University of Toronto Toronto, Ontario

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1 Credit Analysis Moody s International Public Finance Higher Education December 2009 Table of Contents: Summary Rating Rationale 1 Rating Outlook 1 Issuer Overview 2 Key Rating Factors 2 Market Position 2 Government Relationship 3 Governance and Management 3 Operating Performance 3 Debt Profile 4 Balance Sheet Strength 5 Application of Joint-Default Analysis 5 Rating History 5 Annual Statistics 6 Moody s Related Research 9 Analyst Contacts: New York Debra Roane Vice President - Senior Credit Officer Toronto David Rubinoff Team Managing Director Alex Bellefleur Associate Analyst Toronto, Ontario Summary Rating Rationale The Aa1 debt and issuer ratings assigned to the (U of T) reflect the university s consistent operating performance, adjusted to account for the variability of investment returns, and moderate debt burden. Despite the recent investment losses in U of T s endowment, Moody s believes that the university retains strong fiscal flexibility and is able to make ongoing adjustments to its budgets in order to ensure the posting of satisfactory fiscal outcomes. The rating also takes into account U of T s strong market position as Canada s largest post-secondary institution and a national leader in research. Moreover, despite the investment losses, U of T s strong balance sheet illustrates the magnitude of the university s financial resources in relation to its obligations, providing a measure of safety for debenture holders and supporting the high investment-grade rating. Rating Outlook The outlook is stable. This Credit Analysis provides an in-depth discussion of credit ratings for the University of Toronto and should be read in conjunction with Moody s most recent Credit Opinion and rating information available on Moody's website. Click here to link.

2 Issuer Overview The, Canada's largest post-secondary institution, is a comprehensive teaching and research university offering programs in 13 faculties and several schools, including Applied Science & Engineering, Arts & Science, Medicine, Law and Management. Enrolment now approaches 63,000 full-timeequivalents (FTEs). Similar to other universities in the Province of Ontario, the derives its authority from a separate act of the provincial legislature. Key Rating Factors Market Position Strong Market Position Ensures Continued Student Demand Student demand and enrolment at the university have increased measurably in recent years owing to both Greater Toronto Area demographics and provincial higher education policy. These factors, combined with the university s strong academic reputation, are expected sustain continued student demand over the next several years, generating a larger potential student pool and allowing the university to remain highly selective in its offers to prospective students. Enrollment for the academic year reached 62,934 on a full-time equivalent (FTE) basis; from to , enrolment increased by approximately 13%, or 2.4% on a compound annual basis. International students account for 11% of U of T s total enrolment (on a total students basis), up from 7.6% in The relatively high proportion of international students enrolled at U of T reflects the university s excellent reputation and strong international profile. Enrollment Growth to Occur Mainly at Graduate Level As a reflection of provincial government priorities supported by funding for graduate expansion, undergraduate enrollment is expected to decline slightly over the medium term, while increases in graduate enrollment are likely to lead to overall growth in the student population. While currently representing roughly 20% of U of T s student population, the university expects that if the provincial funding environment enables graduate expansion to occur as planned, graduate students would account for approximately 22.5% of total FTEs over the medium term. Moody s views the higher proportion of graduate students at U of T as an enhancement to its market position as the proportion of higher level degrees generally indicates greater research intensity. National Leader in Research The, and its affiliated institutions, including several hospitals, continues to be the leader among Canadian universities in securing federal government research funding from the three granting councils and from other federal programs. Research funding from all sources is substantial and the university continues to rank highly in terms of research output. In , total research grants and contracts recorded by the university amounted to C$435 million, up 37% from the level recorded in In addition to this amount, there are also substantial research grants and contracts awarded to university faculty and administered by the affiliated teaching hospitals. Research activities at the have benefited recently from increased federal funding through, primarily, the Canadian Institute of Health Research and the Canada Research Chairs program. The latter program provides funding for over 1,800 research chairs allocated to degree-granting institutions countrywide. At present, over 250 chairs have been awarded to researchers, the most of any Canadian university. Furthermore, increased funding for research infrastructure is being provided through the Canada Foundation for Innovation and the federal government is now providing some funding to address the indirect costs associated with undertaking research. 2 December 2009 Credit Analysis -

3 Government Relationship Ontario Universities Operate at Arms-Length from Government Like other universities in the Province of Ontario, the was created by a separate act of the provincial legislature. While the province is ultimately responsible, constitutionally, for the delivery of postsecondary education, the, like other Ontario universities, operates at arms-length from the province. The provincial government establishes broad strategies and targets for each university, provides operating grants and has the authority to control tuition fees, but each university retains autonomy to carry out its activities. While the Ontario Ministry of Training, Colleges and Universities monitors developments at individual universities and demands that universities be accountable, the "hands-off" approach to the university sector in Ontario is unlike that in some other Canadian provinces, such as British Columbia and Quebec, where the level of provincial control and oversight is considerably greater. This lower level of provincial oversight and monitoring over Ontario universities, in and of itself, would be viewed as a credit negative, increasing the likelihood that universities could experience financial difficulties without the province being aware of it; however, this relative independence of Ontario universities is balanced by prudent fiscal management. U of T s strong standalone characteristics including strong governance and management mitigate any concerns posed by the relative independence of Ontario universities from the provincial government. Governance and Management Strong Governance and Management Practices The Governing Council oversees the academic, business and student affairs of the university. The Council is composed of 50 members, of whom 25 are internal members (including administrative staff, teaching staff and students) and 25 are external members (including alumni and provincial appointees). A variety of boards and committees oversee specific areas of the university s affairs, including a Business Board, a Planning and Budget Committee, an Audit Committee and a Committee on Academic Policies & Programs. U of T s academic mission is clearly articulated and the Governing Council possesses the tools necessary to effectively oversee and monitor management s activities. The success of U of T in maintaining a strong balance sheet, while meeting academic goals, is underpinned by the development and execution of multi-year frameworks for academic and financial planning. These plans identify performance benchmarks and facilitate the development of operating and capital budgets. Internal financial management policies are comprehensive and support both growth in the university s net asset position and the management of investment and debt related risks. Asset Management Corporation (UTAM), a wholly owned subsidiary, is tasked with managing the investment assets of the university s Long-Term Capital Appreciation Pool (which includes assets of the endowment fund), the Expendable Funds Investment Pool (including short- to medium-term funds) and assets of the university s pension plans. Operating Performance Deficit Recorded in Reflects Investment Losses The university s net loss of C$170 million in reflects primarily an investment loss of C$147 million, owing to the significant downturn in financial markets experienced in the aftermath of the recent global financial crisis. The university suspended its endowment payout in to preserve the value of its endowment. In addition to the investment losses, the university experienced some pressures with respect to salaries and benefits, which increased at a rate of approximately 8% over the previous year, as well as scholarships, fellowships and bursaries, which grew by roughly 16% over the previous year. Moody s, however, makes adjustments to the university s annual fiscal outcomes to smooth the impact of investment returns which introduce volatility to the university s income statement and remove scholarships, 3 December 2009 Credit Analysis -

4 fellowships and bursaries from both revenues and expenses, reflecting the flow-through nature of these expenses. On a Moody s-adjusted basis, U of T posted net income of C$104 million in , equivalent to 5.1% of adjusted revenue, down from C$108 million in , or 5.7% of adjusted revenue. Therefore, adjusting for the investment loss, U of T s fiscal outcome was in line with previous years. On a cash basis of accounting, U of T s operations have generated significant positive funds from operations in recent years, averaging 7% of adjusted revenue in the past six fiscal years. These strong cash results provide internal financing for capital projects, thereby helping to limit debt financing requirements and sustaining U of T s financial position. New Budget Model to Help U of T Address Budget Challenges In , the introduced a new budgeting process designed to improve decisionmaking at the faculty level and better equip the institution with the tools necessary to meet its academic goals. While the previous budgeting model was expense-based, where each division s budget for the year reflected the previous year s budget allocation plus salary increases and any new programs less any across-the-board cuts instituted by the administration, the new model is revenue-based. It first identifies the revenue generated by each division then subtracts amounts for shared administrative services and for a contribution to a University Fund that is used to transfer revenues among divisions. Management has indicated that it will not implement across-the-board expense reductions to manage financial pressures and will instead seek expense containment strategies selectively from each division when necessary. U of T also introduced a rolling five-year operating budget, representing a departure from the fixed five-year plans that had characterized the university s previous operating budgets. The university s objective is to balance the budget over the five-year period and to eliminate any accumulated deficit over the period. U of T s new budget model where faculties are awarded flexibility to implement realignments as required to meet budget targets is expected to increase the university s flexibility in dealing with pressures, as faculties have latitude to reduce costs or increase revenues. As such, Moody s does not expect recent and current challenges stemming from investment losses to create undue financial stress for U of T. Debt Profile Disciplined Borrowing Strategy U of T s borrowing strategy, approved by the Business Board in 2004, states that external borrowing capacity must not exceed 40% of net assets averaged over 5 years; if actual borrowings come to exceed this limit, no further borrowing can be permitted until such time as outstanding borrowing declines to 33% of net assets averaged over 5 years. Since , the university issued four debentures totaling C$510 million to help finance capital outlays. As at April 30, 2009, net direct debt totaled C$555 million, amounting to 27% of adjusted revenues, while interest costs consumed only 1.7% of adjusted revenue during that fiscal year. These low debt and debt service ratios illustrate the university s high degree of fiscal flexibility. U of T currently has approximately C$192 million of unused external borrowing capacity. While the university plans to use a portion of that capacity over the medium term to help finance capital outlays, U of T has sufficient flexibility to monitor the state of the debt capital markets and access them at an opportune time to minimize debt service costs. Moreover, the university can finance capital requirements internally on a temporary basis, given U of T s strong liquidity profile. Moody s considers that utilization of the university s external borrowing capacity complying with the university s borrowing strategy would lead to a debt burden that would remain manageable and in line with the current high rating assigned to the university. 4 December 2009 Credit Analysis -

5 Balance Sheet Strength Investment Losses Lead to Reduction in Endowment Assets At April 30, 2009, the university s endowment assets totaled C$1.3 billion, down from C$1.8 billion one year earlier. The decline reflects the investment losses experienced on the university s Long-Term Capital Appreciation Pool (LTCAP) during the fiscal year. For the fiscal year ended April 30, 2009, the LTCAP experienced a loss of 31%, reflecting the significant downturn spread across the many asset classes in which UTAM invests (public equities, hedge funds, private equity, fixed income and real assets). A significant portion of the investment losses for that fiscal year resulted from UTAM s policy of hedging substantially all foreign currency exposure. Given the strong rebound in world equity markets experienced since March 2009, U of T s LTCAP is expected to recoup some of the losses incurred in UTAM is going through a strategic review of its portfolio, placing greater emphasis on risk management and stress-testing the portfolio from both a liquidity and an asset allocation standpoint. While the fundamental return objectives and risk parameters of the LTCAP real return target of 4%, with a 10% standard deviation over a ten-year period remain in place, the portfolio is expected to be simpler going forward, with a level of complexity more adapted to the size of the portfolio. In , the endowment payout was suspended, reflecting the extent of losses incurred and the university s desire to protect the value of its endowment. The university expects to make a decision on the endowment payout in early But U of T s Balance Sheet Remains Strong Despite the significant losses incurred in , U of T s financial resources have grown over a medium time frame. Net cash and investments, which excludes externally restricted endowments and provides a measure of liquidity, totaled C$1.1 billion at the end of fiscal , up from C$902 million at the end of fiscal Net cash and investments now provide roughly two times coverage of the university s net direct debt. This cushion provides an additional layer of safety for debenture holders and enhances the university s fiscal flexibility. Application of Joint-Default Analysis As a reflection of Moody s joint-default analysis (JDA) methodology for government-related issuers, the university s Aa1 rating is composed of two principal inputs: a baseline credit assessment of 2 on a scale of 1-21 (in which 1 represents the lowest credit risk) and a medium likelihood that the Province of Ontario (Aa1, stable outlook) would act to prevent a default by the university. Medium support is based on Moody s assessment of the risk posed to the province s reputation as a regulator of the university sector if U of T were allowed to default, balanced by the more autonomous status of Ontario's universities vis-à-vis the provincial government as compared to universities in some other Canadian provinces. Rating History Date August 2002 January 2001 Rating Aa1 Aa2 5 December 2009 Credit Analysis -

6 Annual Statistics Debt Statemen (C$ Millions, as at April 30) Mortgages and Term Loans Debentures Net Direct Debt Debt Trends (as at April 30) Net Direct Debt per Student (C$, per FTE) 7,474 7,124 8,066 9,128 8,998 8,824 Net Direct Debt as a % of Revenue [1] [1] Revenue is net of scholarship expenses and adjusted to smooth investment returns. Market Demand Trends (Year Ending April 30) Total Enrolment (FTE) 55,763 57,887 60,203 61,210 62,301 62,934 of which, undergraduate 45,533 47,402 49,669 50,220 50,159 50,336 Total Students 67,297 67,692 70,143 71,202 73,016 73,685 of which, undergraduate 55,369 55,624 58,182 58,915 59,074 59,794 Undergraduate FTEs as a % of Total FTEs Undergraduate Students as a % of Total Students Selectivity (%) [1] Matriculation (%) [2] Average Entry Grade (%) [1] Number of acceptances divided by number of applicants. [2] Number of students enrolling divided by number of acceptances. 6 December 2009 Credit Analysis -

7 Statement of Operations (C$ Millions, Year Ending April 30) Revenue Government Grants for Operations Tuition Fees Grants and Contracts Investment Income (Loss) (146.7) Donations Other Total Revenue 1, , , , , ,899.5 Expenses Salaries and Benefits , , , ,218.3 Materials and Supplies Scholarships, Fellowships and Bursaries Amortization of Capital Assets Interest Payments Other Total Expenses 1, , , , , ,068.7 Net Income (Loss) (169.2) Adjustments Revenue [1] 1, , , , , ,027.9 Expenses [2] 1, , , , , ,924.1 Net Income (Loss) Funds from operations Free cash flow (157.5) (82.9) (69.1) [1] Revenue is net of scholarship expenses and adjusted to smooth investment returns. [2] Net of scholarship expenses. Fiscal Trends (Year Ending 4/30) Provincial Funding as a % of Revenue [1] Net Tuition as a % of Revenue [1] [2] Interest Expense as a % of Revenue [1] Debt Service as a % of Revenue [1] Total Gift Revenue [3] Funds from Operations as a % of Revenue [1] Annual Operating Margin (%) Average Operating Margin (%) (0.9) [1] Revenue is net of scholarship expenses and adjusted to smooth investment returns. [2] Tuition fees are net of scholarship expenses. [3] Includes both donations recorded as revenue and as direct additions to endowments. 7 December 2009 Credit Analysis -

8 Consolidated Balance Sheet (C$ Millions, as at April 30) Assets Cash and Short-term Investments Accounts Receivable Investments 1, , , , , ,388.3 Capital Assets , , , , ,532.4 Other Liabilities 3, , , , , ,909.0 Accounts Payable and Accrued Liability Deferred contributions Long-term Debt and Debentures Deferred Capital Contributions Other Net Assets 1, , , , , ,291.9 Unrestricted (47.7) (144.8) (171.1) (195.1) (231.9) (232.0) Committed Equity in Capital Assets Endowments Externally Restricted 1, , , , , ,081.2 Internally Restricted , , , , , ,617.1 Balance Sheet Trends (As at 4/30) Total Cash and Investments (C$ Millions) 1, , , , , ,211.5 Total Cash and Investments per FTE (C$) 35,301 35,607 37,978 44,130 43,673 35,140 Net Cash and Investments [1] , , ,130.3 Net Cash and Investments-to-Net-Direct- Debt (x) Net Cash and Investments per FTE (C$) 16,177 15,446 15,431 18,879 19,809 17,960 Net Cash and Investments-to-Operations (x) [1] Cash, short-term and long-term investments net of unspent debenture proceeds less externally restricted endowments. 8 December 2009 Credit Analysis -

9 Moody s Related Research Credit Opinion: Ontario, Province of, November 2009 Special Comment: Global Recession and Universities: Funding Strains to Keep Up with Rising Demand, June 2009 (117983) Canadian Provinces Face Challenging Conditions, February 2009 (114544) Government Policies Support Canadian Universities Creditworthiness, December 2008 (112905) Statistical Handbook: Non-US Regional and Local Governments, June 2009 (117472) Rating Methodology: Public Universities Outside the U.S., August 2007 (103498) The Application of Joint-Default Analysis to the Canadian University Sector, December 2008 (96859) 9 December 2009 Credit Analysis -

10 Report Number: Author Debra Roane Production Specialist Yelena Ponirovskaya CREDIT RATINGS ARE MOODY'S INVESTORS SERVICE, INC.'S (MIS) CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MIS DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. CREDIT RATINGS DO NOT CONSTITUTE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS ARE NOT RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. CREDIT RATINGS DO NOT COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MIS ISSUES ITS CREDIT RATINGS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. Copyright 2009, Moody s Investors Service, Inc., and/or its licensors and affiliates (together, "MOODY'S ). All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such information is provided as is without warranty of any kind and MOODY S, in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such information. Under no circumstances shall MOODY S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings and financial reporting analysis observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling. MOODY S hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MOODY S have, prior to assignment of any rating, agreed to pay to MOODY S for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,400,000. Moody s Corporation (MCO) and its wholly-owned credit rating agency subsidiary, Moody s Investors Service (MIS), also maintain policies and procedures to address the independence of MIS s ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually on Moody s website at under the heading Shareholder Relations Corporate Governance Director and Shareholder Affiliation Policy. 10 December 2009 Credit Analysis -