NEW YORK--()--Fitch Ratings assigns the following ratings to general revenue bonds (GRBs) to be issued by the Regents of the University of California (the regents) for the benefit of University of California (UC or the university):
--$400.0 million 2011 series Y-1 (taxable floating rate notes) 'AA+/F1+';
--$100.0 million 2011 series Y-2 (taxable floating rate notes) 'AA+/F1+';
--$100.0 million 2011 series Z-1 (taxable variable rate demand bonds) 'AA+/F1+';
--$50.0 million 2011 series Z-2 (taxable variable rate demand bonds) 'AA+/F1+';
--$265.0 million 2011 series AA-1 (taxable fixed rate notes) 'F1+'; and
--$285.0 million 2011 series AA-2 (taxable fixed rate notes) 'AA+/F1+'.
The series Y-1 and Y-2 taxable floating rate notes and the series AA-1 and AA-2 taxable fixed rate notes are scheduled to price via negotiated sale the week of July 18th. The series Z-1 and Z-2 taxable variable rate demand bonds (VRDBs)are scheduled to price the week of July 25th. The series Y-1, Y-2, Z-1, Z-2, AA-1, and AA-2 are collectively referred to by Fitch as the taxable series 2011 GRBs for the purposes of this Rating Action Commentary.
Proceeds of the taxable series 2011 GRBs will fund a portion ($935 million) of the university's modified fiscal 2012 annual contribution to the UC Retirement Plan (UCRP), including the unfunded portion of normal costs and the interest portion of the unfunded actuarial accrued liability. Proceeds will also finance a portion ($265 million) of the expected fiscal 2012 deferral of $500 million of appropriations from the state of California (state, general obligation bonds rated 'A-'/Stable Outlook by Fitch Ratings), along with other working capital needs; and pay various bond issuance costs.
The university intends to issue an additional $300 million of fixed rate taxable and tax-exempt GRBs on or about Aug. 8, 2011. While ratings on these issues will be assigned closer to the sale date, Fitch's analysis of the UC credit incorporates this $300 million of additional leverage, portions of which are expected to fund new money projects and refund or restructure outstanding debt.
In addition, Fitch affirms the following ratings:
--$4.7 billion fixed rate GRBs at 'AA+';
--$3.7 million fixed rate GRBs (taxable-Clean Energy Renewable Bonds) at 'AA+';
--$1.2 billion GRBs (taxable-Build America Bonds) (Put Structure) at 'AA+/F1+'; and
--$48.7 million California Statewide Communities Development Authority (CSCDA) Recovery Zone Economic Development Bonds (UC Merced Student Housing Phase 4) 2010 series A* at 'AA+'.
*Pursuant to a purchase agreement between CSCDA and the university, CSCDA purchased UC's unrated series X GRBs. The par amount of the 2010 series A bonds (series A bonds) equals the par amount of the series X GRBs, with the latter series irrevocably assigned and pledged for the benefit of the series A bondholders. Payments made by UC towards the unrated series X GRBs will be used by CSCDA to pay debt service on the series A bonds and the series A bonds may not be used for any purpose so long as the series A bonds are outstanding.
The Rating Outlook is Stable.
RATING RATIONALE:
--UC's substantial level of balance sheet resources and liquidity; diverse revenue base, which enables the system to weather temporary weakness in any one funding source; and manageable debt burden, despite the expansive, capital intensive nature of its operations, underpin its 'AA+' rating.
--The short-term 'F1+' rating reflects the university's ability to internally manage variable rate debt programs through a combination of significant liquid reserves and superior market access.
--An exceptional reputation for academics, research, and medical care continues to fuel UC's consistently strong student demand and highly selective admissions despite considerable increases in student charges over the past several years.
--Recent reductions in state appropriations, and the potential for additional cuts through the intermediate term, are partially mitigated by the university's still considerable, though now more limited, ability to raise tuition and fees, and its overall limited reliance on state operating support.
--In addition to an uncertain state funding environment going forward, credit concerns center primarily on the university's significant and growing unfunded pension and retiree health benefits liabilities and UC's recent negative trend in operating performance, which may be difficult to reverse in the current environment.
--Timely measures consistently taken by UC's 26-member regents and highly experienced management team during times of state fiscal stress provides further rating stability.
KEY RATING DRIVERS:
--Continued tuition and fee setting flexibility enabling the university to effectively manage on-going reductions in state support.
--Preservation of resource levels despite near to intermediate term potential calls on liquidity to support institutional initiatives and manage an uncertain state funding environment.
--Gradual restoration of operating performance to approximately a break-even level of performance, aided by the realization of savings from recently implemented cost savings measures.
SECURITY:
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. For GRBs designated as Clean Renewable Energy Bonds, Build America Bonds, and Recovery Zone Economic Development Bonds, UC also receives annual federal subsidies which it uses to offset annual debt service on issues carrying such designation. While the reduction or elimination of a subsidy payment due to a change in law would subject the impacted bonds to extraordinary optional redemption, the university's receipt of the subsidy is immaterial to its credit profile and ability to service outstanding GRB portfolio.
CREDIT SUMMARY:
The university's substantial level of balance sheet resources and liquidity continues to anchor the 'AA+' rating. For fiscal 2010 available funds, defined by Fitch as cash and investments less non-expendable net assets and certain expendable net assets, totaled $14.7 billion, up from $12.6 billion in fiscal 2009. As a percentage of fiscal 2010 operating expenses ($23.4 billion) and pro forma financial leverage ($13.1 billion), fiscal 2010 available funds provided a sound cushion equal to 62.7% to 111.8%, respectively. Both ratios compare favorably with Fitch's expectation for an 'AA+' public university. Debt excludes $2.2 billion of California State Public Works Board (SPWB).Lease rental payments made by UC to SPWB, structured to equal debt service on SPWB bonds, are appropriated annually by the state as a line item in the university's budget.
UC's ability to maintain its financial cushion despite state funding pressures; significant unfunded pension and post-employment benefits liabilities; and the size and scope of its expansive statewide operation is impressive. Fitch continues to view this as a favorable reflection of university leadership and its culture of disciplined budgeting and financial management practices. While additional pressures may be faced over the near term as UC manages a higher contribution to the retirement plan and potentially faces additional funding reductions from stability, its ability to maintain resource levels at or near current levels is assumed in the 'AA+' rating.
Unencumbered, available resources of the university have long buffered UC's sizable research expenditures; necessary investment and reinvestment in facilities and infrastructure (including the related issuance of debt); and volatile state operating environment. These resources, held primarily in the short term investment pool (STIP, $8.2 billion at May 31, 2011) and increasingly in the total return investment pool (TRIP, $3.1 billion), are conservatively invested. STIP investments are managed with a focus on earned income maximization, while TRIP provides slightly enhanced return through investment in a traditional fixed income and equity securities. In addition to STIP and TRIP, UC maintains a more aggressively invested general endowment pool (GEP, $6.8 billion) with a long-term investment horizon; most of the university's illiquid alternative assets (20.1% of fiscal 2010 total investments) are held in the GEP.
At its March 2011 meeting, the regents authorized a $2.1 billion funding plan for its University of California Retirement Plan (UCRP or the plan) to address the erosion of its funding level. The plan's unfunded actuarial accrued liability increased sharply over the past several years due to underperformance of plan investments (expected return is 7.5%) and lower than required contributions made by the university. Underfunding has been exacerbated by a contribution holiday in place for more than two decades prior to 2010. Implementation of the funding plan is occurring in two phases-the first phase occurred on April 1, 2011 with the transfer of approximately $1.1 billion of financial assets from STIP to UCRP. The second phase ($935 million) will be funded from a portion of proceeds from the taxable series 2011 GRBs.
Other changes include phased-in increases of plan contribution rates by members and the university; implementation of a new benefits tier; and lengthening the revised amortization schedule for the unfunded accrued actuarial liability (UAAL). Altogether, plan changes are expected to cover normal costs and interest on the UAAL, although not the full annual required contribution. No resumption in the state's contribution to the plan is assumed.
Fitch does not view the transfer of investments from STIP to UCRP as a significant concern, noting that post-transfer the market value of STIP equals approximately 98.6% of its June 30, 2010 (pre-transfer) value. With the changes outlined above, the university projects the funded ratio of UCRP to decline to just over 70% in fiscal 2013 before steadily increasing thereafter. Concurrent with the pension issue, UC is in the process of revamping its retiree health plan to ease pressure on the health plan's UAAL ($14.9 billion, June 30, 2010) and enable UC to gradually reduce its contribution to 70% of total premium.
UC continues to benefit from one of the most diverse revenue streams in higher education, with no one revenue source representing approximately more than one third of operating revenues. UC's fiscal 2010 operating revenues totaled approximately $21.8 billion. Certain line items, notably state appropriations, investment income and gifts, classified as non-operating revenues in the audited financial statements were reclassified by Fitch as operating revenues. Operations of the university's five academic medical centers provided the bulk (27.5%) of fiscal 2010 operating support. Student generated revenues (24.2%) and grants and contracts (16.0%) contributed smaller, though still sizeable shares.
State appropriations represented just 13.5% of total operating revenues for fiscal 2010, which is significantly lower than many other public colleges and universities, including several at the university's rating level. UC's limited reliance on state appropriations to support operations continues to be viewed favorably in the rating process, especially given the recent substantial reductions in funding and ongoing fiscal challenges facing the state.
To partially manage an expected reduction in state appropriations for fiscal 2012, the regents, during November 2010, approved an 8% increase in tuition and fees effective fall 2011. The governor's 2012 budget initially called for a $500 million reduction in state appropriations to UC. However, the state's adopted budget for fiscal 2012 further reduced the university's appropriation by $150 million for a total appropriation reduction of $650.0 million for fiscal 2012. Mandatory cost increases of approximately $362.5 million, namely for utilities, faculty merit raises, and collective bargaining, also remain unfunded.
The regents plans to address the additional $150 million of state cuts at its next meeting, with the expectation that tuition may be further increased by up to 9.6% for fall 2011. Bridge financing for a portion ($265 million) of expected deferrals of state appropriation payments for July, August, and September 2011 ($500 million) will be managed with the proceeds of the taxable series 2011 GRBs.
Fitch continues to view the university's tuition pricing flexibility as quite strong, noting systemwide enrollment growth in each of the past five fall semesters despite an average annual increase of 14.7% in undergraduate, in-state tuition over the period. While student fee increases are politically unpopular, the university projects that a combined 17.6% tuition increase for fall 2011 would sufficiently cover nearly the entire reduction in fiscal 2012 state aid. Importantly, as UC's in-state total cost of attendance continues to rise, the ability to implement successive, significant increases in student charges, particularly at some of its smaller regional campuses, may become more limited. Fitch continues to monitor this aspect of UC's credit closely.
Based upon a trigger mechanism in the current budget, the state can implement an additional $100 million mid-year funding reduction to UC should state revenue projections fall short of expectations by $1.0 billion or more. The university is exploring strategies other than tuition and fee increases to backfill the majority of the potential additional loss of funding. The use of available operating reserves, quasi-endowment funds, and/or increased investment returns through reallocation of STIP investments to TRIP, have all been cited by the university as possible solutions. In Fitch's view, the potential mid-year fiscal 2012 funding reduction could be managed by UC's financial cushion as it represents just 1.2% of STIP's May 31, 2011 market value.
UC's operating margin has been negative over the past several fiscal years principally as a result of pressured state funding and higher programmatic expenses and employee-related health care costs. As was anticipated by Fitch during its review of UC in May 2010, various budgetary measures adopted during fiscal year 2010, including timely tuition increases, enabled the university to modestly improve the operating margin from a negative 8.3% (fiscal 2009) to a negative 7.5% (fiscal 2010). For fiscal 2011, UC projects the operating margin will approximate the fiscal 2010 level. However, actual performance may exceed fiscal 2010 results as state appropriations ($3.0 billion, base budget) increased in fiscal 2011 reflecting the permanent restoration of previous funding cuts ($199.0 million); the provision of funds for enrollment growth and retiree health benefit cost increases ($65.4 million); and one-time backfilling of certain other funding reductions with federal economic stimulus funds ($106.0 million). Based upon the $650 million of state funding cuts for fiscal 2012, UC's appropriations (base budget) are expected to decline to approximately $2.4 billion, making any fiscal 2011 improvement in operating margin potentially difficult to sustain in fiscal 2012.
Fitch recognizes UC's operating margin will continue to be somewhat more volatile than similarly rated public universities reflecting the unpredictability of annual state funding, and now, increased contributions to the retirement plan. Nonetheless, UC's continuing ability to manage revenue volatility and increased expenditures without materially eroding its financial cushion is assumed in the 'AA+' rating. To structurally realign future operating budgets with the long-term funding realities of the state, UC continues to pursue administrative efficiencies to achieve savings of $500 million over five years. In addition to the changes in funding retiree health benefits discussed above, the university is in the process of integrating financial and administrative systems, streamlining procurement practices, and evaluating changes in certain programs, including undergraduate/graduate health insurance. Various revenue enhancement strategies, including maximizing the recapture of indirect cost recovery revenue from sponsored research, are also under consideration.
UC's pro forma debt burden remains very manageable, with maximum annual debt service (MADS) of approximately $860.0 million (fiscal 2017) representing a manageable 4.0% of fiscal 2010 total operating revenues. MADS includes outstanding UC debt, including the taxable series 2011 GRBs and the up to $300 million of additional GRB debt expected to be issued later this summer. MADS excludes SPWB bonds.
UC's variable rate debt programs include commercial paper (CP, $2.0 billion maximum authorization, not rated by Fitch); series V put bonds ($200 million); pro-forma series Z-1 and Z-2 weekly variable rate demand bonds(series Z bonds, $150 million); pro-forma series AA-1 and AA-2 fixed rate notes (series AA notes, $550.0 million); and pro-forma series Y-1 and Y-2 floating rate notes (series Y notes, $500 million). The 'F1+' rating on CP program and the pro-forma series Z bonds and series Y notes is fully derived from the strength of STIP holdings. UC limits daily maturity of CP to $200 million. As part of its analysis, Fitch reviewed UC's detailed liquidation procedures plan for ensuring the sufficiency of STIP holdings to support variable rate obligations; managing put risk; and responding to a failed remarketing of outstanding CP and VRDBs. Fitch believes this plan to be sufficient.
The 'F1+'rating assigned to the series V bonds primarily reflects UC's ability to manage a hard put of the bonds on May 1, 2013. As part of its liquidation procedures plan, the university has documented steps it will take to ensure sufficiency of available STIP holdings prior to the put date. Additionally, pursuant to this plan, UC will notify CP dealers 270 days prior to the put date that it is closed for any CP maturity on the put date.
The combination of UC's superior market access, which is suggested by the its long-term 'AA+' rating, and the sufficiency of STIP resources, underpin the 'F1+' rating on the series Y floating rate notes. The structure of the floating rate notes gives UC the option to force an unscheduled mandatory tender of bonds ninety days prior to the mandatory tender date (July 1, 2012). In the event bonds tendered as part of the unscheduled mandatory tender cannot be remarketed, bondholders continue to hold the debt until the mandatory tender date and the university would begin the process of either refinancing the notes or converting interest rate modes. Should the university be unsuccessful in its efforts to refinance bonds, STIP resources are more than adequate to meet the potential call on liquidity at the mandatory tender date.
Chartered in 1868, UC is a 10-campus system offering 150 academic disciplines to approximately 225,000 students. UC campuses are located in Berkeley, Davis, Irvine, Los Angeles, Merced, Riverside, San Diego, Santa Barbara, Santa Cruz, with a graduate and research institute in San Francisco. Based upon fall 2010 full-time equivalent enrollment, the university enrolled 216,433 students, up 1.3% from the prior year and approximately 2.5%, on average, since fall 2006.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Criteria for Assigning Short-Term Ratings Based on Internal Liquidity' (June 20, 2011);
--'Revenue-Supported Rating Criteria' (June 20, 2011);
--'College and University Rating Criteria' (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
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 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.
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