Fitch Downgrades Upper Iowa University's Revs to 'BB'; Outlook Negative
CHICAGO--(BUSINESS WIRE)--Fitch Ratings has downgraded its rating to 'BB' from 'BBB' on $66.48 million of private college facility (PCF) revenue bonds, series 2010 and 2012, issued by the Iowa Higher Education Loan Authority (IHELA) on behalf of Upper Iowa University (UIU).
The Rating Outlook remains Negative.
The series 2010 and 2012 bonds are general obligations of the university, payable from all legally available resources. The 2012 bonds are further secured by a first mortgage lien on two dormitory buildings. Both issues have a debt service reserve fund. See discussion of bond covenants below.
KEY RATING DRIVERS
OPERATING DEFICITS DRIVE DOWNGRADE: The downgrade reflects a fiscal 2013 operating deficit considerably weaker than earlier projections, and Maximum Annual Debt Service (MADS) coverage well below the 1.25x coverage covenant. Continued operating stress is expected in the current fiscal 2014.
SIGNIFICANT UNCERTAINTY SUPPORTS NEGATIVE OUTLOOK: Financial performance in fiscal years 2014 and 2015, and the extent to which sufficient progress can be made to meet the coverage covenant, remain uncertain. While total enrollment appears to be relatively steady, an important credit factor given UIU's high tuition dependence, the extent to which UIU can manage expenses without adversely impacting student demand remains to be determined.
SLIM BALANCE SHEET: UIU's balance sheet ratios remain low relative to the 'BBB' rating category, and more consistent with the 'BB' category. In past years, Fitch considered these low liquidity ratios counterbalanced by previously strong operating performance.
HIGH DEBT BURDEN: Fitch considers UIU's 9% MADS burden high to moderately high, particularly given recent negative operating performance. UIU management reports no new long-term debt plans at this time.
MANAGEMENT TURN-OVER: Fitch views significant management turnover as negatively impacting UIU's response to recent operating deficits: a new president started in 2013; a new CFO started in January 2014; there is currently an interim provost; and a new director of admissions started in mid-2013.
FAILURE TO REVERSE DEFICITS OR MEET BOND COVENANTS: Failure to show steady progress in returning to balanced operations and meeting bond covenants - particularly the 1.25x annual coverage covenant within the required time frame (failure to do so would trigger an event of default under the loan agreement) - would result in further negative rating action.
ADDITIONAL DEBT ISSUANCE: Issuance of additional debt prior to stabilized financial operations, or without an increase in resources, would result in a negative rating action.
MANAGE EXPENSES AND ENROLLMENT: UIU's ability over time to manage expenses, grow net tuition revenue, and maintain stable to growing enrollment would be viewed favorably, and could support a return to a Stable Outlook.
UIU was founded in 1857 in Fayette, Iowa. Fayette is located in north central Iowa, about 37 miles northeast of Waterloo and 65 miles north of Cedar Rapids. The university offers both undergraduate and graduate level programming at its residential Fayette campus, 20 educational extension centers in the Midwest, six international centers in two countries, and a distance education center.
UIU's multiple education markets have been viewed favorably in the past by Fitch but are subject to significant competition. This is particularly apparent as the non-traditional on-line and distance programs (about 70% of total operating revenue) are subsidizing full-time undergraduate students. Students attending on-line or at various regional centers have six distinct entry points during each academic year, allowing two full-credit courses over an eight-week term, and some student flexibility. Full-time students at the Fayette Campus have a more traditional two-semester calendar (although the semester is broken into two terms).
UIU reported an $8.2 million operating deficit for the fiscal year ended June 30, 2013 (a negative 15.6% operating margin), which is much larger than expected, and follows a fiscal 2012 deficit of $1.9 million or negative 4.1%. UIU experienced significant management turnover in calendar 2013, which Fitch views as limiting the institution's timely response to operating deficits. However, a new president and CFO are now in place, and the institution is actively engaged in strategic and long-range financial planning. UIU staff reports that the university's new senior management is focused on improving the financial situation. However, budget stress is expected to continue in fiscal 2014. The recent deficits contrast with UIU's average operating surplus of 5.8% in the prior five fiscal years (2007 - 2011).
UIU's revenues are heavily student-fee oriented (96% in fiscal 2013), and even with some enrollment fluctuation have been relatively flat in recent years. However, operating expenses increased at near double-digit levels in each of the last three years, including 9.2% in fiscal 2013, strongly contributing to deficit operations. Fitch views net tuition revenue growth for the traditional full-time Fayette campus students as limited by very high discount rates (in excess of 58% the last two years, and up again in fiscal 2014), and an implicit subsidy of approximately $6 million from the on-line and academic center programs.
A partial contributor to recent deficits is a transition to a more centralized enrollment process starting in fall 2012, and modestly increasing depreciation expense (up about $1.3 million since fiscal 2010). UIU's operating budget does not include depreciation expense or an equivalent line item. UIU reports that over 87% of faculty are part-time and non-tenured, which provides some expense flexibility.
Pressured Debt Service Coverage:
MADS ($4.7 million) coverage was very weak in fiscal 2012 at 0.6X and due to the deficit position, MADS coverage in its entirety could not be met in fiscal 2013. Coverage in 2013 was supported by unencumbered financial resources, without drawing on the debt service reserve.
These levels are well below the 1.25x annual coverage covenant which became effective in fiscal 2013. UIU's fiscal 2013 debt service was $3.7 million, which increases to $4.29 million for 2014 and 2015, and levels out at $4.74 million thereafter. Failure to achieve the coverage covenant is not initially an event of default under the loan agreement but will be in the second full fiscal year following receipt of a consultant report. This could be the end of fiscal 2015 or 2016, depending on when the consultant is retained. See 'High Debt Leverage', below.
Fiscal 2014 Budget Pressures
The fiscal 2014 current fund budget is balanced on a cash basis. However, due to recent operating results, essentially flat overall enrollment, and limited net revenue growth potential from traditional full-time students, achievement of balanced operations and positive debt service coverage remains uncertain. Fitch anticipates fiscal 2014 to again have deficit GAAP results. UIU management reports that the fiscal 2015 budget is under development, a financial consultant is being hired, and that long-term financial projections are not currently available. Expense constraints are continuing; the university stopped its optional employer contribution to the retirement plan for fiscal 2014, for a savings of about $1 million, and is limiting new-employee and staff hires.
Weak Balance Sheet Ratios
UIU's available funds (defined by Fitch as cash and investments less permanently restricted net assets) was $10.9 million at the end of fiscal 2013. This equaled a slim 18% of expenses and 14.2% of debt, levels that are more comparable to the 'BB' rating category for private universities. As part of the available funds calculation, Fitch notes that unrestricted endowment of $3.7 million at June 30, 2013 is quite low compared to peer private institutions.
UIU experienced significant management turn-over in calendar 2013, which Fitch views as a major factor limiting timely response to operating deficits. A new president started in early 2013; a new CFO started in January 2014 (following several months with an interim CFO); there is currently an interim provost; and a new director of admissions started in mid-2013.
Overall FTE enrollment has fluctuated over the last five academic years, but even with a 7% decline in fall 2012 (fiscal 2013) to 5,139, is not inconsistent with historical levels. Fall 2013 enrollment rebounded slightly to 5,327 (up 3.7%) in fall 2013 (fiscal 2014). Most of the fluctuation in the last two years was in non-traditional undergraduate enrollment, counterbalanced somewhat by non-traditional graduate enrollment growth.
Non-traditional students (both on-line and at 20 U.S. academic centers and several international centers) have multiple entry points in UIU's academic calendar, making full-year revenue projections difficult. UIU operations rely heavily on non-traditional student revenue which is subject to significant competition. Further, most full-time undergraduates come from Iowa which has declining numbers of high school students. Fitch believes the burden in the medium term for UIU's financial turn-around will largely come from the non-traditional programs.
High Debt Leverage
Outstanding debt, principally the series 2010 and 2012 revenue bonds, totaled $66.48 million at June 30, 2013. This debt is all fixed rate, with increasing debt service through 2016 and essentially level debt service thereafter. UIU has $10 million in operating leases, primarily related to its various academic sites, which Fitch includes in its long-term debt calculation. The university had a $1 million bank line, with no draws, at the end of fiscal 2013. Early in fiscal 2014, the line was increased to $2 million for working cash, and currently has a $1.5 million draw.
Bond covenants include 1.25x annual debt service coverage, which was not met in 2013 (the year the covenant became effective), and an unrestricted net asset test of 25% of outstanding debt, which was achieved in 2013. Failure to achieve pledged coverage is not an immediate event of default under the loan agreement. UIU is required to hire a consultant, and is in the process of doing so. The university is required to achieve pledged coverage within one full fiscal year after the consultant issues recommendations. This could be fiscal 2015 or 2016, depending on the timing of the consultant report. If the 1.25x coverage test is not achieved in the required time, it becomes an event of default. Fitch considers the covenant risk significant, and an indication that UIU's credit quality is not presently investment grade.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria and Related Research:
--'Fitch Rates Upper Iowa University Revs 'BBB'; Outlook Negative' (January 2013);
--'U.S. College and University Rating Criteria' (May 2013).
Applicable Criteria and Related Research:
U.S. College and University Rating Criteria