Fitch Rates Pennsylvania State System of Higher Ed, Series AO Revs 'AA'; Outlook Stable

NEW YORK--()--Fitch Ratings assigns an 'AA' rating to the following revenue bonds issued by the Pennsylvania Higher Educational Facilities Authority on behalf of the Pennsylvania State System of Higher Education (PASSHE):

--Approximately $12.3 million of Series AO-1 (Tax-Exempt)

--Approximately $18.4 million of Series AO-2 (Taxable)

The bonds are expected to sell competitively the week of June 24th. Bond proceeds will be used to finance certain construction projects and pay costs of issuance.

In addition, Fitch affirms the 'AA' rating on PASSHE's $941.7 million of outstanding revenue bonds.

The Rating Outlook is Stable.

SECURITY

Revenue bonds are an unsecured general obligation of the system.

KEY RATING DRIVERS

STABLE CREDIT CHARACTERISTICS: The 'AA' primarily reflects PASSHE's track-record of generally favorable operating performance, sound financial cushion, and manageable debt burden. Counterbalancing factors include exposure to fluctuations in state funding and recent pressures in headcount enrollment.

ACTIVE RESPONSE SUPPORTS FINANCIAL HEALTH: Decreasing levels of state funding support in recent years led management to take measures to deal with the resulting budgetary pressures; positive operating performance has been maintained as a result of those actions. While the system continues to face various operational pressures, the management team remains committed to taking the necessary steps to preserve the system's financial health.

STATE SUPPORT BEGINNING TO STABILIZE: Following a period of significant cuts in operating support from the state (Pennsylvania GO's rated 'AA+' with a Negative Outlook by Fitch), annual appropriations are showing signs of stabilization. State funding support for operations in fiscal 2013 was held in line with the prior year, while the governor's proposed budget for fiscal 2014 called for the continuation of flat funding support.

ENROLLMENT DECLINES APPEAR MANAGEABLE: The system registered a dip in total headcount enrollment during fall 2012, primarily due to a decline in the number of graduating high school students in the state. Management implemented various budgetary adjustments to temper the impact from a financial standpoint and is instituting several initiatives geared toward stabilizing future enrollment trends.

MANAGEABLE DEBT BURDEN: Fitch views the system's moderate debt burden, track-record of generating satisfactory debt service coverage from annual operations, conservatively structured debt portfolio, and limited future debt plans as indicators of a manageable leverage position.

RATING SENSITIVITY

MARGIN EROSION: A marked decline in operating trends may have a deteriorative effect on PASSHE's financial cushion and ability to service debt from operations.

ADDITIONAL DEBT: The incurrence of additional debt without a commensurate increase in financial resources may negatively pressure the rating.

PRESSURED OFF-BALANCE SHEET HOUSING: Though not expected, significant financial or operational stress at the system's off-balance sheet housing units could pressure PASSHE's financial profile.

CREDIT PROFILE

Pennsylvania State System of Higher Education (PASSHE), the largest provider of higher education in the commonwealth (confirm), includes 14 universities, four branch campuses, several regional centers, and the McKeever Environmental Learning Center. All of the universities are fully accredited by the Middles States Association of Colleges and Secondary Schools.

ACTIVE RESPONSE SUPPORTS FINANCIAL HEALTH

In response to a 14.4% decline in state appropriations for operations in fiscal 2012 relative to the prior year, management implemented a variety of expense reductions, including program retrenchments and staff cutbacks. Simultaneously, the average rate of tuition and fees for resident undergraduate students increased by 9.8%, supporting growth in student-derived revenues. The combination of the revenue and expense adjustments drove a positive operating margin of 2% in fiscal 2012, an impressive outcome given the materiality of state funding reductions during the fiscal year.

Operating performance in fiscal 2013 is expected register closer to break-even levels, which is still consistent with Fitch's expectations for public colleges and universities. While state funding was held flat relative to the prior year, the system experienced some financial stress associated with a 3.2% decline in total headcount enrollment, which stood at 114,471 in fall 2012.

Management addressed the enrollment shortfall in fiscal 2013 through a combination of a 2.9% averaged system-wide increase in undergraduate resident charges and various expense adjustments. Despite recent tuition increases, Fitch notes that resident student charges remain the lowest among four-year postsecondary institutions in the state, although political pressure somewhat constrains the system's pricing flexibility.

The system has experienced growth in benefits-related expenses in recent years, particularly with regard to pensions and employer annuitant health care costs. While both expense line items remain manageable at present, the absence of meaningful cost reform in future years could adversely impact the system's financial profile. Fitch will continue to monitor the situation as it develops.

BALANCE SHEET CUSHION REMAINS SOUND

Generally positive operating performance has supported growth in PASSHE's balance sheet resources. Available funds (cash and investments less certain net assets) totaled approximately $1.24 billion, or 10.9% above the prior year and 33.9% over fiscal 2008. Fitch notes favorably that available funds provided 65.1% and 114.3% coverage of fiscal 2012 operating expenses and pro forma debt. A recent resolution on a previously expired labor contract with faculty required the system to meet certain financial commitments in fiscal 2013, which was funded with financial resources. Fitch notes positively that the drawdown did not materially impact the system's financial cushion.

The system maintained approximately $1.1 billion in off-balance sheet student housing debt at fiscal year-end 2012 across PASSHE's campuses (structured to be non-recourse to the system). Inclusive of these projects, available funds covered a somewhat weaker, though still adequate, 57.8% of debt. Despite the recent enrollment decline in fall 2012, occupancy levels remain sound and continue to contribute toward adequate debt service coverage levels. To date, direct financial support for a project from the system has never been needed.

MANAGEABLE DEBT BURDEN

Fitch views PASSHE's debt burden as moderate, with pro-forma maximum annual debt service (MADS) consuming 6.3% of fiscal 2012 operating revenues. The system regularly generates satisfactory debt service coverage from net operating income, averaging 1.3x between fiscal 2008 and fiscal 2012, including 1.3x in the most recent year. The system's conservatively structured debt portfolio, which includes a rapidly amortizing principal schedule and no exposure to variable rate debt or related interest rate hedges, is viewed favorably.

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

Applicable Criteria and Related Research:

--'Revenue Supported Rating Criteria' (June 3, 2013);

--'U.S. College and University Rating Criteria'(May 10, 2013);

--'Fitch Rates Pennsylvania State System of Higher Ed, Series AN Revs 'AA'; Outlook Stable (Feb. 17, 2012).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria -- Effective June 12, 2012 to June 3, 2013

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015

U.S. College and University Rating Criteria

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=793578

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Contacts

Fitch Ratings
Primary Analyst
Alexander Vaisman, +1 212-908-0721
Analyst
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Susan Carlson, +1 312-368-2092
Director
or
Committee Chairperson
Joanne Ferrigan, +1 212-908-0723
Director
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst
Alexander Vaisman, +1 212-908-0721
Analyst
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Susan Carlson, +1 312-368-2092
Director
or
Committee Chairperson
Joanne Ferrigan, +1 212-908-0723
Director
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com