NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded the rating to 'A-' from 'A+' on approximately $20.8 million Higher Educational Facilities Financing Authority (HEFFA), FL revenue bonds issued on behalf of Bethune-Cookman University (BCU).
The Rating Outlook is Stable.
The bonds are secured by loan payments made by BCU to HEFFA. These loan payments are an unsecured general obligation of BCU.
KEY RATING DRIVERS
ADDITIONAL DEBT DRIVES DOWNGRADE: The downgrade reflects BCU's plan to enter into a $72.1 million capital lease to finance a new 1,200 bed student housing project on campus. Although BCU's projections suggest some growth in balance sheet resources over time, the transaction will increase the university's leverage position and debt burden to levels below the rating category average. At the time of Fitch's last review, the project was pending board approval and key details of the structure were unavailable.
NEED FOR STUDENT HOUSING: BCU's clear strategic need for new student housing partially mitigates the risks of additional debt. Recent enrollment growth and deferred maintenance issues have stretched the university's capacity to house students in on-campus or university-approved housing. Fitch believes that existing enrollment is sufficient to ensure full occupancy of the new facility and existing dorms, which should support sound operations and coverage.
SMALL NEGATIVE MARGINS: BCU posted a small GAAP-based operating deficit in fiscal 2014, similar to 2013 results. Fitch had expected fiscal 2014 results to improve slightly due to enrollment growth and higher net tuition revenue, however expenses were higher than anticipated. Fitch continues to expect a return to balanced operations in fiscal 2015, as well as continued sound coverage of debt service, based on healthy enrollment trends. New lease payments related to the project should be offset by additional project revenues and the discontinuation of certain annual expenses for off-campus housing.
STUDENT DEMAND FOR HOUSING: The additional leverage and escalating fixed costs of the project increase BCU's already high dependence on student-generated revenues. Substantial weakening of BCU's currently healthy demand profile and enrollment levels could be detrimental to operations and negatively pressure the rating.
BALANCE SHEET RESOURCES: Balance sheet metrics are somewhat below 'A' category peers. The rating level assumes at least moderate growth in balance sheet resources relative to debt, due to expected positive project net revenues and additional expense contingencies built into BCU's operating budget, offset by potential near-term capital needs. Failure to achieve moderate growth in, or deterioration of, balance sheet resources relative to debt would negatively pressure the rating.
PROJECT COMPLETION: The rating and Outlook assume successful financing, completion and occupancy of the project. The project agreements mitigate BCU's financial risk in the event of significant delays or construction problems, but challenges related to project completion or financial compliance could be disruptive given the project's location on campus, and BCU's immediate need for additional housing capacity.
BCU was founded in Daytona Beach, FL in 1904 by Mary McLeod Bethune, a major civil and human rights activist. The school was originally founded as an all-girls school for African-Americans. Subsequently, the school merged with Cookman Institute of Jacksonville, FL and later became affiliated with the United Methodist Church. Today, BCU is a co-educational institution and is one of the federally-designated historically black colleges and universities in the United States.
ADDITIONAL DEBT DRIVES DOWNGRADE
BCU plans to enter into a $72.1 million capital lease to finance a new 1,200 bed student housing project on campus. Fitch's criteria considers capital lease obligations equivalent to debt, and the transaction will result in debt-related metrics below those of 'A' category peers.
Available funds ($54.5 million as of June 30, 2014) would cover an adequate 55.6% of pro forma debt - $98.0 million including the lease obligations. Fitch expects some growth in balance sheet resources and amortization of existing debt to improve this figure by the time the lease is recorded in fiscal 2016. However, available funds relative to debt will fall sharply from the strong 210.4% as reported in 2014 before the lease transaction. In addition, BCU's debt burden is projected to increase from a moderately low 3.6% in fiscal 2014 to a moderate 6.0% in fiscal 2017, the first year BCU is required to make lease payments.
HEALTHY DEMAND SUPPORTS NEED FOR STUDENT HOUSING
BCU has a clear strategic need for additional on-campus student housing due to a healthy demand profile and the importance of a residential experience to the university's mission. Recent enrollment growth and the loss of some housing capacity due to deferred maintenance issues have stretched the university's ability to house students. BCU is currently leasing hotel beds and off-campus apartments for over 900 students to meet excess housing needs. In addition, BCU reports that approximately 300 accepted students had to withdraw in fall 2014 due to its inability to secure appropriate housing.
The recently expanded campus housing policy now requires all students to live in housing provided (on- or off-campus) or approved by BCU. Given this requirement, existing enrollment of 4,045 is sufficient to fully occupy the 3,002 on-campus beds after project completion. Fitch views this favorably, as no enrollment growth is required to fill the project. BCU has agreed to direct students to the new dormitory on a first-fill basis. While no formal feasibility study was conducted, Fitch believes that this anecdotal evidence, combined with the university's expectation of further enrollment growth, demonstrate a clear need for new campus housing.
NEGATIVE MARGIN; STABLE COVERAGE
Healthy demand and enrollment trends should support the project as well as the university's overall operating performance and debt service coverage. Fitch notes favorably that the lease payments, which begin in fall 2016 (fiscal 2017), will replace hotel and apartment leases of similar amounts. The project itself is also projected to generate additional net revenues for the university throughout its life.
BCU posted a small 1.9% operating deficit in fiscal 2014, similar to the prior year. Fitch had expected fiscal 2014 results to improve slightly due to enrollment growth and higher net tuition revenue, but operations were unchanged due to higher than anticipated expenses. Fitch continues to expect a return to balanced operations in fiscal 2015 based on continued enrollment growth in fall 2014 and additional contingencies in the operating budget. All-in debt service coverage is expected to remain acceptable for the rating category after project completion, as the project should generate net revenues in excess of lease payments.
MANAGEABLE TRANSACTION RISKS
Fitch believes overall transaction risks are manageable. The lease features a 40-year term and annual 1.5% rent escalations, which effectively backload debt service through expiration in fiscal 2056. Fitch views this structure as somewhat more aggressive for the university generally, but notes that the existing bonds mature in 2032. Along with lease escalations, BCU is projecting consistent 3% annual increases in room and board charges. While this amount is below the 5% historical rate of room and board hikes, Fitch considers this assumption inherently uncertain over such a long period of time, especially given increased concerns about affordability in the sector. Fitch gains comfort from a structural cushion, such that 1.5% annual increases would still maintain project profitability throughout its life. Flat room and board rates would maintain project profitability through at least 2032.
Fitch does not believe the subordinate structure materially diminishes the risks of additional debt and fixed costs due to the project, but it is necessary to comply with existing covenants. While the lease obligations are contractually subordinate to the bond obligations, Fitch believes that BCU's obligation to fill the project housing on a priority, first-use basis limits the benefit to bondholders.
The 2010 bond documents would not have permitted additional indebtedness in the amount contemplated for the project on parity with the outstanding bonds. Additional parity debt requires meeting both coverage and leverage tests. However, subordinate debt requires meeting only a 1.0x debt service coverage test (pro forma).
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 Bethune-Cookman Univ, FL's Revs at 'A+'; Outlook Stable', Sept. 8, 2014.
An external appeal committee decision resulted in an outcome that is different from the committee decision that was appealed.
Applicable Criteria and Related Research:
U.S. College and University Rating Criteria