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TMCNet:  Fitch Affirms Linn State Technical College, MO's Rev Bonds at 'BBB'; Outlook Revised to Negative

[May 14, 2014]

Fitch Affirms Linn State Technical College, MO's Rev Bonds at 'BBB'; Outlook Revised to Negative

NEW YORK --(Business Wire)--

Fitch Ratings has affirmed the 'BBB' long-term rating on approximately $7.7 million of outstanding series 2006 auxiliary revenue bonds issued by Linn State Technical College (LSTC or the college).

The Rating Outlook is revised to Negative from Stable.

SECURITY

The bonds are special obligations of the college payable solely from net auxiliary system revenues, including dining facilities, bookstore, residence halls, commons building and activity center (pledged revenues). A cash-funded debt service reserve fund equal to maximum annual debt service (MADS) has been established.

KEY RATING DRIVERS

RATING AFFIRMED; OUTLOOK TO NEGATIVE: The 'BBB' rating represents healthy demand for LSTC's academic and vocational programs and its distinctive niche in post-secondary education in the state which drives demand for its auxiliary services. Offsetting these strengths are LSTC's limited balance sheet resources and multiple years of negative margins, compounded by a challenging state funding environment. The Negative Outlook is driven by the auxiliary system's failure to meet its annual debt service (ADS) coverage requirement in fiscal 2013.

INADEQUATE AUXILIARY COVERAGE: Pledged revenues generated in fiscal 2013 provide ADS coverage below the 1.25x rate covenant. The Negative Outlook reflects Fitch's uncertainty around projected improvements in fiscal 2014 given weak budgeting practices that do not ensure system covenant compliance, in addition to management's apparent lack of system over-site.

GROWING ENROLLMENT: Sustained demand for LSTC's diverse and advanced programs has resulted in annual enrollment growth which is positive for fueling growth in pledged revenues. LSTC's full time equivalents (FTE) achieved a record-high level for fall 2013.

COLLEGE'S IMPROVED OPERATIONS: Although still negative on a combined GAAP-basis, the college's operating performance modestly improved in fiscal 2013 though management projects slightly negative fiscal 2014 margins due to an increase in expenses related to program expansion and increased salary/benefit costs.

RATING SENSITIVITIES

ADEQUATE PLEDGED REVENUES: A return to Stable Outlook is predicated on the college's ability to generate sufficient net cash flow from the auxiliary system to meet the 1.25x coverage requirement in the near term (fiscal 2014), following a year in which the debt service coverage covenant was violated.

ADDITIONAL AUXILIARY DEBT: Although not planned, issuance of additional system debt, without a commensurate increase in pledged revenues available for repayment, could diminish coverage levels which may negatively impact the rating.

OPERATING PERFORMANCE: Inability to implement effective cost control measures, coupled with a material shift in enrollment-related revenue or state support, could negatively impact operating performance and the rating. Conversely, Fitch notes that LSTC's consistent ability to generate positive margins over the long term would be positive for the rating.

CREDIT PROFILE

Founded in 1961, LSTC is a two-year, publicly-supported vocational and technical school with its main campus located in Linn, Missouri (the state's general obligation bonds are rated 'AAA' by Fitch). LSTC is the only state-supported, post-secondary technical educational center in Missouri. Offering advanced technical education in both traditional and emerging technologies, the college is state and federally funded and supports economic development in the state. As of July 1, 2014, the college will be renamed the State Technical College of Missouri.

AUXILIARY SYSTEM DEBT

The system comprises the cafeteria, bookstore, housing, and activity center. The college's total long-term debt outstanding is composed entirely of system debt ($8.8 million). On a combined basis, the college's MADS burden is moderately low at 4.1% (based on unrestricted operating revenues of $20.6 million). Positively, combined net income of the college covers system MADS ($838,000 in 2024) by a strong 3.5x. While the college expresses a willingness to support system debt service from consolidated resources, if necessary, there is no legal requirement to do so. Further, no additional debt issuance is expected in the near term, which reflects positively on LSTC's overall leverage ratios.

INSUFFICIENT SYSTEM CASH FLOW

In fiscal 2013, net operations of the sytem were negative $67,000, after positive results of $53,000 in fiscal 2012 which management attributes largely to non-recurring expenses in the student activity center that year. However, Fitch notes that while a decrease in system-wide net cash flows from operations is partly due to non-recurring repair and replacement costs, certain increased operating expenses, including salary and benefit costs and higher utility costs, are expected to be recurring. Fitch believes that, without careful management of expenses, this could lead to insufficient net cash flow of the auxiliary system to meet the required coverage requirement in the near term.

The bond rate covenant requires that LSTC generate net system auxiliary revenues equal to 1.25x system ADS. On a net auxiliary system revenue basis, fiscal 2013 pledged revenues ($779,500) covered system ADS ($649,000) by 1.20x, which is lower than the requirement and the previous year's coverage of 1.34x.

Management is projecting an increase in auxiliary system net cash flow in fiscal 2014. Positively, LSTC's combined fiscal 2014 interim financials (for the first six-month period) reflect auxiliary enterprise revenues are tracking slightly ahead (2.3%) of the same time last year and auxiliary expenses are tracking 12.3% behind the same period last year. While projections provided to Fitch appear reasonable, Fitch is unable to ascertain which expenses across all auxiliary services are recurring given the lack of any budget plan for the enterprises of the system. An increase in recurring expenses could make it difficult for coverage to return to historical levels expected for a 'BBB' rating.

The Negative Outlook reflects Fitch's uncertainty regarding the system's projected fiscal 2014 performance which is based on weak budgeting practices. Currently, the college's budgeting process for its auxiliary operations does not specifically plan for compliance with the coverage requirement under the rate covenant. While the college is working to remedy the situation, an inability to generate projected coverage in fiscal 2014 may negatively impact the rating.

NICHE PROGRAMS DRIVE HEALTHY DEMAND

Headcount enrollment growth remains strong, increasing 6.8% in fall 2013 (and 13.3% over the past five years, i.e. fall 2009-2013). Fall 2013 FTE enrollment reached a record high of 1,294 students. LTSC offers both day and evening courses with a limited physical plant that is capable of accommodating approximately 1,800 students.

LSTC fills a distinctive niche in post-secondary education in the state offering technical education ranging from an FAA-certified aviation maintenance program to the country's only associate degree in applied science focused on nuclear energy. LSTC is supported by a diverse group of business and industry partners looking to maintain a pipeline of qualified technical workers and whose input generates a unique programming mix (not easily replicated) which limits competition and drives student demand.

As of April, 2014, the college has received 1,532 applications, comparing favorably over same period last year. While acceptances to date are down 55 students over the prior year, LSTC is an open-enrollment institution. According to management, as the college's programs become more selective the quality of the incoming class is expected to improve. Programs have limited capacities and are typically set based on an assessment of the job market and local demand for workers. The college's increasing selectivity is tied to job market over-saturation which would hurt the college's job placement rates, an important funding metric for state support.

COLLEGE'S SMALL BUT DIVERSIFIED OPERATIONS

Student generated revenues and annual state appropriations remain the college's largest funding sources (42.8% and 21.7% of fiscal 2013 revenues, respectively). Due to the volatile state funding environment in Missouri, the appropriations share has declined over the past few years, but has largely stabilized in fiscal 2013. Actual state appropriated funding for fiscal 2014 (reported by the CFO) increased 5.3% to $4.71 million, essentially matching funding expectations. This includes a nominal amount of performance funding.

In fiscal 2013, LSTC's combined operating margin (GAAP-basis) modestly improved. The college generated close to break-even operating results (-0.2%) in fiscal 2013, up from (-0.6%) in fiscal 2012, which is viewed favorably after several years of negative operation. In fiscal 2014, the college is conservatively expecting a slightly greater GAAP operating deficit than in fiscal 2013, but is expecting break-even cash-flows. According to management, enrollment growth/new program expansion drove up expenses in fiscal 2014. A 2% increase in salary expense and benefit costs/retirement contributions was partially planned for fiscal 2014 after a five-year salary freeze.

COLLEGE'S LIMITED CUSHION IMPROVES

The college's available funds, or cash and investments not permanently restricted, provide a fairly limited financial cushion but grew a healthy 16.84% to $7.64 million in fiscal 2013 which, while not pledged, is viewed favorably by Fitch.

For fiscal 2013, available funds represent 37% of operating expenses and 86.6% of total long-term debt. Positively, available funds are highly liquid with minimal exposure to alternative asset classes (private equity and hedge funds). Fitch views favorably the growth in the college's financial cushion which would enable the college to support and cash-flow shortfall of the system, if necessary, although they are not legally required to do so.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'U.S. College and University Rating Criteria' (May 12, 2014);

--'Fitch Affirms Linn State Technical College, MO's Rev Bonds at 'BBB'; Outlook Stable', dated May 22, 2013.

Applicable Criteria and Related Research:

U.S. College and University Rating Criteria--Effective May 10, 2013--May 12, 2014

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708049

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=830137

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON (News - Alert) THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.


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