Credit Rating Analytics and Strategic Positioning

Credit Rating Analytics and Strategic Positioning Pam Clayton, Director Wells Fargo Securities Susan Fitzgerald, Sr. Vice President Moody s Investors Service

How are Ratings Used? Ratings impact the pricing of a college or university s bonds For tax-exempt bonds, the rating impacts the spread to the AAA MMD Yield Curve The first table reflects a college with ratings of Aaa/AAA while the second table reflects a college with ratings of Baa1/BBB+. The column spread to MMD for each table reflects the extra yield that is required to sell the bonds when compared to a AAA general obligation MMD scale. Indicative Higher Education Pricing, as of April 15, 2014 Assumptions "Aaa/AAA" Pricing "Baa1/BBB+" Pricing Maturity Coupon "AAA" MMD 1 Spread to MMD Yield Spread to MMD Yield 2015 5.000% 0.15% 0.02 0.170% 0.35 0.500% 2016 5.000% 0.37% 0.05 0.420% 0.50 0.870% 2017 5.000% 0.64% 0.05 0.690% 0.65 1.290% 2018 5.000% 0.92% 0.05 0.970% 0.80 1.720% 2019 5.000% 1.17% 0.06 1.230% 0.90 2.070% 2020 5.000% 1.49% 0.08 1.570% 1.00 2.490% 2021 5.000% 1.76% 0.10 1.860% 1.10 2.860% 2022 5.000% 1.99% 0.12 2.110% 1.15 3.140% 2023 5.000% 2.17% 0.15 2.320% 1.20 3.370% 2024 5.000% 2.30% 0.18 2.480% 1.25 3.550% 2025 5.000% 2.42% 0.18 2.600% 1.25 3.670% 2026 5.000% 2.53% 0.18 2.710% 1.25 3.780% 2027 5.000% 2.64% 0.18 2.820% 1.25 3.890% 2028 5.000% 2.75% 0.18 2.930% 1.25 4.000% 2029 5.000% 2.84% 0.18 3.020% 1.25 4.090% 2030 5.000% 2.92% 0.18 3.100% 1.25 4.170% 2031 5.000% 3.00% 0.18 3.180% 1.25 4.250% 2032 5.000% 3.07% 0.18 3.250% 1.25 4.320% 2033 5.000% 3.14% 0.18 3.320% 1.25 4.390% 2034 5.000% 3.20% 0.18 3.380% 1.25 4.450% 2039 5.000% 3.43% 0.15 3.580% 1.25 4.680% 2044 5.000% 3.51% 0.15 3.660% 1.25 4.760% 1 AAA M M D rates as of April 15, 2014. Subject to change. 2

Moody s Rates Nearly 800 Colleges & Universities Public Universities Private Colleges Community Colleges Non-US Universities Over 230 $118B of outstanding debt Over 280 $83B of outstanding debt More than 250 $30B of outstanding debt 20 in UK, Australia, Canada, Mexico, Singapore» In addition, Moody s rates:» Around 115 not-for-profit institutions, $13.5 billion of rated debt» Approximately 40 independent K-12 schools, $1.2 billion of debt Source: Moody's Municipal Financial Ratio Analysis 3

Rating Process Management & Governance Capital Program & Debt Rating Market Position Financial Reserves & Liquidity Operating Performance Source: Moody's Municipal Financial Ratio Analysis 4

US Higher Education Rating Approach: Quantitative Factors» Factors 1-3: Weighted quantitative sub-factors generate grid score Source: Moody s US Not-For-Profit Higher Education Methodology 5

US Higher Education Rating Approach: Non-Quantitative Factors» Factors 4-5: Non-quantitative analytical adjustments provide below the line notching to grid score Source: US Not-For-Profit Higher Education Methodology 6

Additional Metrics Further Inform Analysis Market Position Total enrollment (FTE) % of enrollment that is undergraduate Educational expenses per student Total tuition discount (%) Operating Performance Operating margin Return on cash & investments Return on financial resources Return on net assets Balance Sheet & Capital Investment Monthly liquidity as % of cash & investments Debt to cashflow Capital spending ratio Age of plant Capital expense to operations 7

Strategies to Address Rating Concerns Verify ratios computed by rating agencies Need to understand the definition of the components of the ratio, some adjustments may be necessary Factors that can impact ratios on a comparative basis Amortization Rapid amortization and bullet maturities. If college amortizes debt rapidly, then annual debt service will be higher than debt that amortizes over 30 or 40 years. Bullet maturities impact Maximum Annual Debt Service calculation. Impacts two ratios: 1) Debt Service to Expenses and 2) Operating Margin Depreciation If college uses method other than straight line over useful life, it should be noted. Notify rating agencies as soon as possible when changes/events occur: Enrollment declines Significant variances to budget Approval or changes to plans Strategic Plan, Capital improvement Plan, Fundraising Campaign Key administrator resignations Impact of natural disaster Best Practices Keep a list of rating agency contacts so they can be notified when changes occur Maintain debt, swap and investment policies Invite rating analysts for site visits 8

Strategies for Strong & Diversified Income Statements Fiscal Year 2013 Operating Revenues % of Operating Revenues Net Tuition and Fees $ 310,231 9.74% Research 1,600,460 50.22% Gifts 177,257 5.56% Fees and Services 182,019 5.71% Other 204,650 6.42% Support from investments 597,517 18.75% Auxiliary 114,461 3.59% Total Operating Revenues $ 3,186,595 100% Indirect Cost Recovery for Depreciation Excess of Endowment Payout Reinvested Matching Debt Structure Level Principal Bullet Maturity Structuring debt with level principal payments would serve as a better match with college s primary funding source. Assumes most of the research funding is from grants which include the recovery of indirect cost (ICR). Included in the ICR is depreciation. If depreciation is calculated based on straight line method, then equal annual amounts of principal could be structured to match annual depreciation of the facility financed. Bullet maturities allow any excess funds to be reinvested. As long as investment rate exceeds rate on debt, the bullet structure may be optimal. 9

Strategies for Strong Balance Sheets Assets Investments $ 10,030,314 Accounts Receivable 900,440 Prepaid Expenses 96,362 Fixed Income Securities $ 2,034,823 Commingled Capital Nonmarketable Assets 5,369,400 Investments 5,220,228 Total Assets $ 16,396,516 $ 10,030,314 Short Term Treasuries $ 1,152,000 Long Term Treasuries 882,823 Funds 1,864,955 Equity Securities 910,308 $ 2,034,823 Liabilities Variable Rate Debt $ 1,152,000 Asset Liability Management Portion of investments held in short term floating rate securities can be matched with variable rate debt issuance of the college or university. Investments provide natural hedge for the variable rate debt Amount of investments will generally meet or exceed the amount of variable rate debt 10

2014 Moody s Outlook for US Higher Ed & NFPs Negative Outlook Horizon: 12-18 months Key Drivers 1. Slowly growing revenue eclipsed by pressure to increase expenses 2. Heightened competition, including changing delivery and business models 3. Flat to declining governmental funding and apportionment may not be predictable 4. Political scrutiny and increased regulatory oversight add uncertainty Counterpoints 1. Proven adaptability to weak economic conditions 2. Fundamental demand for higher education is still high 3. Stronger earnings by educational attainment 11

Revenue Growth Slows While Expense Pressure Builds» Operating margins expected to contract» Continued focus on affordability will result in weak net tuition revenue growth» Value of higher education questioned as student loan default rates continue to rise» Investments and philanthropy: Better returns, but volatile; increasing global competition for philanthropy % of Obligors with Expenses Growing Faster than Revenues Expense Growth Exceeds Revenue Growth Public Private CCD 70% 60% 50% 40% 30% 20% 10% 0% 2008 2009 2010 2011 2012 Source: Moody's Municipal Financial Ratio Analysis 12

Weak Net Tuition Revenue Growth for Large Majority Net tuition revenue declines anticipated in FY 2014 Private Universities Decline Growth between 0% and 2% Growth greater than 2% Public Universities Decline Growth between 0% and 2% Growth greater than 2% 100% 100% 80% 80% 60% 60% 40% 40% 20% 20% 0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013* (est.) 2014** (proj.) 0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013* (est.) 2014** (proj.) Note: FY 2004 to FY 2012 data are actuals. *FY 2013 estimated; **FY 2014 projected Source: Moody's Municipal Financial Ratio Analysis (FY 2004 - FY 2012); Moody's 2013 Tuition Survey (FY 2013 - FY 2014) 13

Quest for Efficiency in Face of Decelerating Revenues 35% % public universities cutting expenses % private universities cutting expenses % public universities with declining revenue % private universities with declining revenue 30% 25% % of universities 20% 15% 10% 5% 0% 2005 2006 2007 2008 2009 2010 2011 2012 Est. 2013 Source: Moody's MFRA 14

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