Fitch Upgrades University of North Carolina at Chapel Hill's Bonds to 'AAA'

NEW YORK--(BUSINESS WIRE)--Fitch Ratings upgrades the following series of bonds issued by the University of North Carolina Board of Governors on behalf of the University of North Carolina at Chapel Hill (UNC-CH) as follows:

--$930.5 million fixed-rate general revenue bonds to 'AAA' from 'AA+';

--$112.8 million fixed-rate general revenue bonds (Build America Bonds) to 'AAA' from 'AA+';

--$69.2 million variable-rate general revenue bonds to 'AAA/F1+' from 'AA+/F1+';

--$875,000 fixed-rate housing system revenue bonds to 'AAA' from 'AA'.

The Rating Outlook is Stable.

RATING RATIONALE:

--The general revenue bonds (GRB) upgrade to 'AAA' reflects UNC-CH's superior financial flexibility, highlighted by its ability to grow resources while simultaneously managing a sizeable capital improvement plan (CIP) and reductions in operating support from the state of North Carolina (the state, general obligation bonds rated 'AAA' by Fitch).

--Exceptionally strong coverage of housing system bond debt service (25.7 times (x) during fiscal 2010) by pledged net revenues and the closed nature of the lien securing housing system debt support the housing system revenue bonds upgrade to 'AAA'; outstanding housing system revenue bonds fully mature in fiscal 2012.

--UNC-CH's substantial financial cushion; consistently sound operating performance, supported by diverse funding streams; exceptionally strong student demand and academic quality; and an experienced leadership team anchor the 'AAA' rating.

--Financial pressures relating to recent state funding reductions have been managed through a combination of tuition and fee increases and budgetary restraint designed to have minimal impact on UNC-CH's educational quality and research output.

--Major initiatives to construct, expand, or renew academic and research facilities and infrastructure have been funded and implemented by the university, with CIP related debt needs ($461 million) extremely manageable over the next five years.

--The short term 'F1+' rating reflects UNC-CH's ability to cover the maximum potential liquidity need of its weekly rate variable rate demand bonds ($69.2 million) and commercial paper program (not rated) by a minimum of 1.25x from internal high quality, highly liquid resources.

KEY RATING DRIVERS:

--Continued, timely action on the part of management to mitigate the effect of potential future state funding reductions on operating performance.

--Preservation of balance sheet resources through continued balanced, active management of invested funds.

SECURITY:

GRBs are secured on a parity basis by legally defined available funds of UNC-CH (pledged revenues), including unrestricted general fund balances and unrestricted quasi-endowment fund balances ($1.5 billion during fiscal 2010). Specifically excluded from pledged revenues are state appropriations, tuition, and restricted funds. For the series 2009B GRB's designated as Build America Bonds for purposes of The American Recovery and Reinvestment Act (ARRA) of 2009, UNC receives a cash subsidy payment from the United States Treasury equal to 35% of interest payable. Housing system debt is secured by net revenues of the housing system ($22.8 million).

CREDIT SUMMARY:

As is typical for an 'AAA' public university, UNC-CH's substantial resource base is fueled by consistently break-even to positive operating performance in most fiscal years and significant fundraising prowess. Between fiscal 2006 and fiscal 2010, available funds, or cash and investments less restricted non-expendable net assets and expendable net assets for capital projects and debt service, increased at an average annual rate of 6.4%, from $2.1 billion (fiscal 2006) to $2.7 billion (fiscal 2010). As a percentage of fiscal 2010 operating expenses and total financial leverage, available funds represented a solid 114.9% and 195.3%, respectively, with both metrics comparing favorably with the 'AAA' rating level.

Non-marketable securities, including private equity, hedge funds and real estate, represented approximately 74.2% of fiscal 2010 total investments. UNC-CH's increased exposure to alternative assets over the past decade is somewhat concerning to Fitch, particularly given the valuation and liquidity issues that often accompany these investments. However, the university does not rely upon these holdings for potential liquidity needs and instead maintains a temporary investment pool and, by statute, an investment in the state treasurer's short-term investment fund for this purpose; assets in both funds are conservatively invested. Fitch continues to view UNC-CH's liquidity and investment management practices favorably, noting that roughly half of long-term investments could be liquidated, if needed, within six months. UNC Management Company, Inc. continues to provide investment management services for UNC-CH and other members of the University of North Carolina System.

Growth in available funds over the past five fiscal years is impressive when considering UNC funded significant portions of a $2.3 billion rolling 10-year CIP and endured financial market related investment losses of approximately 19.6% between fiscal 2008 and fiscal 2009, a significant portion of which has since been recovered. The university bond financed roughly 41.3% of fiscal 2000-2009 CIP project costs, with state funds and reserves funding smaller, though still considerable shares. As UNC activated and funded CIP projects, bonded debt increased by 58.6%, to approximately $1.2 billion, between fiscal 2006 and fiscal 2010. At the same time, however, the university actively fundraised to minimize the impact of this increase in leverage and directly pay all or a portion of select project costs. Despite a plateauing of contributions since the conclusion of the Carolina First capital campaign (fiscal 2008), annual alumni giving remains robust (25% giving rate), with UNC-CH consistently ranking among the top 30 public and private universities nationally for fundraising.

The university's consistent ability, in most years, to generate a positive operating margin, also helps to bolster its financial resources. For fiscal 2010, the operating margin improved to 1.5%, as several of UNC-CH's primary revenue streams, including grants and contracts (35.5% of total operating revenues); student generated revenues (25.4%); and net patient service revenues (10.2%) experienced volume growth or improved reimbursement. In addition, operating expenditures increased by only a modest 2.8% as layoffs related to state funding cuts; a state mandated furlough; and suspension of employee merit increases constrained escalation in salaries and benefits expense. On a GAAP basis, UNC-CH expects operating performance for fiscal 2011 to roughly equal the fiscal 2010 level.

State appropriations (22.8% of fiscal 2010 operating revenues) were reduced by $44.6 million (10%) in fiscal 2010. However, a result of the university's receipt of supplemental funds for enrollment growth and other initiatives, along with ARRA funds backfilling certain reductions, the fiscal 2010 financial statements indicate an increase (0.6%) in state appropriations. Base budget appropriations were again cut in fiscal 2011 by approximately $38.9 million on a recurring ($23.4 million) and non-recurring ($15.5 million) basis. To manage the effect of these reductions, UNC-CH implemented budgetary cuts, of varying degrees, across all operating units, centers, and institutes and utilized its considerable demand and pricing flexibility to back-fill the loss in state aid with increased student revenues. Despite an 18.5% increase in tuition and mandatory fees for the fall 2010 semester, UNC-CH did not experience any softening in demand and it remains one of the lowest priced institutions within its peer group of nationally recognized flagship public universities.

Given the state's projected budget shortfall of up to $2.4 billion for fiscal 2012, UNC-CH is expecting a 15% reduction in its base appropriation level. To fully offset this reduction, the university plans to enhance operating revenues through increasing tuition (6.5%); modestly growing enrollment (up to 3%); and using a portion of internal reserves. These reserves, created purposely by the university to manage state appropriation cuts, have been funded over time from accumulated operating surpluses. UNC-CH also plans to limit expenditure growth through continuing the salary and selective hiring freeze implemented in fiscal 2010 for a second year.

As an 'AAA' rated public university, UNC-CH maintains the financial flexibility to manage risks attendant to floating rate debt, interest rate hedges, and non-amortizing debt structures. Variable rate debt, including weekly variable rate demand bonds (VRDBs) ($69.2 million) and outstanding commercial paper ($53.7 million), represented a manageable 10.2% of the university's total debt portfolio as of March 31, 2011. Two swaps ($119.7 million notional amount) containing industry standard risk mitigants synthetically fix the interest rate on VRDBs; a third forward starting swap ($150 million) remains outstanding to potentially hedge a future issuance of variable debt. As of March 31, 2011, the marked to market value on the total swap portfolio was -$50 million. There are no collateral positing requirements at the current rating level and the university has no plans to terminate any of the swaps at this time.

Two of the university's outstanding GRBs contain large bullet maturities that come due between fiscal 2033 and fiscal 2037. Given UNC-CH's superior credit profile, and related market access, Fitch expects these maturities would be refinanced prior to maturity. In the event the bullets were paid when due, maximum annual debt service ($151.6 million, fiscal 2033) would represent a moderately high, though manageable, 6.4% of fiscal 2010 operating revenues. If the bullets were evenly amortized through final maturity of their respective issues, the debt burden would decline to a fairly low 4.1%.

UNC-CH typically covers annual debt carrying charges by approximately 2.0x as a result of its consistently sound operating performance. While up to $461 million of additional GRB debt may be issued over the next five years to fund various academic, research, student life, and athletic projects, the university's debt capacity at the current rating level sufficiently supports these financings. Certain projects may be partially or fully funded by contributions.

Established in 1789, UNC-CH is a member of the 17-member University of North Carolina System and is the state's flagship university. For fall 2010, UNC-CH enrolled 29,390 students, of which 63% were undergraduates. UNC-CH's demand indicators continue to reflect its market position as a highly selective, research oriented public university.

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

Applicable Criteria and Related Research:

--'Criteria for Assigning Short-Term Ratings Based on Internal Liquidity', dated June 20, 2011;

--'Revenue-Supported Rating Criteria', dated June 20, 2011;

--'College and University Rating Criteria', dated Dec. 29, 2009.

For information on Build America Bonds, visit 'www.fitchratings.com/BABs'.

Applicable Criteria and Related Research:

Criteria for Assigning Short-Term Ratings Based on Internal Liquidity

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637129

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130

College and University Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493170

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