Fitch Rates Univ. of CA's 2016 Ltd Project Gen Revs and Med Center Pooled Revs 'AA-'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned the following ratings to the Regents of the University of California's (UC) series 2016 limited project revenue bonds (LPRBs) and medical center pooled revenue bonds (MCPRBs):

--$410 million LPRBs, 2016 series K 'AA-';

--$100 million LPRBs, 2016 series L (taxable) 'AA-';

--$1 billion MCPRBs, 2016 series L 'AA-'.

The LPRBs are expected to sell the week of June 20, 2016 and the MCPRBs are expected to sell in Late July 2016. LPRB proceeds will be used to finance and refinance the acquisition, construction, improvement and renovation of certain athletic, parking, recreational, dining, and student and faculty housing facilities, as well as to refund approximately $140 million in outstanding general revenue bonds (GRBs). MCPRB proceeds will be used to finance various capital projects and refund approximately $725 million of outstanding MCPRBs and hospital revenue bonds.

Fitch also affirmed UC's long term ratings as detailed at the end of this release.

The Rating Outlook is Stable.

SECURITY

LPRBs are secured by a lien on the gross revenues of LPRB-financed projects, subordinate to debt service on general revenue bonds (GRBs; which are secured by a broad pledge of UC's unencumbered revenues, namely gross tuition and fees, indirect cost recovery revenues, auxiliary receipts, and a portion of state general fund appropriations). MCPRBs are secured by the revenues derived from the operation of UC's five medical centers. At the discretion of the Regents, what is included in the respective revenue pledges can be adjusted.

KEY RATING DRIVERS

EXCEPTIONAL REPUTATION: The ratings are supported by UC's strong reputation for academics, research and medical care that continues to promote consistently strong student demand and selective admissions, and growing patient volumes.

SOLID FINANCIAL CUSHION: Substantial balance sheet resources, diverse revenues and a manageable pro forma debt burden help to offset weaker operations, significant pension and retiree health benefit liabilities, and ongoing capital needs.

OPERATING IMPROVEMENT: Systemwide, university operating margins remain negative on a full accrual basis. However, results have improved somewhat over the past two years due to enrollment growth, improved state funding and effective expense control.

IMPROVED FUNDING ENVIRONMENT: Recent state funding increases add stability to UC's operating budget after significant cuts in prior years. UC has limited reliance on state support, as it accounts for less than 10% of operating revenues.

RATING SENSITIVITIES

SUSTAINED MARGIN IMPROVEMENT: The rating is sensitive to the University of California's (UC) continued ability to sustain operating improvement, with ongoing progress towards returning to a breakeven level of performance.

BALANCE SHEET PRESERVATION: Failure to maintain balance sheet liquidity, given the additional debt expected to be issued over the next few years, could pressure UC's rating.

STUDENT MIX: Current legislative efforts to further limit out-of-state student enrollment could affect UC's revenue flexibility over time. The rating is sensitive to UC's ability to manage any potential revenue declines associated with fewer out-of-state students that pay significantly higher tuition.

CREDIT PROFILE

Chartered in 1868, UC is a comprehensive research university with 10 campuses located throughout California (GOs 'A+') in Berkeley, Davis, Irvine, Los Angeles, Merced, Riverside, San Diego, Santa Barbara, Santa Cruz, and a graduate campus in San Francisco for health sciences. UC has five academic medical centers including 11 hospitals in connection with its six medical schools and other health science disciplines; four law schools; and a statewide agricultural and natural resources division. In addition, UC operates and manages a national laboratory under direct contract and is a member in joint ventures operating and managing two other national laboratories for the Department of Energy.

UC continues to benefit from an exceptional reputation, which drives strong student demand and selective admissions. Fiscal 2015 enrollment totaled approximately 250,000 full-time equivalent (FTE) students; applications to the university continue to grow, with over 206,000 applications received for fall 2016. Management reports that all nine undergraduate campuses saw gains in applications, ranging from 12% increases at both Berkeley and Los Angeles to a 29% increase at Merced over the past two years. The three largest schools by FTE in fiscal 2015 were UC Los Angeles, UC Berkeley and UC Davis.

UC's highly regarded medical centers have a combined total of 3,654 licensed beds with 3,264 available beds as of March 31, 2016. The five medical centers make up the fourth largest health delivery system in California and handle approximately 165,000 annual patient admissions.

OPERATIONS CONTINUE TO IMPROVE

UC's operating margin has improved over the past two years but remains negative on a full accrual basis. UC generated an operating margin of negative 2.7% in fiscal 2015, up from negative 3.7% in 2014 and approximately negative 9% in 2013. Improving operating results reflect growth in medical center revenues, increasing state support, continued enrollment growth and ongoing efforts to contain expenses. Fitch anticipates further incremental improvement toward balanced operations due in part to continued expense management.

The California Assembly recently passed AB 1711 which would limit the number of out-of-state students enrolled at UC, and the bill is expected to go to the Senate shortly. Fitch will monitor UC's efforts to mitigate the potential revenue decline, which if unabated, may negatively impact the rating and/or outlook. However, any enrollment cap would likely be phased in over a multi-year period, so it is anticipated that UC would have time to develop a strategy to make necessary adjustments.

FINANCIAL CUSHION OFFSETS DEFICIT OPERATIONS

UC maintains a solid financial cushion. Fitch believes its substantial balance sheet resources continue to support the rating and partially offset pressured operations and an increasing debt load. As of March 31, 2016, UC's three primary investment funds held assets of approximately $23.8 billion including $6.4 billion in the short-term investment pool (STIP), $8.7 billion in the total return investment pool (TRIP), and $8.7 billion in the general endowment pool (GEP).

Available funds (AF; defined as cash and investment less nonexpendable and certain expendable restricted net assets) were substantial at $20.5 billion as of June 30, 2015, up from $19.7 billion as of June 30, 2014. The 2015 AF level was equal to 69.6% of operating expenses ($29.46 billion) and 93.5% of pro forma debt ($21.93 billion, including operating leases and blended component unit debt).

THE MERCED PROJECT

Continued growth in student demand for a UC education has constrained the system's available capacity. In order to alleviate some of this stress, UC plans to finance expansion of the Merced campus over the next few years through a public-private partnership. This project will provide academic, residential and student life facilities, to be constructed and operated by a third party, that will accommodate 10,000 students by 2020. UC owns the land and the buildings to be constructed, and will issue bonds over the next few years for a total of $600 million. Upon completion, UC will make ongoing availability payments composed of payments for capital and operating expenses over approximately 35 years.

The developer will be selected in June and UC expects to move forward in the near term, with final design and approvals expected in July 2016.

UC'S ACADEMIC MEDICAL CENTERS

UC has the fourth largest health delivery system in California, with five medical centers (Davis, Irvine, Los Angeles, San Diego and San Francisco) that include 11 hospitals with approximately 165,000 patient admissions, and over 356,000 ER visits per year. Additionally, UC has a large health training program, with six medical schools that, collectively, educate nearly 50% of all medical students in California.

Key financial indicators remain steady. The operating margins, though relatively strong at each institution, did decline in 2015 over 2014 at all but Los Angeles and San Diego. Operating margins ranged from a low of 2.6% (San Francisco) to a high of 13% (San Diego), and days cash ranged from 53 (San Francisco) to 142 (Los Angeles).

In 2015, total discharges across the system grew by 3.5%. Average length of stay has remained relatively constant, at about 5.9, reflecting the high acuity level served by the UC Medical Centers (case mix index ranging between 1.73 at Davis to a high of 2.07 at San Francisco). Year over year, outpatient visits increased at each medical center, for an overall increase of 8.4%.

For the nine months ending March 31, 2016, the medical system utilization data show continued improvement versus the prior year. Patient days are up 5.3%, outpatient visits are up 8.7%, and total operating revenue up 8.5%.

Revenues pledged under the MCPRBs' indenture totaled $8.6 billion at June 30, 2014 and increased to $9.7 billion at June 30, 2015, comparing favorably to the level of MCPRBs outstanding at that time, at approximately $2.8 billion.

LIMITED PROJECT REVENUE BONDS

LPRBs are secured by specific project revenues. The projects associated with the 2016 bonds include student housing, faculty housing, athletic facilities, recreational, parking facilities, dining/food services facilities and other lease facilities and are located at nine of UC's campuses and the Lawrence Berkeley National Laboratory (LBNL). Parity LPRB projects consist of approximately 130 projects located on all of the campuses, the Office of the President and LBNL.

It is expected that once projects have been approved, and subsequently constructed, rates will be charged in an amount sufficient to operate and maintain the facility.

Over the period 2011 through 2014, according to data provided by UC, pledged revenues associated with the LPRBs have grown at a CAGR of 15.22%, and reached $1.24 billion in 2015. During the same period, maximum annual debt service (MADS) coverage has increased annually - reaching 5.2x in 2014. In fiscal 2015, coverage was 4.6x.

The pledged revenue streams associated with the LPRBs and MCPRBs support the respective debt service requirements. The fact that the Regents have the discretion to adjust the pledged revenue streams provides some coverage flexibility.

LEVERAGE GROWING, BUT MANAGEABLE

Pro forma debt of approximately $21.9 billion includes all GRBs, LPRBs, MCPRBs and $550 million of bonds expected to be issued through 2020 to fund the milestone payments associated with the UC Merced project. While the debt level continues to grow, it remains manageable at 4%.

The rating assumes that additional debt, some of which will fund revenue-generating projects, will be commensurate with an increase in available resources and further improvement in operations.

Fitch affirms the following outstanding long-term ratings:

--General Revenue Bonds at 'AA'

--Limited Project Revenue Bonds at 'AA-'

--Medical Center Pooled Revenue Bonds at 'AA-'

--California State-wide Communities Development Authority,

--Recovery Zone Economic Development Bonds (UC Merced Student --Housing Phase 4), 2010 Series A at 'AA'

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

Information has been provided by Barclays, as underwriter.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. College and University Rating Criteria (pub. 12 May 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=748013

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1006033

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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Joanne Ferrigan
Senior Director
+1-212-908-0723
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Tipper Austin
Associate Director
+1-212-908-9199
or
Committee Chairperson
James LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Joanne Ferrigan
Senior Director
+1-212-908-0723
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Tipper Austin
Associate Director
+1-212-908-9199
or
Committee Chairperson
James LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com