Fitch Rates University of Texas System's Ser 2016I Rev Financing System Refunding Bonds 'AAA'

CHICAGO--()--Fitch Ratings has assigned a 'AAA' rating to the $190 million Board of Regents of The University of Texas System (UTS) revenue financing system (RFS) refunding bonds, series 2016I (the bonds).

The bonds are expected to sell via negotiation the week of Oct. 24. Bond proceeds will refund certain outstanding RFS bonds for savings and pay issuance expenses.

The Rating Outlook is Stable.

SECURITY

RFS debt is secured by a lien on and pledge of all legally available revenues and fund balances of the UTS system. Specifically excluded from the pledge are state appropriations, the Available University Fund (related to Permanent University Fund [PUF] income), and the income or corpus of the Permanent Health Fund.

KEY RATING DRIVERS

STABLE CREDIT CHARACTERISTICS: The 'AAA' RFS rating is supported by the system's substantial resource base, positive operating history and coverage, revenue diversity, stable enrollment and program demand, and an experienced management team.

MANAGEABLE CAPITAL PLANS: UTS maintains adequate capacity to issue additional debt associated with its substantial capital improvement plan. The plan entails approximately $2.6 billion of PUF and RFS debt over six years; immediate plans include about $352 million of additional state-supported tuition revenue bonds (TRBs) later in calendar 2016. The system's debt burden remains moderate at 4.5% of operating revenue. Fiscal 2015 operations provided ample coverage of pro forma maximum annual debt service (MADS) at about 2.7x.

EXCEPTIONAL RESOURCE BASE: UTS benefits from substantial endowments, including a two-thirds share in the PUF. These endowments are not generally pledged to RFS bonds and are not included in balance sheet ratios. However, they provide significant university financial flexibility and balance sheet strength. Estimated market value of all UTS endowments at Aug. 31, 2016, including the PUF at $17.9 billion, was about $26.6 billion.

RATING SENSITIVITIES

MATERIAL CHANGE IN PERFORMANCE: Deterioration of The University of Texas System's operating performance, debt service coverage, or performance of its substantial healthcare operations, combined with a significantly weakened balance sheet, could pressure the RFS rating. Fitch views such changes as unlikely at this time.

CREDIT PROFILE

UT was established under the 1876 Texas Constitution. Its current eight academic institutions and six health care institutions are geographically dispersed throughout the state. The system enjoys strong and stable enrollment. System headcount is 228,539 in fall 2016 (preliminary) - about 3% more than the prior year. Most UTS growth occurs outside of the flagship Austin campus, which has been at capacity for many years.

UTS' growing medical schools and healthcare operations represented a significant 31% of fiscal 2015 operating revenues. Additionally, UTS benefits from a two-thirds share of the state-constitution established PUF, as well as other endowments. The market value is significant compared to most public universities; market value of all UTS endowments was $26 billion as of Aug. 31, 2015. At Aug. 31, 2016, the unaudited value was $26.6 billion.

SOLID OPERATING PERFORMANCE

The system consistently produces positive operating results, a solid balance sheet and stable enrollment, factors that Fitch considers consistent with its 'AAA' rating. UTS' fiscal 2015 operating surplus, as adjusted by Fitch, was a positive $596 million, an operating margin of 3.5%. Excluding $625 million of non-cash other post-employment benefit (OPEB) accruals, the margin would increase to about 7.2%. UTS management reports that the system expects to continue pay-as-you-go OPEB payments. Financial statements for the fiscal year ended Aug. 31, 2016 are not yet available.

The system benefits from broad revenue diversity. Fiscal 2015 operating revenues included healthcare (31.2%); grants and contracts (19.2%); net student revenues (12.5%); state appropriations (12.3%); and investment income (7.8%, as adjusted by Fitch). State operating appropriations increased in the 2014/2015 biennium, and increased another 11% for the current 2016/2017 biennium. State appropriations may pull back somewhat, as the state has directed its agencies to reduce their budget requests by 4% for the 2018/2019 biennium. Tuition increases have been modest system-wide for several years, including fall 2015, with a continued focus on student affordability. For fall 2016, the board approved modest increases that varied by system campus; UT-Austin's tuition increased by about 3%.

UTS' research presence remained strong in fiscal 2015 with $2.08 billion of related expenses, similar to fiscal 2013 even with federal sequestration constraining growth in research awards. Additionally, the system's sizable healthcare operations, as a whole, generate positive cash flow.

LOW DEBT BURDEN; SOLID COVERAGE

MADS on UTS' combined RFS, PUF and various lease obligations is about $731 million (due in 2018), equal to a moderate 4.5% of fiscal 2015 operating revenues. The system's sizeable operating base contributes to a relatively low debt burden. Additionally, about 31.2% of RFS debt service is eligible for TRB debt service reimbursement from the state.

Texas recently approved state capital funding in the form of TRB project authorizations, including a substantial $922 million for UTS. The unissued balance of $352 million TRBs are expected to be issued in calendar 2016. TRBs are issued as parity RFS debt, with related debt service reimbursed (but not pledged) by the state. Additionally, the system may issue various refunding bonds or permanently finance RFS commercial paper (CP).

Management expects to continue issuing certain RFS debt to support its extensive capital improvement plan (including TRBs) in the form of CP and then permanently finance it as long-term debt. The UTS board reduced its RFS CP authorization to $1.25 billion from $1.75 billion in August 2016. The plan calls for $6.3 billion of capital projects between 2017 and 2022, of which 59% has or will be debt funded; of that amount, almost half will be supported by state TRB payments or separately secured PUF bonds. UTS' self-supporting healthcare operations also support a large component of RFS debt service.

UTS produces solid annual operating cash flow, resulting in strong institutional debt service coverage. Net income available from operations in fiscal 2015 was 2.7x MADS of $751 million. When adjusted for non-cash OPEB accruals, MADS coverage would increase to about 3.5x.

BALANCE SHEET STRENGTH

Available funds (AF), defined by Fitch as cash and investments less certain restricted net assets, were $13.3 billion at Aug. 31, 2015. AF equaled 82% of operating expenses ($16.2 billion) and a stronger 122% of pro forma debt (about $10.9 billion). The liquidity-to-debt ratio is conservative, as it includes authorized but unissued CP. Fitch considers these ratios comparable to recent years, and consistent with the rating category.

The AF calculation excludes significant restricted endowments, including the PUF, which had a combined market value of about $26.6 billion at Aug. 31, 2016. The system's strong balance sheet cushion and revenue diversity support the 'AAA' rating.

Relevant Committee Date: Sept. 2, 2016

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

Applicable Criteria

Rating U.S. Public Finance Short-Term Debt (pub. 17 Nov 2015)
https://www.fitchratings.com/site/re/873508

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/site/re/750012

U.S. College and University Rating Criteria (pub. 12 May 2014)
https://www.fitchratings.com/site/re/748013

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Contacts

Fitch Ratings
Primary Analyst:
Susan Carlson, +1-312-368-2092
Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst:
Tipper Austin, +1-212-908-9199
Associate Director
or
Committee Chairperson:
Emily Wong, +1-415-732-5620
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com