rate payable under the Existing Swap Agreement as described under SECURITY FOR THE BONDS above. Interest on the unhedged portions of the Prior Bonds bearing interest at variable rates is calculated at an assumed rate of 3.5%. (3) Totals may not be exact due to rounding. (4) Interest on the hedged portion of the Senior Lien Indebtedness is calculated at the fixed rate payable under the related interest rate swap agreement. Interest on the unhedged portions of the Senior Lien Indebtedness bearing interest at variable rates is calculated at an assume rate of 3.5%. -20-

27 THE PROJECTS The Projects expected to be financed with the proceeds of the Bonds, together with the proceeds of the CP Notes to remain outstanding and other available Issuer funds, include: (i) the Michigan Stadium Renovation and Expansion; (ii) the North Quad Residential and Academic Campus; (iii) the Stephen M. Ross School of Business; (iv) Flint Student Housing; (v) the Softball Stadium; and (vi) various other capital projects of or for the benefit of the University. Michigan Stadium Renovation and Expansion The renovations of the Football Stadium at a cost of $226,000,000 include the creation of approximately 400,000 square feet of new facilities in five structures and renovation of approximately 50,000 square feet of existing facilities. The two main sideline buildings will accommodate media facilities, concession areas, seating, an additional concourse, 83 suites and 3,200 indoor and outdoor club seats. Three of the buildings will house restrooms, concessions and support functions such as first-aid, police and security and the will-call ticket office. The project will also include widening of the aisles and added handrails in the existing bowl. The renovation will address needed infrastructure upgrades related to site work, utilities, restrooms, concessions, and various mechanical and electrical systems. The capacity of the stadium will be approximately 108,000 following completion of the project. North Quad Residential and Academic Complex This complex at a cost of $175,000,000 will include residential space consisting of suite-style units that respond to students contemporary needs, and not currently available in the University s housing inventory. The academic space will include the majority of the School of Information, and several highly complementary programs from the College of Literature, Science, and the Arts including Communication Studies, Film and Video Studies, and the Language Resource Center. Classrooms, dining, gallery space, group study areas, and some amenities will also be part of the complex. Flexible and integrated living and learning space will facilitate collaboration and engagement between students and faculty. The mixed-use development will foster student interaction and learning and will provide an appropriate mix of academic, residential, and formal and informal gathering spaces. North Quad will include sufficient space to accommodate approximately 460 student beds and living areas, dining facilities, and, academic and support spaces. Stephen M. Ross School of Business The Stephen M. Ross School of Business project costing $145,000,000 involves the demolition of Davidson Hall, Assembly Hall and Paton Center, and construction of a new building of approximately 270,000 gross square feet. The enhancement project is supported by a $100 million gift from Mr. Ross and will consist of seven floors housing twelve state-of-the-art classrooms, an auditorium and colloquium, faculty offices, student service activities space, and a central gathering space that will provide seating areas and a food court. The heart of the project is a town square that is expected to facilitate the spontaneous gathering together of the entire business school community. Flint Student Housing This project at a cost of $21,300,000 includes the creation of an approximately 100,000 gross square foot residence hall with approximately 310 beds and living-learning spaces on the first floor. There will be one-, two- and four-bedroom units, including handicapped-accessible units. All units will contain one or two bathrooms, a kitchen, and living room. On-campus student housing will allow the University to attract students from beyond its commuter range and will help change the character of the campus from commuter to commuter-residential. -21-

28 Softball Stadium The expansion and renovation of the Alumni Field softball complex at a cost of $5,500,000 includes an addition, new grandstands and outfield seating for approximately 2,300 spectators, including accommodations for barrier-free spectator areas. The project includes new public restrooms, concession areas, media facilities, an indoor practice facility, and the creation of pedestrian plaza areas at the entrances. The Donald R. Shepherd Softball Building, built in 1998, will be expanded to allow for additional team meeting and athletic training areas. PLAN OF REFUNDING The Issuer will use a portion of the proceeds of the Bonds, together with other available funds, to refund $73,200,000 of the Issuer s Commercial Paper Notes, Series G (the Series G Notes ), the proceeds of which were used to provide interim financing for certain capital projects of the Issuer. The portion of the Series G Notes being refunded by the Bonds is hereinafter referred to as the Refunded Notes. The Refunded Notes are being refunded in order to establish permanent financing for certain capital projects of the Issuer. Proceeds of the Bonds in the amount of $73,200,000 will be deposited with the Issuer and used to pay a portion of the maturing principal of and interest on the Refunded Notes on the respective maturity dates. The Refunded Notes will be paid within 90 days of the date of delivery of the Bonds. The Refunded Notes will not be defeased until the respective payment dates. SOURCES AND USES OF FUNDS The proceeds of the Bonds will be applied to pay the costs of the Projects, refunding the Refunded Notes, and to pay certain expenses incurred in connection with the issuance of the Bonds, as set forth below. Sources of Funds Principal Amount of the Bonds $224,145,000 Estimated Investment Earnings 2,540,000 Total Sources $226,685,000 Uses of Funds Cost of the Projects to be Funded from Bond Proceeds $153,010,000 Cost of Refunding of the Refunded Notes 73,200,000 Costs of Issuance (including Underwriter s discount) 475,000 Total Uses $226,685,

29 THE UNIVERSITY OF MICHIGAN General The University of Michigan (the University ) was originally chartered in 1817 by the Michigan territorial legislature and located in Detroit. In 1837, after Michigan had been admitted to the United States, the State of Michigan renewed the charter and located the University in Ann Arbor, where classes were first held in The University is providing educational services in the fall of 2007 to an enrollment of 56,531 students in the various undergraduate, graduate and professional divisions. For the academic year ended June 30, 2007, the University awarded 8,257 undergraduate, 4,966 graduate, and 707 professional degrees. The main campus of the University is located in Ann Arbor, 43 miles west of Detroit. Major branches are also maintained in the cities of Dearborn and Flint, Michigan. The University is comprised of nineteen degree granting schools, colleges and divisions in Ann Arbor: A. Alfred Taubman College of Architecture and Urban Planning; School of Art & Design; Stephen M. Ross School of Business; School of Dentistry; School of Education; College of Engineering; Horace H. Rackham School of Graduate Studies; School of Information; Division of Kinesiology; Law School; College of Literature, Science, and the Arts; Medical School; School of Music, Theater & Dance; School of Natural Resources and Environment; School of Nursing; College of Pharmacy; School of Public Health; Gerald R. Ford School of Public Policy; and School of Social Work. The Dearborn campus is comprised of four schools and colleges: the College of Arts, Sciences and Letters; College of Engineering and Computer Science; School of Education; and School of Management. The Flint campus is comprised of four schools and colleges: the College of Arts and Sciences, School of Education and Human Services, School of Health Professions and Studies, and School of Management. Undergraduate programs in approximately 439 fields of study are offered by these three campuses. The University s accredited graduate professional programs include: architecture, business, chemistry, dentistry, dental hygiene, engineering, forestry, journalism, law, information and library studies, medicine, music, nursing, pharmacy, physical therapy, public health, social work and teacher education. Programs of study leading to graduate and graduate professional degrees are provided by the University in approximately 467 fields of study. Accreditations and Memberships The University is a member of the Association of American Universities, an organization of sixty-two of the leading research universities of the United States and Canada. Institutional accreditation is obtained from North Central Association of Colleges and Schools. All of the University s professional programs of study are fully accredited by the appropriate accrediting agencies. Regents of the University The University is governed by the Regents of the University, consisting of eight members elected at large in the biennial state-wide elections and the President of the University who serves as an ex officio member. The Regents serve without compensation for overlapping terms of eight years. According to the Michigan Constitution of 1963, the Regents have general supervision of the institution and the control and direction of all expenditures from the institution s funds. Dr. Mary Sue Coleman is in her sixth year as president of The University of Michigan. She is also a professor of biological chemistry in the U-M Medical School and professor of chemistry in the College of Literature, Science, and the Arts. Dr. Coleman was president of the University of Iowa for seven years before becoming Michigan's 13th president on August 1,

30 Facilities - Ann Arbor Campus Academic and Administrative Facilities. For fiscal year 2007, The University of Michigan had approximately 538 buildings used for academic instruction, research, patient care, athletics and administrative functions. These buildings are situated on the University s Ann Arbor Campus, which is located on 3,070 acres. The University has approximately 18,000 acres outside of Ann Arbor, including the Dearborn and Flint campuses. Over time, The University of Michigan has a sustained commitment to addressing its facilities capital needs and selectively increasing its physical plant to meet new areas of research and teaching. Much of the major maintenance activity includes the updating of buildings infrastructure and the structural needs that develop with the passage of time. Over the last decade, the University has invested an average of $312 million per year for renovation and replacement of buildings and related infrastructure. This past fiscal year was no exception, as the University completed more than 421 capital projects across campus, an investment of more than $507 million. In addition to the facilities previously described in the Projects section, a number of renovation and rehabilitation projects to protect the University s most important historical landmarks are currently underway. The College of Engineering is completing the Solid State Electronics Laboratory Addition and Renovation housed in the Electrical Engineering and Computer Science Building. The project includes an addition to house a clean room, chemical storage and support for the College of Engineering. The Alumni Memorial Hall Museum of Art is currently undergoing renovation and an addition on the north end to address current space needs and future growth in collections and programming. The Walgreen Drama Center under constriction will provide an important destination venue for North Campus, and will be located along a major pedestrian connection between the School of Music and the central core of North Campus. The Walgreen Drama Center will house a 250-seat Arthur Miller Theatre. The theatre will be designed as flexible performance space and as an appropriate community venue. The University has consistently used funding provided by the State of Michigan for capital expenditures to renovate existing buildings, since identifying other sources of funding for such purposes is quite challenging. At this time, over $27 million is being expended as part of the State s periodic capital outlay program, with approximately 69% of approved funds coming through the generosity of the State. The projects currently being funded in part with state capital outlay include the Student Activities Building, Observatory Lodge, and Phoenix Memorial Lab on the Ann Arbor Campus. At the Flint campus, state funding is being used to renovate the David M. French Hall. Health System Facilities. The University of Michigan Health System is comprised of the University of Michigan Medical School and its Faculty Group Practice; inpatient units with a total of 913 licensed beds; 30 health centers; and Michigan Health Corporation. The inpatient units include: University Hospital and Kellogg Eye Center; C.S. Mott Children s Hospital, Holden Perinatal Center, Women s Hospital and the new Cardiovascular Center, which opened in June The new C.S. Mott s Children s and Women s Hospital under construction will consist of a stateof-the-art clinical facility, and connectors to existing facilities. The facility will be connected to the existing Taubman Health Center via a link as well as the Simpson Parking Structure. The clinical facility will include 200 pediatric beds, 40 obstetric beds, 26 adult bone marrow transplant beds, 12 operating rooms, four C-Section rooms, a pediatric emergency department, a full range of diagnostic and treatment areas, outpatient clinics, and offices for clinical faculty and support staff. Construction began in 2006 and is scheduled to be completed in Spring

31 The Kellogg Eye Center expansion consists of a 230,000 gross square foot building with eight floors. The facility will house the Department of Ophthalmology and Visual Sciences and the William K. and Delores S. Brehm Center for Type I Diabetes Research and Analysis Libraries. The University houses library, museum, and archival collections of importance and breadth. Libraries, museums, and collections serve the academic community as a bridge to ideas, past and present; research resources generated over centuries; information in a variety of formats and delivery systems; and applications of modern digital technology. The total University of Michigan holdings number nearly 8,200,000 volumes. Within the purview of the Provost and Executive Vice President for Academic Affairs, the University of Michigan Ann Arbor Campus library system is administered centrally through the University Librarian and Dean of Libraries, and is composed of the following units: Area Programs Library, Art Architecture and Engineering Library, Asia Library, Askwith Media Library, Biological Station Library, Buhr Shelving Facility, Dentistry Library, Fine Arts Library, Government Documents Center, Harlan Hatcher Graduate Library, Information and Library Studies Library, Map Library, Museums Library, Music Library, Papyrology Collection, Public Health Library, Shapiro Science Library, Shapiro Undergraduate Library, Social Work Library, Special Collections Library, and the Taubman Medical Library. In addition, four major library units are maintained and administered separately from the University Library. They are the Bentley Historical Library, which houses the Michigan Historical Collections and the University Archives, reporting to the Provost and Executive Vice President for Academic Affairs; the Kresge Business Administration Library, reporting to the Dean of the School of Business Administration; the Law Library, reporting to the Dean of the Law School; and the William L. Clements Library reporting to the Provost and Executive Vice President for Academic Affairs. In addition, the Gerald R. Ford Library and Museum, a presidential library operated by the National Archives and Records Administration (an agency of the United States Government), is physically housed on the University's North Campus. Other independent libraries include the Population Studies Center Library, Sumner and Laura Foster Library, Towsley Reading Room, and the Transportation Research Institute Library. Technology Infrastructure. The University operates several large data centers to provide computing services to campus. Administrative Information Services, Information Technology Central Services, and the Medical Center Information Technology units each operate large server-based environments in the data centers. These server-based environments provide a wide range of functions including administrative information systems, electronic mail, electronic conferencing, computation, file storage, and clinical information systems. Many of the University s administrative systems are based in PeopleSoft applications. Web interfaces to many administrative functions support student and employee self-service and distribution of information to managers in academic departments across the University. An extensive data warehouse allows for ad hoc data query and reporting and management decision support capabilities. Twenty seven centrally managed campus computing sites provide general access to desktop computing services and the Internet to faculty, staff and students. Residents of University Housing also have access to Residential Computing Sites in all residence halls. Several schools and colleges provide access to computing sites and classrooms for use by their students and faculty. UM CourseTools is an online toolkit comprised of many features that faculty may choose from depending on their needs. Faculty may choose to make announcements and share resources such as documents and URLs, use online discussion boards for their classes, or use a course website on which students can work on and submit assignments electronically, either individually or in collaboration with their peers. The University libraries provide computing facilities for use by campus patrons and the general public. -25-

32 Housing and Dining Facilities. The University provides both family and graduate apartments and single student housing. Family and graduate housing consists of four apartment complexes, containing approximately 1,100 units that had a 10.8% vacancy rate during the fiscal year. Single student housing is provided in seventeen residence halls and one apartment complex containing approximately 10,000 beds. Dining facilities in twelve centrally located residence halls are able to provide food service for all single student housing. During the academic year the vacancy rate was 4.7% for single student housing. The Residential Life Initiatives (RLI) is a planned approach for the renewal, revitalization, and modernization of campus residential facilities. Following an extensive study of campus housing and dining at Michigan and peer institutions, preliminary recommendations call for: (i) Construction of the North Quad Residential and Academic Complex that combines a new residence hall in the range of 460 beds, with suite style configuration, and an academic building on the site of the Frieze Building; (ii) renovation of two architecturally significant buildings, Mosher-Jordan and Stockwell; (iii) construction of a new Hill Dining Center will offer marketplace seating and café-style services and renovation of existing facilities to meet student needs for quality, variety and extended hours; (iv) continuation of life safety initiatives and information technology upgrades in all residence halls. The RLI is expected to be funded primarily from University resources and General Revenue obligations. New academic space in the North Quad Complex will allow a close link between students academic and residential experiences. This will be an innovative mixed use environment for all students, not just those that live in the residence hall. Shared spaces can be used by faculty and students, together and individually, for creative and scholarly projects. Shared spaces could include meeting rooms, production facilities, studios, classrooms, seminar rooms or a small auditorium. These shared spaces will complement the private spaces for residential areas and for faculty offices. Other Facilities. Some of the University s other facilities include museums of natural history, archaeology, art, anthropology, paleontology, and zoology; University Herbarium; Matthaei Botanical Gardens; and Nichols Arboretum. These facilities, with the exception of the Herbarium, are open to the public. Faculty and Staff The University s faculty and staff aggregated 34,073 full-time equivalent employees in the fall of Members of the University of Michigan s faculty totaled 5,995 and consisted of 1,591 professors, 882 associate professors, 875 assistant professors and instructors, 1,222 lecturers, and 1,425 supplemental faculty members. Of the total faculty, 3,238 staff held tenure or tenure-track appointments. Eight unions are presently recognized at The University of Michigan, covering approximately 10,000 service, nursing staff, maintenance employees, house officers, police/security, non-tenured track instructional staff and graduate student teaching assistants. The University considers its relations with its employees to be good. Bargaining Unit Contract Expiring American Federation of State, County and Municipal Employees July 26, 2009 Graduate Employees Organization - American Federation of Teachers March 1, 2008 International Union of Operating Engineers November 28, 2009 Lecturer s Employees Organization May 15, 2010 Michigan Nurses Association and University of Michigan Professional Nurses Association June 30, 2008 Police Officers Association of Michigan December 12, 2009 University of Michigan House Officers Association August 31, 2009 University of Michigan Skilled Trades Union -26- July 31, 2008

33 Student Enrollment The University s Ann Arbor campus student population is drawn from throughout the world. In the fall term of 2007, approximately 31% of Ann Arbor campus undergraduate students resided in the United States but outside of Michigan; another 5% were international students. The students at the Dearborn and Flint campuses are predominantly Michigan residents. The total number of students (undergraduate, graduate and professional) attending the University of Michigan s three campuses during the last five years is shown in the following table. Total Enrollment Fall Term Ann Arbor Dearborn Flint Total Enrollment ,031 9,022 6,152 54, ,533 8,631 6,188 54, ,993 8,613 6,422 55, ,025 8,566 6,527 55, ,042 8,606 6,883 56,531 The University of Michigan projects that total enrollment will remain stable at or near current levels. The following table indicates the total fall enrollment of undergraduate and graduate (including professional programs) students combined for all three campuses. Also indicated are the full-time equivalent and total annual credit hours for all students attending the University. Student Enrollment Fall Term Under- Graduate Graduate and Professional Total Full-Time Equivalent Annual Total Credit Hours ,741 17,464 54,205 47,427 1,418, ,897 17,455 54,352 47,694 1,422, ,709 17,319 55,028 48,421 1,428, ,767 17,351 55,118 48,703 1,463, ,555 17,976 56,531 49,943 1,471,

34 Student Admissions The table below sets forth the total number of first year applications received and accepted, and the number of first year students enrolled at the Ann Arbor campus, for the fall terms indicated. Student Admissions Fall Term Applications Received Admissions Granted Percent Admitted Students Enrolled Percent Enrolled Percent Applications Enrolled ,943 13, % 5, % 21.4% ,293 13, % 6, % 28.4% ,882 13, % 6, % 25.6% ,806 12, % 5, % 20.9% ,474 13, % 5, % 21.8% Admission to the University continues to be highly competitive with the number of applications far exceeding the number of students admitted. Since 2005, applications for undergraduate admissions have shown an increasing trend with approximately one student admitted for every two applicants. Applications to the graduate schools are approximately three times greater than the number of students admitted. In the fall of 2007, the top quarter of first year students had an average 3.90 high school grade point average. The decline in applications for fall of 2004 reflects a more extensive application process started by the University. The revised process requires several essays, recommendations by teachers in addition to school guidance counselors and a more comprehensive application. The University believes that the revised requirements may have reduced applications from students who were not serious about attending or who would have applied with little chance of being accepted. As of February 3, 2008, the University has received over 26,600 freshman applications for Fall 2008, which represents a 5.2% increase over the comparable period in The University expects that applications will reach a new record this year. Student Tuition and Fees Tuition, Room and Board and Other Fees: For the academic year, Student Tuition and Fees in the Ann Arbor campus are as follows: Tuition and Fees Student Tuition and Fees Resident Nonresident Undergraduate (fewer than 55 credit hours) $ 10,258 $ 31,112 Undergraduate (55 or more credit hours) 11,586 33,310 Graduate 15,558 31,468 Business Administration 38,100 43,100 Law 38,760 41,760 Dentistry 26,354 41,272 Medicine 24,566 38,930 The cost of room and board to students for a two-person room in the academic year is $8,190 in the Ann Arbor campus. Students in the Ann Arbor campus are currently charged an additional -28-

35 $881 per academic year ($691 of which is included in the table above), mainly for Student Health Services, infrastructure maintenance, and registration. Financial Operations of the University The financial statements of the University have been prepared in accordance with accounting principles generally accepted in the United States of America, as prescribed by the Governmental Accounting Standards Board (GASB). The financial statements include the individual schools, colleges and departments, the University of Michigan Hospitals and Health Centers, Michigan Health Corporation (a wholly-owned corporation created to pursue joint venture and managed care initiatives), The Veritas Insurance Corporation, (a wholly-owned captive insurance company) and M-CARE (a formerly wholly owned health maintenance organization). The University receives the major portion of its revenues from student fees, the State of Michigan, the Federal Government, and the University of Michigan Health System, which includes the University of Michigan Hospitals and Health Centers, University Medical School, formerly owned M- CARE, Michigan Health Corporation, and other medical activities. The table below presents the Consolidated Statement of Revenues, Expenses, and Changes in Net Assets for Fiscal Years ending June 30, 2005, 2006 and

36 Consolidated Statement of Revenues, Expenses, and Changes in Net Assets Fiscal Year Ended June 30 (in thousands) Operating Revenues Student tuition and fees $ 765,201 $ 834,365 $ 891,634 Less: scholarship allowances 146, , ,952 Net student tuition and fees 618, , ,682 Federal grants and contracts 674, , ,289 State and local grants and contracts 13,843 9,282 12,937 Nongovernmental sponsored programs 120, , ,498 Sales and services of educational departments 110, , ,020 Auxiliary enterprises: Patient care revenues and managed care premiums 1,841,240 1,990,453 1,983,636 Student residence fees (allowances of $15,690 in 2007, $15,689 in 2006, $14,801 in 2005) 66,254 70,229 70,255 Other revenues 113, , ,151 Student loan interest income and fees 1,831 1,368 1,903 Total Operating Revenues 3,560,675 3,782,950 3,835,371 Operating Expenses Compensation and benefits 2,592,098 2,757,920 2,961,914 Supplies and services 1,104,824 1,150,214 1,103,928 Depreciation 253, , ,048 Scholarships and fellowships 75,398 83,839 83,712 Total Operating Expenses 4,026,053 4,256,001 4,433,602 Operating loss (465,378) (473,051) (598,231) Nonoperating Revenues (Expenses) State educational appropriations 374, , ,446 Private gifts for other than capital and endowment purposes 107,181 90, ,692 Net investment income 874, ,841 1,572,591 Interest expense (21,738) (27,128) (30,606) Total Nonoperating Revenues, Net 1,334,959 1,387,663 1,985,123 Income before other revenues (expenses) 869, ,612 1,386,892 Other Revenues (Expenses) State capital appropriations 7,023 20,126 6,413 Capital gifts and grants 118,962 64,787 64,870 Private gifts for endowment purposes 78,272 86,228 94,798 Other 6,568 (11,957) 60,023 Total Other Revenues, Net 210, , ,104 Increase in net assets 1,080,406 1,073,796 1,612,996 Net Assets, Beginning of Year 7,729,943 8,810,349 9,884,145 Net Assets, End of Year $ 8,810,349 $ 9,884,145 $ 11,497,141 For further information, see Appendix A Audited Financial Statements of the University. -30-

37 State of Michigan Finances The State s efforts to diversify its economy have seen success, as reflected by the fact that the share of employment in the State in the manufacturing sector has fallen from 21.1 percent in 1990 to 19.1 percent in 2000 and 14.5 percent in Durable goods manufacturing still represents a sizable portion of the State s economy. Reflecting the economic conditions in the State, Moody s Investors Service, Inc. lowered the State s general obligation bond rating to Aa3 in April Standard & Poor s Ratings Services lowered its rating on such bonds to AA- in May Fitch, Inc. lowered its rating of the State s general obligation debt to AA- in January Although the national economy mostly recovered from the 2000 downturn prior to the present weakness, the State s economic slowdown has continued and the recovery has been hampered by continued job losses, mostly in the manufacturing sector. As a result, since November of 2001, the State has been forced to take a variety of measures to balance its general fund and school aid fund budgets each year. These have included actions occurring during the process of adopting budgets prior to the commencement of each fiscal year, and actions taken during the course of the year when revenues have fallen short of original projections. The actions taken have included some revenue enhancements and a larger number of expenditure cuts, as well as some one-time measures, including use of the State s Budget Stabilization Fund, accounting adjustments and changing the timing of revenue receipts. Included within the expenditure cuts have been significant reductions in appropriations to Michigan s public four-year higher education institutions. Since , initial State operating appropriations to Michigan s higher education institutions declined from approximately $1.8 billion to approximately $1.6 billion for fiscal year The final University s appropriations for operating purposes have fallen from approximately $416 million to approximately $332 million over the same time period, prior to the restoration in October The resulting share of the University s revenues provided by State appropriations has declined from 12% in fiscal year to 6% in fiscal year For fiscal year , the State budgeted $373 million in State operating appropriations for the University, an increase of 3%. However, because of lower projected revenues for the State s general fund, the State, by Executive Order, initially deferred $16.9 million of the University s appropriations. Later, the State Legislature enacted legislation to delay an additional $16.9 million and reduce by $6.4 million the University s appropriations. In October 2007, the University received the $33.8 million of deferred appropriations. For fiscal year , the State faced a serious revenue shortfall, starting with the enacted elimination of the Single Business Tax (SBT) by December 31, SBT produced approximately $1.9 billion per year, out of total State General Fund revenues and other financing resources of approximately $23.4 billion. Most of the SBT revenues supported the State s general fund expenditures, including higher education. The State Legislature enacted a new Michigan Business Tax, an increase in the income tax rate from 3.9% to 4.35%, and made cuts to existing programs to balance the State budget for the fiscal year. For the first time, The University of Michigan-Ann Arbor, Michigan State University and Wayne State University are separated from the other State universities into a separate section in the State budget for higher education because of the research mission and economic development activities of these institutions. The budget adopted by the State includes appropriations for the three campuses of the University of $370 million, reflecting a 1% increase from the final appropriations. At the State s Revenue Estimating Conference held January 2008, the forecast of a $234.1 million decline in the general fund revenues coupled with a $259.1 surplus in the general -31-

38 fund revenues may indicate that no significant budget cuts would be necessary to balance the State budget for the fiscal year. For fiscal year , the Governor proposed an economic stimulus package and higher spending for some programs including education with no additional taxes. The Governor proposed a 3% increase for higher education institutions with funding distributed by a formula that recognizes the importance of students completing their degrees. For the three research universities including the University, the formula will place greater emphasis on research and commercialization activities. The University anticipated the reductions in State Appropriations over the past years and planned accordingly. Tuition rate increases, net revenue increases from increased activity, and expenditure reductions balanced the cuts in State appropriations for the University. Further appropriation cuts (or even increases insufficient to cover necessary cost increases) may result in additional tuition increases, or programmatic reductions and other efficiency measures. The Michigan Constitution of 1963 limits the amount of total revenues of the State raised from taxes and certain other sources to a level for each fiscal year equal to a percentage of the State s personal income for the prior calendar year. In the event that the State s total revenues exceed the limit by one percent or more, the Michigan Constitution of 1963 requires that the excess be refunded to taxpayers. The Michigan Constitution of 1963 also effectively limits State spending for State programs, including appropriations to State universities, by annually requiring the proportion of total State spending paid to local units of government, as a group, to be maintained at not less than that proportion in effect in the State s fiscal year. Further information with respect to the State s financial position and with respect to certain litigation which may have an impact on the State s finances may be obtained by a review of the State s Annual Financial Report, which may be obtained from the Department of Management and Budget, Office of Financial Management, State of Michigan, Lansing, Michigan and from a review of the Official Statements prepared by the State or its agencies in connection with debt offerings, which are normally filed with one or more nationally recognized Municipal Securities Information Repositories. -32-

39 Student Financial Aid The following table summarizes the financial aid provided to University students for the three years ending June 30, A substantial portion of funds provided are derived from sources outside the University. All programs furnished by the federal government and the State are subject to appropriation and funding by the respective legislatures. Student Financial Aid Fiscal Year Ended June 30 (in thousands) Grants, Scholarships & Fellowships: University/State (Primarily University) $ 130,199 $ 137,772 $ 144,008 Federal 47,865 47,149 48,688 Other 58,360 73,266 79,657 Total Grants, Scholarships & Fellowships 236, , ,353 Loans Issued:* Loans Managed by the University: Federal 23,910 17,592 20,117 University 3,833 3,672 4,377 Total Loans Managed by the University 27,743 21,264 24,494 Federal Direct Lending 193, , ,480 Work-study 6,284 6,435 6,513 Total Financial Aid to Students $ 464,406 $ 488,003 $ 523,840 * Not included as Expenses and Revenues in the University's Financial Statements. -33-

40 Gifts, Grants, Contracts and Research Expenditures As of June 30, 2007, the University was engaged in approximately 7,300 separate research and other sponsored activities. During the most recent fiscal year, the University received approximately 2,500 new awards from external sources, totaling approximately $835 million to be received in 2007 and future years. Federal agencies continue to provide the largest portion of funds. The Department of Health and Human Services is the single largest sponsor. The following table sets forth the amounts of research expenditures during the past three fiscal years, identified by source. Federal Sources Research Expenditures Identified By Source Fiscal Year Ended June 30 (in thousands) Department of Health and Human Services $ 376,037 $ 402,259 $ 405,659 Department of Education 5,337 5,412 6,044 National Science Foundation 68,062 63,663 65,320 Other Federal Agencies 122, , ,528 Total Federal Sources 571, , ,551 Nonfederal Sources Foundations, Charities and Health Agencies 30,649 28,673 29,604 Industry 34,703 33,585 38,594 State, Local and Foreign Governments 12,299 9,979 7,185 Endowment Income 4,850 4,837 6,079 Professional Societies and Associations 6,810 5,598 6,600 Other, including Other Schools and Universities 7,837 8,128 8,664 Total Nonfederal Sources 97,148 90,800 96,726 University Funds 109, , ,690 Total All Sources $ 778,062 $ 796,965 $ 822,967 The research expenses reported in the table above differ from those reported in the Combined University financial statements primarily due to Departmental Research, which comes from University Funds. Departmental Research is treated as an instruction expenditure in the certified financial statements, and as a research expenditure for management reporting purposes. Departmental Research is required by OMB Circular A-21 to be reported as instruction for external financial reporting purposes. Private Sector Campaigns Comprehensive fund raising efforts at the University are directed toward support of annual programs and for longer term endowment and facility goals. Private gift revenues totaled $300 million for the fiscal year ending June 30, The University receives private gifts from individuals, corporations, foundations, and other sources. -34-

41 The Michigan Difference campaign was publicly launched on May 14, 2004 and will run through the fall of 2008 with a $2.5 billion goal in gifts, pledges and bequest intentions. This goal includes $2.1 billion in cash and pledges and $400 million in new bequests. Since launching the quiet phase of the campaign in 2000, as of December 31, 2007, the University has raised $2.4 billion in cash and pledges and $415 million in bequests, for a total of $2.8 billion or 113% of the goal. The University closed a highly successful five-year development campaign on September 30, 1997, raising more than $1.4 billion in gifts, pledges, and new bequest intentions. Endowment and Other Invested Funds Endowment and Other Invested Funds consist mainly of true endowment funds and funds functioning as endowment, and are also identified as part of the University Endowment Fund. The principal of true endowment funds cannot legally be expended, while the principal of funds functioning as endowment can be expended. When the terms of the gifts or restrictions on funding sources permit, the funds are permitted to participate in the endowment pool and are commingled for investment purposes. The distribution policy for the endowment pool was changed as of July 1, 2006 to 1.25% quarterly (5% annualized) of the preceding twenty eight-quarter average market value of the fund shares from a twelvequarter moving average. The change will be implemented gradually over the next three years. For additional information see Appendix A - Audited Financial Statements of the University. The following table sets forth the market value of the University s Endowment Fund excluding Life Annuity Agreements at June 30 for each of the years indicated: The University Endowment Fund (in thousands) June Market Value $ 4,931,338 5,652,262 7,089,830 billion. The unaudited market value of the University Endowment Fund as of December 31, 2007 is $7.4 Physical Plant and New Construction During the past three fiscal years, the University s investment at cost in land, land improvements, infrastructure, buildings, equipment, library materials, and construction in progress increased from approximately $5.8 billion at June 30, 2005 to approximately $6.9 billion at June 30,

42 The following table reflects the investment on an original cost basis in plant, with recognition of accumulated depreciation for the periods indicated. Investment in Plant - Physical Properties Fund (in thousands) Year Ended June 30 Gross Investment in Plant Accumulated Depreciation Net Investment In Plant 2005 $5,808,992 $2,703,524 $3,105, ,378,605 2,925,164 3,453, ,901,333 3,145,935 3,755,398 Other Indebtedness of the University As of December 31, 2007, the University had $400,515,000 in obligations outstanding, including bond related interest rate swap transactions, secured by and payable from General Revenues. The University has financed certain facilities by means of bond issues or term loans payable from revenues of the projects constructed, some other specific revenues, and in some cases, from other legally available funds. As of December 31, 2007, the University had outstanding $93,547,246 of such indebtedness, including bond related interest rate swap transactions, other than the outstanding Hospital Revenue Bonds. The University operates a hospital complex as an auxiliary enterprise consisting of 913 licensed beds. As of December 31, 2007, the University had outstanding $570,270,000 of Hospital Revenue Bonds, and bond related interest rate swap transactions, which are payable solely from revenues generated by Hospital operations. In order to improve its liquidity support for several of its bond issues, the University has entered into three lines of credit secured by General Revenues and providing a $450 million total line of credit. The University plans to have an additional line of $200 million secured by General Revenues for the liquidity of its variable rate indebtedness to be effective on or prior to the date of delivery of the Bonds. The University is not obligated to continue or maintain the lines of credit and may, at its option, amend or terminate the lines of credit without notice to, or the consent of, any party. Capital Programs and Additional Financing in Fiscal Years 2008 and 2009 The University has an ongoing capital improvement program consisting of new construction and renovation of existing facilities. These projects are expected to be funded from a variety of sources, including gifts, State appropriations and University funds. In addition to the present borrowing, depending on market conditions, the University expects that it may issue approximately $160 million for new projects in Fiscal Years 2008 and Anticipated projects to be financed include Athletics, and the Residential Life Initiative (RLI) projects. Retirement Plan The University has a defined contribution retirement plan for all qualified employees through the Teachers Insurance and Annuity Association - College Retirement Equities Fund ( TIAA-CREF ) and Fidelity Management Trust Company ( FMTC ) mutual funds. All regular and supplemental instructional and primary staff are eligible to participate in the plan based upon age and service requirements. Participants maintain individual contracts with TIAA-CREF, or accounts with FMTC, and are fully vested. -36-

43 Eligible employees generally contribute 5 percent of their pay and the University generally contributes an amount equal to 10 percent of employees' pay to the plan. Participants may elect to contribute additional amounts to the plan within specified limits that are not matched by University contributions. The University is presently current in all amounts due with respect to TIAA-CREF and FMTC contributions. Postemployment Benefits The University provides certain health care and other postemployment benefits for retired employees. Substantially all of the approximately 32,000 permanent University employees may become eligible for these benefits. Health care benefits for the approximately 9,100 retirees and survivors, including dependents, at June 30, 2007 are provided through insurance companies and health maintenance organizations, whose premiums are based in part on the benefits paid. The University recognizes the cost of providing these benefits on a pay-as-you-go basis, which is included in operating expenses and amounted to approximately $32,600,000 and $32,055,000 for the years ended June 30, 2007 and 2006, respectively. Certain organizations are currently required to record the estimated present value of non-pension postretirement benefits as a liability in their financial statements. Based on current actuarial assumptions and presuming a continuation of the current level of benefits, the University estimates the value of those benefits at $1,470 million at June 30, GASB Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions, issued in June 2004, calls for the measurement and recognition of the cost of other postemployment benefits ( OPEB ) during the periods when employees render their services. The University is required to implement this statement in fiscal 2008, which will result in an increase in liabilities and a decrease in net assets to reflect the actuarially determined liability for OPEB. This statement provides for various methods of calculating and recording the OPEB liability; accordingly, the liability recorded by the University upon implementation may differ from current estimates. Legal Claims The University is a party to various pending legal actions and other claims in the normal course of business. The University believes that the outcomes of these matters will not have a material adverse affect on its financial position. -37-

44 TAX MATTERS General In the opinion of Miller, Canfield, Paddock and Stone, P.L.C., based upon its examination of the documents described in its opinion, under existing law, as presently interpreted, the interest on the Bonds (a) is excluded from gross income for federal income tax purposes and (b) is not an item of tax preference for purposes of the federal alternative minimum tax imposed on individuals and corporations. It should be noted, however, that certain corporations must take into account interest on the Bonds in determining adjusted current earnings for the purpose of computing such alternative minimum tax. The opinion is subject to the condition that the Issuer comply with all requirements of the Internal Revenue Code of 1986, as amended (the Code ), that must be satisfied subsequent to the issuance of the Bonds in order that interest thereon be (or continue to be) excluded from gross income for federal income tax purposes. Failure to comply with certain of such requirements could cause the interest on the Bonds to be included in gross income retroactive to the date of issuance of the Bonds. The Issuer has covenanted to take all actions within its control to comply with all such requirements. Bond Counsel will express no opinion regarding other federal tax consequences arising with respect to the Bonds and the interest thereon. Bond Counsel is further of the opinion that under existing law, as presently interpreted, the Bonds and the interest thereon are exempt from all taxation in the State of Michigan, except inheritance and estate taxes, taxes on gains realized from the sale, payment or other disposition thereof and, with respect to certain taxpayers, a portion of the Michigan Business Tax, as described below. Under the Michigan Business Tax Act (the MBTA ), which became effective on January 1, 2008, as presently interpreted, the Bonds will be excluded from the calculation of "net capital" for purposes of taxation of financial institutions, and, so long as the interest on the Bonds qualifies for exclusion from gross income for federal income tax purposes as described above, such interest will be excluded for purposes of calculating the Business Income Tax component of the Michigan Business Tax. The MBTA does not provide, however, for an exclusion of the interest on the Bonds from "gross receipts" for purposes of the Modified Gross Receipts component of the Michigan Business Tax. Bond Counsel will express no opinion regarding the effect on the exclusion of interest on the Bonds from gross income for federal income tax purposes, nor as to the exclusion of the Bonds and the interest thereon from taxation by the laws of the State of Michigan, of any future conversion of the Bonds to a Rate Period other than a Daily Rate Period or a Weekly Rate Period. There are additional federal tax consequences relative to the Bonds and interest thereon. The following is a general description of some of these consequences, but it is not intended to be complete or exhaustive, and investors should consult their tax advisors with respect to these matters. For federal income tax purposes: (a) tax-exempt interest, including interest on the Bonds, is included in the calculation of modified adjusted gross income required to determine the taxability of social security or railroad retirement benefits; and (b) the receipt of tax-exempt interest, including interest on the Bonds, by life insurance companies may affect the federal income tax liabilities of such companies; (c) the amount of certain loss deductions otherwise allowable to property and casualty insurance companies will be reduced (in certain instances below zero) by 15% of, among other things, tax-exempt interest, including interest on the Bonds; (d) interest incurred or continued to purchase or carry the Bonds may not be deducted in determining federal income tax; (e) commercial banks, thrift institutions and other financial institutions may not deduct their costs of carrying certain obligations such as the Bonds; (f) interest on the Bonds will be included in effectively connected earnings and profits for purposes of computing the branch profits tax on certain foreign corporations doing business in the United States; (g) passive investment income, including interest on the Bonds, may be subject to federal income taxation for Subchapter S Corporations that have Subchapter C earnings and profits at the close of the taxable year if greater than 25% of the gross receipts of such Subchapter S Corporation is passive investment income, -38-

45 and (h) the receipt or accrual of interest on the Bonds may cause disallowance of the earned income credit under Section 32 of the Code. Future Developments No assurance can be given that any future legislation or clarifications or amendments to the Code, if enacted into law, will not contain proposals which could cause the interest on the Bonds to be subject directly or indirectly to federal or State of Michigan income taxation, adversely affect the market price or marketability of the Bonds, or otherwise prevent the holders from realizing the full current benefit of the status of the interest thereon. Further, no assurance can be given that any such future legislation, or any actions of the Internal Revenue Service, including, but not limited to, selection of the Bonds for audit examination, or the course or result of any examination of the Bonds, or other Bonds which present similar tax issues, will not affect the market price of the Bonds. On May 21, 2007, the United States Supreme Court agreed to review the decision of a Kentucky appellate court in the case of Davis v Department of Revenue of Kentucky and on November 5, 2007 heard oral arguments in this case. The Kentucky court held that under the Constitution of the United States, the Commonwealth of Kentucky may not exempt interest on bonds issued by that state or political subdivisions thereof from state and local taxes unless that state also provides such exemption to interest on bonds issued by other states and political subdivisions. Michigan law is similar to the Kentucky law in question, in that it generally exempts from state and local taxes interest on bonds issued by the State of Michigan and Michigan political subdivisions, but not interest on bonds issued by other states or political subdivisions. The outcome of such review, and its impact, if any, on the exemption of the Bonds and interest thereon from state and local taxes in Michigan, or on the market value of the Bonds, cannot be predicted. INVESTORS SHOULD CONSULT WITH THEIR TAX ADVISORS AS TO THE TAX CONSEQUENCES OF THEIR ACQUISITION, HOLDING OR DISPOSITION OF THE BONDS. Information Reporting and Backup Withholding Information reporting requirements will apply to interest paid after March 31, 2007 on taxexempt obligations, including the Bonds. In general, such requirements are satisfied if the interest recipient completes, and provides the payor with, a Form W-9, Request for Taxpayer Identification Number and Certification, or unless the recipient is one of a limited class of exempt recipients, including corporations. A recipient not otherwise exempt from information reporting who fails to satisfy the information reporting requirements will be subject to backup withholding, which means that the payor is required to deduct and withhold a tax from the interest payment, calculated in the manner set forth in the Code. For the foregoing purpose, a payor generally refers to the person or entity from whom a recipient receives its payments of interest or who collects such payments on behalf of the recipient. If an owner purchasing the Bonds through a brokerage account has executed a Form W-9 in connection with the establishment of such account, no backup withholding should occur. In any event, backup withholding does not affect the excludability of the interest on the Bonds from gross income for federal income tax purposes. Any amounts withheld pursuant to backup withholding would be allowed as a refund or a credit against the owner s federal income tax once the required information is furnished to the Internal Revenue Service. -39-

46 LITIGATION At the time of delivery of the Bonds, the Issuer will certify that there is no litigation or other proceeding pending or, to the knowledge of the Issuer, threatened, in any court, agency or other administrative body restraining the issuance of the Bonds, or in any way affecting the validity of any provision of the Bonds, the Trust Agreement or the Resolution authorizing the Bonds. CREDIT RATINGS Moody s Investors Service, Inc. ( Moody s ) and Standard & Poor s Ratings Services, a division of The McGraw-Hill Companies, Inc. ( S&P ) have assigned long-term ratings to the Bonds of Aaa and AAA, respectively. In addition, Moody s and S&P have assigned short-term ratings to the Bonds of VMIG 1 and A-1+, respectively. A further explanation of the rating by Moody s may be obtained from such agency at 7 World Trade Center at 250 Greenwich Street, New York, New York 10007, and a further explanation of the rating by S&P may be obtained from such agency at 55 Water Street, New York, New York These ratings reflect only the view of such rating agencies and an explanation of the significance of such ratings may be obtained only from such rating agencies. There is no assurance that such ratings will continue for any period of time or that they will not be revised downward or withdrawn entirely by such rating agencies if, in the judgment of such rating agencies, circumstances so warrant. Any revision or withdrawal of the ratings assigned to the Bonds could affect the market price of the Bonds. UNDERWRITING The Bonds are being purchased, subject to certain conditions, by UBS Securities LLC, as Underwriter. The Bond Purchase Agreement provides for the Underwriter to purchase all of the Bonds, if any are purchased, at an Underwriter s discount of $224, from the original public offering price of par. CERTAIN LEGAL MATTERS Certain legal matters incident to the authorization and issuance of the Bonds are subject to the approval of Miller, Canfield, Paddock and Stone, P.L.C., Detroit, Michigan, Bond Counsel. The form of opinion of Bond Counsel with respect to the Bonds is attached as Appendix C. Certain matters will be passed on for the Underwriter by its counsel, Hawkins Delafield & Wood LLP, New York, New York. EXEMPT FROM ONGOING DISCLOSURE The Bonds are exempt from the continuing disclosure requirements of Rule 15c2-12 of the Securities and Exchange Commission because the Bonds are subject to tender at intervals of less than 270 days and are issuable in minimum denominations of $100,000. In the past five years the University has not failed to comply, in all material respects, with any previous disclosure undertaking entered into in connection with any tax-exempt debt offerings. INDEPENDENT ACCOUNTANTS The financial statements of the University as of and for the years ended June 30, 2007 and 2006 included in Appendix A to this Official Statement have been audited by PricewaterhouseCoopers LLP, independent accountants, as stated in their report appearing in Appendix A. -40-

47 MISCELLANEOUS During the initial offering period for the Bonds, copies of the Trust Agreement are available for inspection at the Office of the Treasurer, 3003 South State Street, Wolverine Tower, Ann Arbor, Michigan The execution and delivery of this Official Statement has been duly authorized by the Issuer. REGENTS OF THE UNIVERSITY OF MICHIGAN By: /s/ Timothy P. Slottow Executive Vice President and Chief Financial Officer -41-

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49 APPENDIX A AUDITED FINANCIAL STATEMENTS OF THE UNIVERSITY

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51 THE UNIVERSITY OF MICHIGAN CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED JUNE 30, 2007 and 2006 with REPORT OF INDEPENDENT AUDITORS

52 THE UNIVERSITY OF MICHIGAN JUNE 30, 2007 and 2006 Page(s) Report of Independent Auditors... 1 Management s Discussion and Analysis (Unaudited) Consolidated Financial Statements: Statement of Net Assets Statement of Revenues, Expenses and Changes in Net Assets Statement of Cash Flows Notes to Financial Statements Supplementary Information: Report of Independent Auditors on Supplementary Information Consolidating Schedule of Net Assets Consolidating Schedule of Revenues, Expenses and Changes in Net Assets

53 PricewaterhouseCoopers LLP 1900 St. Antoine Street Detroit MI Telephone (313) Facsimile (313) Report of Independent Auditors The Regents of the University of Michigan In our opinion, the accompanying consolidated statement of net assets and the related consolidated statements of revenues, expenses and changes in net assets and of cash flows present fairly, in all material respects, the financial position of the University of Michigan (the University ) at June 30, 2007 and 2006, and its consolidated revenues, expenses and changes in its net assets and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the University's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. The Management's Discussion and Analysis ( MD&A ) on pages 2 through 24 is not a required part of the financial statements but is supplementary information required by the Governmental Accounting Standards Board. We have applied certain limited procedures, which consisted principally of inquiries of management regarding the methods of measurement and presentation of the MD&A. However, we did not audit the information and express no opinion on it. August 30,

54 THE UNIVERSITY OF MICHIGAN Management s Discussion and Analysis (Unaudited) Introduction The following discussion and analysis provides an overview of the financial position of the University of Michigan (the University ) at June 30, 2007 and 2006 and its activities for the three fiscal years ended June 30, This discussion has been prepared by management and should be read in conjunction with the financial statements and the notes thereto, which follow this section. The University is a comprehensive public institution of higher learning with approximately 55,000 students and 6,400 faculty members on three campuses in southeast Michigan. The University offers a diverse range of degree programs from baccalaureate to post-doctoral levels through 19 schools, colleges and divisions, and contributes to the state and nation through related research and public service programs. The University, in total, employs more than 48,000 permanent and temporary staff. The University also maintains one of the largest health care complexes in the world through its Hospitals and Health Centers ( HHC ). HHC consists of three hospitals, 30 health centers and more than 120 outpatient clinics. HHC is an integral part of the University s Health System which also includes the University s Medical School; Michigan Health Corporation, a wholly-owned corporation created to pursue joint venture and managed care initiatives; and M-CARE, a wholly-owned health maintenance organization which was sold effective December 31, The University consistently ranks among the nation s top universities by various measures of quality, both in general academic terms, and in terms of strength of offerings in specific academic disciplines and professional subjects. Excellence in research is another crucial element in the University's high ranking among educational institutions. Research is central to the University s mission and permeates its schools and colleges. In addition to the large volume of research conducted within the academic schools, colleges, and departments, the University has more than a dozen large-scale research institutes outside the academic units that conduct, in collaboration with those units, full-time research focused on long-term interdisciplinary matters. The University s Health System also has a tradition of excellence in teaching, advancement of medical science and patient care, consistently ranking among the best health care systems in the nation. 2

55 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued Financial Highlights The University s financial position remains strong, with assets of $13.8 billion and liabilities of $2.3 billion at June 30, 2007, compared to assets of $12.0 billion and liabilities of $2.1 billion at June 30, Net assets, which represent the residual interest in the University s assets after liabilities are deducted, increased $1.6 billion in fiscal 2007, to $11.5 billion at June 30, Changes in net assets represent the University s results of operations and are summarized for the years ended June 30, 2007 and 2006 as follows: (in millions) Operating revenues and state educational appropriations $ 4,167.8 $ 4,147.9 Total expenses 4, ,283.1 (296.4) (135.2) Net investment income 1, Gifts and other nonoperating revenues, net Increase in net assets $ 1,613.0 $ 1,073.8 Net assets increased $1.6 billion in 2007 and $1.1 billion in 2006 primarily due to net investment income of $1.6 billion and $960 million in 2007 and 2006, respectively. The results of operations reflect the University s focus on maintaining its national standards academically, and in research and health care, while addressing declining state appropriations and rising health care, regulatory, and facility costs in a competitive recruitment environment for faculty and health care professionals. The results of operations also reflect the sale of M-CARE effective December 31, Operating revenues and state educational appropriations increased 0.5 percent, or $20 million, while total expenses increased 4 percent, or $181 million. Gifts and other nonoperating revenues increased 35 percent to $337 million, which includes a $160 million gain on the sale of M-CARE. The University invests its financial assets to maximize total return with an appropriate level of risk. While the University s working capital is invested in relatively short duration assets, the University invests its endowment with a strategy that seeks to maximize total return over the long term. The success of this long-term investment strategy is evidenced by strong returns over sustained periods of time and the University s ability to limit losses in the face of challenging markets. 3

56 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued Sale of M-CARE Formed by the University in 1986, M-CARE offered managed health care benefits to the employees of the University and other employers in Southeast Michigan. Completing the sale of M-CARE to Blue Cross Blue Shield of Michigan ( Blue Cross ) and its subsidiary Blue Care Network in fiscal 2007 enabled the University to make a smooth transition with a non-profit, community-minded, quality-oriented partner, at a time when the health insurance industry is experiencing great turbulence, including the rapid growth of consumer driven health care plans and emerging technologies that require significant capital investment. This sale enables the University to better direct its resources toward its core mission of education, research and patient care. Subscription premiums revenue recognized by M-CARE from employers other than the University totaled approximately $197 million and $405 million for the six months ended December 31, 2006 and the year ended June 30, 2006, respectively. Proceeds from the sale, net of expenses, totaled $258 million and the University recognized a $160 million gain on the sale in fiscal The purchase price will be adjusted based on certain changes in net assets pursuant to terms of the sales agreement; however, such amount is not expected to be material. As part of the sale, Blue Cross also committed up to $10 million to launch a joint venture with the University. This venture will commission research and other projects aimed at improving the quality of health care in the state of Michigan, and transforming the way patient care is delivered in the state and beyond. University members enrolled in M-CARE at the time of the sale will maintain the same coverage through December 31, Replacement health plans designed and funded by the University, similar to the current M-CARE HMO and GradCare plans, will be available for calendar 2008 in addition to the other health plan choices offered by the University. The replacement plans will be offered only to the University community and administered by Blue Cross. Using the Financial Statements The University s financial report includes three financial statements: the Statement of Net Assets; the Statement of Revenues, Expenses and Changes in Net Assets; and the Statement of Cash Flows. These financial statements are prepared in accordance with Governmental Accounting Standards Board ( GASB ) principles, which establish standards for external financial reporting for public colleges and universities and require that financial statements be presented on a consolidated basis to focus on the University as a whole. 4

57 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued Statement of Net Assets The statement of net assets presents the financial position of the University at the end of the fiscal year and includes all assets and liabilities of the University. The difference between total assets and total liabilities net assets is one indicator of the current financial condition of the University, while the change in net assets is an indicator of whether the overall financial condition has improved or worsened during the year. Assets and liabilities are generally measured using current values. One notable exception is capital assets, which are stated at historical cost less an allowance for depreciation. A comparison of the University s assets, liabilities and net assets at June 30, 2007 and 2006 is summarized as follows: (in millions) Current assets $ 2,431 $ 2,337 Noncurrent assets: Endowment, life income and other investments 7,380 5,963 Capital assets, net 3,755 3,453 Other Total assets 13,829 11,998 Current liabilities Noncurrent liabilities 1,440 1,201 Total liabilities 2,332 2,114 Net assets $ 11,497 $ 9,884 The University continues to maintain and protect its strong financial foundation. This financial health, as reflected in the statement of net assets at June 30, 2007 and 2006, results from the prudent utilization of financial resources including careful cost controls, preservation of endowment funds, conservative utilization of debt, and adherence to a long-range capital plan for the maintenance and replacement of the physical plant. Current assets consist primarily of cash and cash equivalents, operating and capital investments, and accounts receivable. Total current assets increased $94 million, to $2.4 billion at June 30, Cash and cash equivalents and operating investments totaled $1.2 billion at June 30, 2007, which represents approximately three months of total expenses excluding depreciation. Current liabilities consist primarily of accrued compensation, accounts payable, deferred revenue, commercial paper and the current portion of bonds payable. Total current liabilities decreased $21 million, to $892 million at June 30, 2007, primarily due to a decrease in investment trade settlements payable. 5

58 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued Endowment, Life Income and Other Investments The University s endowment, life income and other investments increased $1.4 billion, to $7.4 billion at June 30, This increase primarily resulted from favorable investment performance and the receipt of new endowment funds through gifts and transfers, offset by endowment distributions to beneficiary units for operations. The composition of the University s endowment, life income and other investments at June 30, 2007 and 2006 is summarized as follows: (in millions) Endowment investments $ 7,090 $ 5,652 Life income investments Noncurrent portion of insurance and benefits obligations and managed care investments $ 7,380 $ 5,963 The University's endowment funds consist of both permanent endowments and funds functioning as endowment. Permanent endowments are those funds received from donors with the stipulation that the principal remain inviolate and be invested in perpetuity to produce income that is to be expended for the purposes specified by the donors. Funds functioning as endowment consist of amounts (restricted gifts or unrestricted funds) that have been allocated by the University for long-term investment purposes, but are not limited by donor stipulations requiring the University to preserve principal in perpetuity. Programs supported by endowment funds include scholarships, fellowships, professorships, research efforts, and other important programs and activities. The University uses its endowment funds to support operations in a way that strikes a balance between generating a predictable stream of annual support for current needs and preserving the purchasing power of the endowment funds for future periods. The major portion of the endowment is maintained in the University Endowment Fund, which is invested in the University s Long Term Portfolio, a single diversified investment pool. The University s endowment spending rate policy provides for an annual distribution of 5 percent of the one-quarter lagged, moving average fair value of University Endowment Fund assets, with distributions limited to 5.3 percent of current fair value. Any capital gains or income generated above the spending rate are reinvested so that in lean times funds will be available. Because the spending rate is based on a multiple year moving average fair value, the percent distributed for operating purposes is different when stated in the context of current fair value. Actual distributions were 3.8 percent, 4.1 percent and 4.2 percent of the fair value of the endowment at June 30, 2007, 2006 and 2005, respectively. Effective July 1, 2006, the moving average period was extended from three years to four years and it is being extended by one quarter each subsequent quarter until it reaches seven years. This change is expected to reduce distribution volatility, as well as better preserve and grow the endowment corpus over time. 6

59 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued Capital and Debt Activities One of the critical factors in continuing the quality of the University s academic, research and clinical programs is the development and renewal of capital assets. The University continues to implement its long-range plan to modernize its complement of older facilities, along with balanced investment in new construction. Capital asset additions totaled $611 million in 2007, as compared to $616 million in Capital asset additions primarily represent replacement, renovation and new construction of academic, research and clinical facilities, as well as significant investments in equipment, including information technology. Current year capital asset additions were primarily funded with gifts and net assets designated for capital purposes of $403 million, as well as debt proceeds of $202 million and state capital appropriations of $6 million. Construction in progress, which totaled $349 million at June 30, 2007 and $557 million at June 30, 2006, includes important new facilities for patient care, research, instruction and student residential life. Construction projects completed in 2007 include new buildings for the Cardiovascular Center and the Gerald R. Ford School of Public Policy. The Cardiovascular Center facility is one of the nation s first fully comprehensive cardiovascular treatment centers, with operating rooms, patient rooms, clinics, classrooms and laboratories. In addition to giving cardiovascular patients an all-in-one location for their care, this new clinical building will help meet the surging demand for cardiovascular services and bring together specialized services and facilities that are now located throughout the University s Health System. This state-of-the-art facility, whose construction commenced in 2003, is located just south of the University Hospital. To provide parking for patients and staff, a 465-space parking structure was also constructed as part of this project. Joan and Sanford Weill Hall houses the Gerald R. Ford School of Public Policy and serves as the southern gateway to the Central Campus. Located at State and Hill streets, this new building enabled the consolidation of three Ford School campus locations into a single facility with classrooms, a library, research centers, a computer laboratory, faculty offices and public spaces for conferences and lectures. With its new space, the Ford School is adding an undergraduate major, growing its faculty, and expanding the scope of its educational programming. Renovation and expansion projects completed in 2007 include the School of Public Health facilities. This project provided modernization of building systems and additional space, through replacement of the east-west wing of the Henry F. Vaughan Public Health Building with modern laboratories, classrooms, conference rooms and community focused research space. The facility s innovative design and state-of-the-art technology better enable faculty and students to address today s top public health priorities, including new genetic technologies, the financing of health care, the globalization of health, public health preparedness and the prevention and treatment of infectious disease. The addition also connects to the Thomas Francis Jr. Building to form one public health complex which serves as a crossroads of activity, from research and teaching to academe and community. 7

60 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued At June 30, 2007, many significant facility enhancement projects are underway for critical academic, patient care, research and residential life facilities. Business education has undergone a fundamental change from lecture-style classes to interactive methods that integrate individual preparation, teamwork and in-class discussion, while effectively utilizing advanced technology. Construction is in progress on a new facility for the Stephen M. Ross School of Business which will support the School's distinct, team-based learning that bridges theory and practice. Classrooms, offices and other spaces will be arranged in a setting conducive to collaboration inside the school. Technology designed into the building will foster interaction with firms and organizations around the world. In order to make way for the new structure, Davidson Hall, Paton Accounting Center, Assembly Hall and an electrical switching station were demolished. The University expects this new facility to be completed in Fall C.S. Mott Children s and Women s Replacement Hospitals are being constructed to meet increasing patient demand and accommodate future research, education and clinical care innovations. The new state-of-the art facility for these hospitals will further enhance specialty services for newborns, children and pregnant women not offered anywhere else in Michigan, including programs for Level I pediatric trauma, pediatric liver transplant, and craniofacial anomalies as well as high-risk pregnancy and specialty gynecological services. With a clinic building of nine floors and an inpatient building of twelve floors, the new facility will be approximately 1.1 million gross square feet. After the new facility for the replacement hospitals is completed in 2011, the facility housing the existing C.S. Mott Children s and Women s hospitals will be used to benefit the entire Health System. During 2007, the University broke ground on a new state-of-the art eye center that will more than double capacity for eye care, research and education, as well as give scientists more space to search for a cure for Type 1 diabetes. The new facility, which includes eight floors for clinics, surgery and research, will serve the growing number of patients who need advanced eye care and access to the latest research discoveries. Large windows and a full wall of glass panels on the building's façade will allow natural light to fill the clinics and common space, of particular benefit to patients whose vision is impaired. Clinics will have space for patient education and comfortable waiting areas designed to aid patient flow. Research areas will feature open laboratories to encourage collaboration and provide flexibility as research projects grow. The new facility will also house the Brehm Center for Type 1 Diabetes Research and Analysis, which will provide opportunities for collaboration among diabetes and vision scientists, particularly on vision loss caused by diabetes. The new eye center, which is expected to open in 2010, will be adjacent to and connected to the current Kellogg Eye Center tower. 8

61 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued The University also began construction of its first new student residence hall in more than 40 years. Combining sophisticated classroom and academic space with residence space for 460 students, the North Quad Residential and Academic Complex will provide classrooms, studios and offices for five information and communications-related university programs. The result will be an environment in which interactions among students and faculty flow from classrooms to hallways to faculty offices to living quarters. The living spaces, like the whole of the project, are designed to facilitate student learning, and student social and programmatic needs. The University expects this new facility to be completed in Summer Mosher-Jordan is the University s first residence hall to undergo a comprehensive renewal and renovation. This project, which continued in 2007, is preserving the existing historic areas and details, while creating new community environments by reconfiguring current spaces and completing significant infrastructure upgrades. The project also includes a new, multi-level lobby and entrance to provide a single point of entry for residents and visitors, as well as centralized services for students in both houses of Mosher-Jordan. Infrastructure upgrades include new plumbing, elevators, heating, ventilation, fire detection and suppression systems, wired and wireless high-speed network access, renovated bath facilities, and accessibility improvements. Taking place along with this renovation is the creation of Hill Dining Center which will enable the University to consolidate dining services for all of the Hill area residence halls. This innovative new dining center will be attached to Mosher- Jordan on the rear of the building facing Palmer Field and will feature a marketplace style facility with seating for 700 as well as a food emporium on the top floor with café style seating for 70. The University expects this project to be completed in Fall The Museum of Art s historic home, Alumni Memorial Hall, is undergoing a transformative facility expansion and restoration. An addition will nearly double the Hall s size to address space needs and allow for future growth in collections and programming, while the renovation will address needed infrastructure improvements. The addition consists of three floors with a lower level and will provide space for galleries, collections, exhibitions, classrooms, and administration. The University expects this project to be completed in Summer An expansion and renovation of the Solid State Electronics Laboratory in the Electrical Engineering and Computer Science Building is also underway. The laboratory facility, which was established in 1986, is in need of infrastructure updates and additional space for testing and prototype development. This project will provide a new clean room and support space as well as architectural, mechanical and electrical improvements. The renovation and expansion of this facility, which has been renamed the Michigan Nanofabrication Facility, will result in one of the premier nanofabrication facilities in the world and support important new energy initiatives, nanotechnology, microchip fabrication and other research initiatives. The University expects this project to be completed in December

62 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued The University takes seriously its financial stewardship responsibility and works hard to manage its financial resources effectively, including the prudent use of debt to finance capital projects. A strong debt rating is an important indicator of the University s success in this area. During 2007, Moody s Investors Service affirmed its highest credit rating (Aaa) for bonds backed by a broad revenue pledge based on the University s extremely strong credit fundamentals, including significant financial resources, strong market position and consistent operating performance derived from a well diversified revenue base. Standard & Poor s Ratings Services also affirmed its highest credit rating (AAA) based on the University s national reputation for excellence, strong financial performance, exceptional record of fundraising, and manageable debt burden and capital plan. Only two other public universities have received the highest credit ratings from both Moody s and Standard & Poor s. Long-term debt activity for the year ended June 30, 2007, and the type of revenue it is supported by, is summarized as follows: Beginning Balance Additions Reductions Ending Balance (in millions) Commercial Paper: General revenues $ 97 $ 52 $ 39 $ 110 Bonds and Notes: General revenues Hospital revenues Faculty Group Practice revenues Student residences revenues Student fee revenues $ 918 $ 203 $ 79 $ 1,042 The University maintains a combination of fixed and variable rate debt with effective interest rates that averaged 4.04 percent in 2007 and 3.75 percent in Consistent with the University s capital and debt financing plans, total outstanding debt increased $124 million, or 14 percent, to $1.0 billion at June 30, 2007, and interest expense increased 13 percent, to $31 million. The University utilizes commercial paper, backed by a general revenue pledge, to provide interim financing for its capital improvement program. Outstanding commercial paper is converted to longterm debt financing, as appropriate, within the normal course of business. At June 30, 2007 and 2006, commercial paper totaled $110 million and $97 million, respectively, and is included in current liabilities. In April 2007, the University issued $150 million in variable rate hospital revenue bonds to provide $126 million in funds for health system capital projects, including the replacement C.S. Mott Children s and Women s Hospitals, and to convert $24 million of commercial paper to long-term debt. In May 2007, the University entered into a floating-to-fixed interest rate swap agreement for a notional amount tied to a portion of the outstanding balance of the Series 2002 General Revenue Bonds, which totaled $58 million at June 30, The swap agreement converts the floating variable rate on these bonds, which was 3.73 percent at June 30, 2007, to a fixed rate of 3.54 percent commencing June 2007 through April

63 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued Net Assets Net assets represent the residual interest in the University s assets after liabilities are deducted. The composition of the University's net assets at June 30, 2007 and 2006 is summarized as follows: (in millions) Invested in capital assets, net of related debt $ 2,864 $ 2,615 Restricted: Nonexpendable: Permanent endowment corpus Expendable: Net appreciation of permanent endowments 1,420 1,022 Funds functioning as endowment 1,492 1,190 Restricted for operations and other Unrestricted 4,068 3,610 $ 11,497 $ 9,884 Net assets invested in capital assets represent the University's capital assets net of accumulated depreciation and outstanding principal balances of debt attributable to the acquisition, construction or improvement of those assets. The $249 million increase reflects the University's continued development and renewal of its capital assets in accordance with its long-range capital plan. Restricted nonexpendable net assets represent the historical value (corpus) of gifts to the University's permanent endowment funds. The $76 million increase primarily represents new gifts. Restricted expendable net assets are subject to externally imposed stipulations governing their use. This category of net assets includes net appreciation of permanent endowments, funds functioning as endowment and net assets restricted for operations, facilities and student loan programs. Restricted expendable net assets totaled $3.6 billion at June 30, 2007, as compared to $2.8 billion at June 30, Although unrestricted net assets are not subject to externally imposed stipulations, all of the University s unrestricted net assets have been designated for various academic and research programs and initiatives, as well as capital projects. In addition, unrestricted net assets include funds functioning as endowment of $3.1 billion and $2.4 billion at June 30, 2007 and 2006, respectively. 11

64 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued Statement of Revenues, Expenses and Changes in Net Assets The statement of revenues, expenses and changes in net assets presents the University s results of operations. In accordance with GASB reporting principles, revenues and expenses are classified as either operating or nonoperating. A comparison of the University s revenues, expenses and changes in net assets for the three years ended June 30, 2007 is summarized as follows: (in millions) Operating revenues: Student tuition and fees, net of scholarship allowances $ $ $ Sponsored programs Patient care revenues and managed care premiums 1, , ,841.2 Other , , ,560.7 Operating expenses 4, , ,026.1 Operating loss (598.2) (473.0) (465.4) Nonoperating and other revenues (expenses): State educational appropriations Private gifts Net investment income 1, Interest expense (30.6) (27.1) (21.7) State capital appropriations Endowment and capital gifts and grants Other 60.0 (11.9) 6.6 Nonoperating and other revenues, net 2, , ,545.8 Increase in net assets 1, , ,080.4 Net assets, beginning of year 9, , ,729.9 Net assets, end of year $ 11,497.1 $ 9,884.1 $ 8,810.3 One of the University s greatest strengths is the diverse streams of revenue that supplement its student tuition and fees, including private support from individuals, foundations and corporations, along with government and other sponsored programs, state appropriations and investment income. The University continues to aggressively seek funding from all possible sources consistent with its mission in order to supplement student tuition and prudently manage the financial resources realized from these efforts to fund its operating activities. 12

65 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued The following is a graphic illustration of revenues by source, both operating and nonoperating, which are used to fund the University s operating activities for the year ended June 30, 2007 (amounts are presented in thousands of dollars). Significant recurring sources of the University s revenues are considered nonoperating, as defined by GASB, such as state appropriations, private gifts and distributions from investments. Fiscal Year 2007 Revenues for Operating Activities 13

66 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued The University measures its performance both for the University as a whole and for the University without its Health System and other similar activities. The exclusion of the Health System allows a clearer view of the operations of the schools and colleges, as well as the central administration. The following is a graphic illustration of University revenues by source, both operating and nonoperating, which are used to fund operating activities other than the Health System, for the year ended June 30, 2007 (amounts are presented in thousands of dollars). Fiscal Year 2007 Revenues for Operating Activities Excluding Revenues from the University s Health System Tuition and state appropriations are the primary sources of funding for the University's academic programs. There is a direct relationship between the growth or reduction in state support and the University s ability to restrain tuition fee increases. Together, net student tuition and fees and state appropriations increased 1 percent, or $11 million, to $1.1 billion in 2007, as compared to a 5 percent, or $47 million, increase in

67 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued Downturns in state of Michigan tax revenues continue to put pressure on the state budget. State support has declined each year since fiscal 2002 when state educational appropriations revenue totaled $416 million. For the three years ended June 30, 2007, state educational appropriations revenue consisted of the following components: (in millions) Base appropriations $ $ $ Net (rescission) restoration (40.4) $ $ $ Due to volatility in the state budget, the University s base appropriations continue to be subject to mid-year rescission and restoration. Net revenues from state educational appropriations decreased $43 million, or 11 percent, to $332 million in 2007 from The $40 million mid-year rescission in 2007 consists of a reduction in base of $6 million and a deferral of $34 million until fiscal The net restoration in 2006 of $2.9 million represents the return of a 2005 net mid-year rescission. The net restoration in 2005 of $8.3 million primarily represents the return of a portion of the 2004 mid-year rescission of $11.2 million, which was received because the University limited its 2005 resident undergraduate tuition increases to inflation, offset by a net mid-year rescission of 2005 base appropriations of $2.9 million. To offset the decrease in state appropriations, net student tuition and fees revenue has increased 16 percent, or $100 million, over the past two years. For the three years ended June 30, 2007, net student tuition and fees revenue consisted of the following components: (in millions) Student tuition and fees $ $ $ Scholarship allowances (172.9) (158.7) (146.2) $ $ $ In 2007, net student tuition and fees revenue increased 6 percent, or $43 million, to $719 million, which reflects a 7 percent, or $57 million, increase in gross tuition and fee revenues offset by a 9 percent, or $14 million, increase in scholarship allowances. Tuition rate increases in 2007 averaged 5.8 percent for all undergraduate students on the Ann Arbor campus, with an 8 percent tuition rate increase for the Dearborn and Flint campuses and a 5 percent increase for most graduate tuition rates. The University also experienced a modest growth in the number of students. 15

68 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued In 2006, net student tuition and fees revenue increased 9 percent, or $57 million, to $676 million, which reflects a 9 percent, or $69 million, increase in gross tuition and fee revenues offset by a 9 percent, or $13 million, increase in scholarship allowances. Tuition rate increases in 2006 were 12.3 percent for resident undergraduate students on the Ann Arbor campus, with an 11.9 percent tuition rate increase for the Dearborn and Flint campuses and a 6 percent increase in most other tuition rates including those for nonresidents. The University also experienced a modest growth in the number of students. Despite declines in state appropriations over the past five years, the University s tuition increases have been among the lowest in the state and in the Big Ten, which reflects a commitment to affordable higher education for Michigan families. At the same time, the University has also increased scholarship allowances to benefit students in financial need. While tuition and state appropriations fund a large percentage of University costs, private support is becoming increasingly essential to the University s academic distinction. Private gifts for other than capital and endowment purposes totaled $111 million in 2007, as compared to $90 million in 2006 and $107 million in The University receives revenues for sponsored programs from various government agencies and private sources, which normally provide for both direct and indirect costs to perform these sponsored activities. Revenues for sponsored programs increased 0.7 percent, or $6 million, to $824 million in For 2006, revenues for sponsored programs increased 1.2 percent, or $10 million, to $818 million. A significant portion of the University s sponsored programs revenues relate to federal research and its growth is consistent with the national trend of stabilized federal research activity. Patient care revenues and managed care premiums for the three years ended June 30, 2007 is summarized as follows: (in millions) Patient care revenues $ 1,786.8 $ 1,585.4 $ 1,462.6 Managed care premiums $ 1,983.6 $ 1,990.5 $ 1,841.2 The majority of these revenues relate to patient care services, which are principally generated within the University s hospitals and ambulatory care facilities under contractual arrangements with governmental payers and private insurers. Managed care premiums represent subscription revenue recognized by M-CARE from contracts associated with employers other than the University. Patient care revenues increased 13 percent, or $201 million, to $1.8 billion in 2007, as compared to an increase of 8 percent, or $123 million, to $1.6 billion in The increased revenues for both years primarily resulted from a growth in both outpatient and inpatient volume, as well as increased reimbursement rates from third party payers. The decrease in managed care premiums in 2007 reflects the sale of M-CARE which was effective December 31, 2006.

69 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued Net investment income for the three years ended June 30, 2007 is summarized as follows: (in millions) Interest and dividends, net $ $ $ Increase in fair value of investments 1, $ 1,572.6 $ $ Net investment income totaled $1.6 billion in 2007, as compared to $960 million in 2006 and $875 million in The increase in net investment income is primarily the result of strong performance of the University s nonmarketable limited partnerships and non-us dollar equities and consistent positive returns from the University s absolute return strategies during the past three years, combined with a meaningful increase in invested balances over the same time period. The University s endowment investment policies are designed to maximize long-term total return, while its income distribution policy is designed to preserve the value of the endowment and generate a predictable stream of spendable income. With the Michigan Difference capital campaign well underway, gifts and grants for endowment and capital purposes continue to be a significant part of sustaining the University s excellence. Private gifts for endowment purposes totaled $95 million in 2007, as compared to $86 million in 2006 and $78 million in Capital gifts and grants totaled $65 million in 2007, as compared to $65 million in 2006 and $119 million in Over the past three years, major capital gifts have been received in support of the University s wide-ranging building initiatives which include the Stephen M. Ross School of Business, Health System, Intercollegiate Athletics and College of Engineering capital projects. Net other nonoperating revenues in 2007 include the $160 million gain on the sale of M-CARE, offset by the establishment of an $83 million liability for the University s faculty retirement furlough program. During 2007, the University recorded a liability for the program, of which $81 million is considered noncurrent. Faculty hired prior to January 1, 1984 who meet eligibility requirements are eligible for a terminal furlough year that may be taken as the last year preceding retirement or in partial installments over two or three years prior to the effective date of retirement. In addition to revenue diversification, the University continues to make cost containment an ongoing priority. This is necessary as the University continues to face significant financial pressure, particularly in the areas of compensation and benefits, which represent 66 percent of total expenses, as well as in the areas of energy, technology and ongoing maintenance of facilities and infrastructure. 17

70 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued A comparative summary of the University s expenses for the three years ended June 30, 2007 is as follows (amounts in millions): Operating: Compensation and benefits $ 2, % $ 2, % $ 2, % Supplies and services 1, , , Depreciation Scholarships and fellowships , , , Nonoperating: Interest $ 4, % $ 4, % $ 4, % The University is committed to recruiting and retaining outstanding faculty and staff and the compensation package is one way to successfully compete with peer institutions and nonacademic employers. The resources expended for compensation and benefits increased 7 percent, or $204 million, to $3.0 billion in Of this increase, compensation expense increased 6 percent, to $2.28 billion, and employee benefits increased 11 percent, to $685 million. For 2006, compensation increased 6 percent, to $2.14 billion, and employee benefits increased 8 percent, to $618 million. The majority of the compensation expense increase occurred in the Health System, where nursing and other health professionals were added to support higher patient volume levels. Increases in wage rates also accounted for a significant portion of the expense growth, a reflection of the high demand for nurses and other health professionals and an industry-wide shortage of personnel in these fields. In addition, staffing levels were increased in many administrative and support areas, to further strengthen these areas and in response to the increasing regulatory burden borne by health systems. In 2007, the Health System had a growth in compensation expense of 9 percent, which includes a growth in employees of 5 percent, while the rest of the University had a growth in compensation expense of 4 percent, with a minimal change in the number of employees. In 2006, the Health System had a growth in compensation expense of 10 percent, which includes a growth in employees of 4 percent, while the rest of the University had a growth in compensation expense of 3 percent, with a minimal change in the number of employees. 18

71 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued Employee benefits expense grew at a higher rate than compensation over the past two years primarily because of the rising costs of health insurance and prescription drugs. Health care benefits are one of the most significant employee benefits and over the past several years, the University has implemented several initiatives to better control its rate of increase, encourage employees to choose the lowest cost insurance plan that meets their needs and share with employees a small portion of health insurance cost increases. The University utilizes a single pharmacy benefit administrator to manage all pharmacy benefits with University oversight. The University also actively promotes and manages generic drug utilization and has achieved a 60 percent generic dispensing rate in 2007, as compared to 57 percent in 2006 and 53 percent in In January 2006, the University unbundled pharmacy benefit claim processing and mail order services and selected separate vendors for each service to achieve better discounts for retail and mail order pricing arrangements and additional rebates. Compared to most employers, the University is in a unique position to utilize internal experts to advise and guide its health care and drug plans. For example, the University utilizes a Pharmacy Benefits Advisory Committee, which consists of internal experts such as Health System physicians, pharmacy faculty and an on-staff pharmacist, to monitor the safety and effectiveness of covered medications as well as to optimize appropriate prescribing, dispensing and cost effective use of prescription drugs. The University also benefits from campus collaborations such as a College of Pharmacy study which was the foundation for a cost saving pill-splitting program with select cholesterol lowering drugs which began in January Current campus collaborations include several which are part of the Michigan Healthy Community initiative, a campus-wide effort to encourage healthier living through increased activity, attention to physical safety in the workplace, and other health and wellness efforts. The health and wellness programs offered by the University through this initiative have resulted in greater integration of evidence-based wellness programming into the University s benefit programs. For example, MHealthy: Focus on Diabetes, a groundbreaking two-year pilot program, launched in July 2006, reduces or eliminates co-pays for selected medications for employees and dependents who have diabetes to encourage the proper and sustained use of specific drugs that help people manage their diabetes and to help prevent or reduce the long-term complications of the disease. The MHealthy: Focus on Medicines program, which commenced in 2007, offers employees, retirees and dependents taking nine or more prescription medications a comprehensive medication review with a university pharmacist to optimize treatment and reduce drug interaction risks. These initiatives reflect the reality of the national landscape, while remaining true to the commitment we make to our employees for a robust benefits package. 19

72 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued Supplies and services expenses decreased 4 percent, or $46 million, to $1.1 billion in 2007, as compared to a 4 percent, or $45 million, increase in This reflects the impact of the sale of M- CARE effective December 31, As the majority of its expenses were non-salary, the sale of M- CARE six months into fiscal 2007 had a meaningful effect on this category of expense. Excluding the impact of M-CARE, a 7 percent increase would have been experienced in In addition to their natural (object) classification, it is also informative to review operating expenses by function. A comparative summary of the University s expenses by functional classification for the three years ended June 30, 2007 is as follows (amounts in millions): Operating: Instruction $ % $ % $ % Research Public service Institutional and academic support Auxiliary enterprises: Patient and managed care 1, , , Other Operations and maintenance of plant Depreciation Scholarships and fellowships , , , Nonoperating: Interest $ 4, % $ 4, % $ 4, % Instruction and public service expenses increased 5 percent, or $43 million, to $831 million in 2007, as compared to a 2 percent, or $16 million, increase in These increases are consistent with the small level of growth in the related revenue sources. To measure its total volume of research expenditures, the University considers research expenses, included in the above table, as well as research related facilities and administrative expenses, research initiative and start-up expenses, and research equipment purchases. These amounts aggregated $823 million in 2007, as compared to $797 million in 2006 and $778 million in This represents an increase of 6 percent, or $45 million, from 2005 to Patient and managed care expenses increased 1 percent, or $17 million, to $1.9 billion in 2007, as compared to a 7 percent, or $124 million increase in This reflects the impact from the sale of M-CARE effective December 31, Excluding the impact of M-CARE, a 7 percent increase would have been experienced in

73 THE UNIVERSITY OF MICHIGAN Management's Discussion and Analysis (Unaudited)--Continued Operations and maintenance of plant expenses totaled $256 million in 2007, as compared to $249 in 2006 and $213 million in The increase from 2005 to 2007 of 20 percent, or $43 million, primarily resulted from bringing additional buildings online and rising energy prices. Total scholarships and fellowships provided to students aggregated $272 million in 2007, as compared to $258 million in 2006 and $236 million in 2005, an increase of 15 percent over the past two years. Tuition, housing and fees revenues are reported net of aid applied to students accounts, while amounts paid directly to students are reported as scholarship and fellowship expense. Scholarships and fellowships for the three years ended June 30, 2007 are summarized as follows: (in millions) Paid directly to students $ 83.7 $ 83.8 $ 75.4 Applied to tuition and fees Applied to University Housing $ $ $ The following graphic illustrations present total expenses by function, with and without the University s Health System and other similar activities: 21