|[February 05, 2014]
Fitch Downgrades University of California General Rev Bonds to 'AA'; Outlook Stable
NEW YORK --(Business Wire)--
Fitch Ratings downgrades its long-term rating on the Regents of the
University of California's (UC) general revenue bonds (GRBs) to 'AA'
from 'AA+'. At the same time, Fitch downgrades UC's limited project
revenue bonds (LPRBs) and medical center pooled revenue bonds (MCPRBs)
to 'AA-' from 'AA', and affirms its short-term 'F1+' rating as detailed
at the end of this release.
The Rating Outlook is Stable.
GRBs are secured primarily by a broad pledge of UC's unencumbered
revenues, namely gross tuition and fees, indirect cost recovery
revenues, and auxiliary receipts. LPRBs are secured by a junior lien on
the gross revenues of LPRB-financed projects, subordinate to debt
service on GRBs. MCPRBs are a limited obligation of UC, secured by the
revenues derived from the operation of its five medical centers.
KEY RATING DRIVERS
LACK OF ANTICIPATED PROGRESS: The downgrade reflects UC's slower than
anticipated progress towards stabilizing its operating performance. The
university's operating margin (on a full accrual basis) remained
negative in fiscal 2013, falling slightly to negative 8.9% from negative
8.4% in fiscal 2012; its sixth consecutive year of an operating deficit.
Fitch had anticipated improvement in fiscal 2013 over fiscal 2012
EXCEPTIONAL REPUTATION: The rating continues to be underpinned by UC's
strong reputation for academics, research and medical care that
continues to promote consistently strong student demand and selective
admissions, and growing patient volumes. On the academic side, this is
despite considerable increases in student charges over the past several
years, although a tuition freeze has been in effect for the past two
SOLID FINANCIAL CUSHION: Substantial balance sheet resources, diverse
revenues, and a manageable debt burden despite an increase in financial
leverage over the past decade, partially offset UC's negative operating
results, significant pension and retiree health benefit liabilities, and
substantial capital needs.
STABILIZING STATE FUNDING: Following several years of cuts, slightly
improved funding in fiscal 2014 should provide a level of stability to
UC's operating budget over the near term. Partly offsetting the steep
decline in funding over the past few years is the university's limited
reliance on the state for operating support and the timely measures
taken by UC's seasoned management team during times of state fiscal
RESOURCE SUFFICIENCY: The 'F1+' rating is based on UC's ability to cover
the maximum potential liquidity demands presented by its variable-rate
debt programs by at least 1.25x from internal resources, including cash
and highly liquid, highly rated investments.
MARGIN IMPROVEMENT: Rating stability is predicated on UC's ability to
stem operating losses, with annual improvement towards returning to a
near-breakeven level of performance. The Stable Outlook assumes that
operating improvement will be evidenced in fiscal 2014, supported by the
implementation of various university initiatives to control expenses and
the state's improved fiscal position.
BALANCE SHEET PRESERVATION: Fitch expects UC to maintain balance sheet
liquidity at or near current levels, which is particularly important
given its sizeable future capital needs, portions of which will likely
continue to be debt-financed.
Chartered in 1868, UC is a comprehensive graduate research university
with 10 campuses located in Berkeley, Davis, Irvine, Los Angeles,
Merced, Riverside, San Diego, Santa Barbara, Santa Cruz, and a graduate
campus in San Francisco for health sciences. It also operates five
academic medical centers, four law schools, and a 135,000-acre statewide
agricultural and natural resources division. UC's exceptional reputation
is the basis for its strong demand and selective admissions. Fiscal 2013
enrollment totaled 238,156 students. Applications continue to grow, with
more than 183,000 applicants applying to UC campuses for the fall 2014
term, up almost 5% from the prior fall term. The university's overall
acceptance rate remains fairly selective at about 59% for fiscal 2013.
Slower than Anticipated Operating Improvement
UC's operating margin slipped slightly in fiscal 2013 to negative 8.9%
from negative 8.4% in fiscal 2012, the university's sixth consecutive
year with an operating deficit (on a full accrual basis). Fitch had
expected operating improvement in fiscal 2013 as was noted in prior
rating reports. The systemic mismatch between revenue and expenses and
lack of expected progress towards margin improvement are the primary
drivers of the rating downgrade.
The Stable Rating Outlook reflects Fitch expectation of marginal
operating improvment for fiscal 2014 and beyond, based on the improved
state funding environment and modest enrollment growth, coupled with
past tuition increases, and positive fiscal impact expected to be
realized through various cost-saving initiatives. Fitch also views
positively the strong emphasis on system-wide cost containment and
budgetary initiatives that UC's new president, Janet Napolitano, has
implemented. While she has only been in office since fall 2013, these
timely actions should serve UC well following several very challenging
years for the university. These initiatives are in addition to various
other programs implemented by UC to curtail expense growth and boost
revenues via improved efficiencies across the system's 10 campuses.
Financial Cushion Continues to Offset Operating Performance
Fitch believes UC's financial cushion supports the 'AA' rating.
Available funds (cash and investments less nonexpendable restricted net
assets) grew to a substantial $18 billion as of June 30, 2013. Available
funds covered fiscal 2013 operating expenses ($27.3 billion) and debt
(about $17.3 billion) by a solid 66% and 104%, respectively. Debt
includes revenue bonds, commercial paper (CP), bank loans, capital
leases, and non-cancellable operating leases. These liquidity metrics
continue to reflect a solid financial cushion, and while comparable to
Fitch's 'AA' category medians for public universities, they are below
those of other institutions rated 'AA+' by Fitch. Fitch considers these
liquidity metrics, when coupled with UC's consistently negative
operating margin, inconsistent with an 'AA+' rating.
UC benefits from a diverse revenue base, a credit factor Fitch views
favorably. Its largest funding sources include revenues derived from the
operation of its medical centers (29.7% of fiscal 2013 operating
revenues), grants and contracts generated by its substantial sponsored
research activities (21.7%), and student-generated revenues, including
tuition, fees, and auxiliary receipts (18.7%). State appropriations
still represent a notable sum ($2.37 billion in fiscal 2013) although as
a percent of revenues represented just 9.4%, compared to 16% in fiscal
UC does not prepare interim financial statements on a university-wide
basis, making it difficult to predict fiscal 2014 results. However, the
medical centers produce quarterly financial statements and continue to
perform well, which provides a level of stability as they are UC's
largest revenue stream.
Following several years of significant cuts, state appropriations to UC
have stabilized and slightly increased for fiscal years 2013 and 2014.
Fitch rates California GOs 'A' with a Stable Outlook. Fitch views the
additional funding positively, although this is somewhat offset as UC
did not raise tuition for 2013-2014. This was the second year of flat
student charges, and the first year of the governor's proposed four-year
Complex, Yet Manageable Capital Structure
UC's debt obligations have grown in recent years, but its debt burden
remains manageable. Total pro forma maximum annual debt service (MADS)
occurs in fiscal 2019 at roughly $1.2 billion, including UC's $286.5
million of 2013 series AH put bonds that it intends to remarket in
fiscal 2019. MADS consumed a moderate 4.8% of fiscal 2013 operating
revenues of $25 billion.
Fitch notes that GRBs, LPRBs and MCPRBs are each secured by separate,
designated revenue streams. General revenues securing GRBs totaled a
substantial $10.1 billion in fiscal 2013 compared to GRB pro forma MADS
of roughly $876 million. Adjusting for the 2013 series AH put bonds, GRB
average annual debt service is a more manageable $417.4 million.
Based on its large size and operating scope, UC has significant future
capital needs, portions of which will likely continue to be
debt-financed, including a potential issuance later this fiscal year.
Due to its moderate debt burden and solid balance sheet cushion, Fitch
believes UC has some debt capacity at the current rating. However,
additional leverage, coupled with a lack of measurable operating
improvement could further stress the university's operations.
Fitch downgrades the following ratings:
--$7.52 billion GRBs to 'AA' from 'AA+';
--$3.3 million GRBs 2011 series W (taxable Clean Renewable Energy Bonds)
to 'AA' from 'AA+';
--$48.7 million California Statewide Communities Authority, Recovery
Zone Economic Development Bonds (UC Merced Student Housing Phase 4) 2010
series A to 'AA' from 'AA+';
--$500 million GRBs 2011 series Y (taxable floating-rate notes) to
'AA/F1+' from 'AA+/F1+';
--$150 million GRBs 2011 series Z (taxable variable-rate demand bonds)
to 'AA/F1+' from 'AA+/F1+';
--$286.5 million GRBs 2013 series AH (taxable fixed-rate notes, six-year
put) to 'AA' from 'AA+';
--$600 million GRBs 2013 series AL (variable-rate demand bonds) to
'AA/F1+' from 'AA+/F1+';
--$600 million GRBs 2013 series AK (put structure) to 'AA' from 'AA+';
--$1.99 billion LPRBs to 'AA-' from 'AA';
--$2.82 billion MCPRBs to 'AA-' from 'AA';
--$2 billion taxable and tax-exempt CP program affirmed at 'F1+'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
'U.S. College and University Rating Criteria' (May 10, 2013);
'Rating U.S. Public Finance Short-Term Debt' (December 9, 2013);
'Fitch Rates $300MM California GOs 'A'; Outlook Stable' (October 25,
'University of California' (September 16, 2013).
Applicable Criteria and Related Research:
University of California
Rating U.S. Public Finance Short-Term Debt
U.S. College and University Rating Criteria
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