CHICAGO--(BUSINESS WIRE)--Fitch Ratings has downgraded the rating on the series 2011 and 2013 revenue financing system (RFS) revenue bonds issued by Texas Public Finance Authority (TX) for Texas Southern University (TSU) to 'BBB' from 'BBB+'.
The Rating Outlook has been revised to Stable from Negative.
RFS debt is secured by pledged revenues, which include a broad mix of pledged tuition, auxiliary receipts, rentals, fees and other income from TSU. The RFS bond pledge specifically excludes state operating appropriations.
KEY RATING DRIVERS
STRESSED CREDIT CHARACTERISTICS: The downgrade is driven by very weak available funds ratios, a high 10% debt burden, two years of institutional coverage less than 1.0x, and expected budget stress in fiscal 2016 due to delayed dorm construction. The Stable Outlook is supported by operating and capital support from the state of Texas (rated 'AAA' by Fitch), a diverse revenue mix, and modestly improved fiscal 2014 operating results and enrollment.
ENROLLMENT PRESSURES CONTINUE: TSU's enrollment grew modestly in fall 2014 (up about 6%); although this only partially reversed the 9% decline in fall 2013 and remains well below historical levels. Students remain vulnerable to changes in federal PELL eligibility rules. Fall 2015 enrollment is yet to be determined.
HIGH DEBT BURDEN: TSU's high debt burden is only partially mitigated by a history of state debt service support for about 41% of outstanding debt.
LOW LIQUIDITY AND COVERAGE: TSU's very low available funds ratios add significant credit risk in conjunction with still negative GAAP operating performance. Institutional debt coverage has been below 1.0x in both fiscals 2014 and 2013.
ENROLLMENT AND OPERATING PERFORMANCE: Texas Southern University's failure to stabilize enrollment, grow net tuition revenue, and steadily progress to at least break-even operations on a full accrual basis may lead to a further negative rating action.
HIGH DEBT BURDEN: Any increase in debt without parallel growth in operating performance or available funds may trigger a negative rating action. Fitch considers debt supported by state tuition revenue bond (TRB) reimbursements as neutral and does not expect any credit impact from expected issuance of authorized TRBs.
LIQUIDITY CONCERNS: Failure to steadily improve available funds ratios and build working cash reserves over time may cause a negative rating action.
DEPENDENCE ON FEDERAL FUNDING PROGRAMS: TSU students are highly dependent on federal grants and loans to pay tuition; changes in program rules and regulations have greater effect on the university than many other institutions.
TSU is a public four-year university established in 1947, and is located on a campus approximately three miles from downtown Houston. TSU is one of the largest historically black colleges and universities (HBCU) in the U.S. The university serves a mix of undergraduate, graduate and professional schools. Most students commute or live off campus, as the university currently provides housing for less than 20% of its students. TSU offers professional programs in pharmacy, business and the Thurgood Marshall School of Law. In fall 2015, two new engineering degrees were offered.
TSU received a full 10-year accreditation with SACS, effective December 2011, following two probationary periods. A new management team and board were installed in 2007. There have subsequently been some key senior management team changes, which Fitch views positively. An interim provost was appointed from within the faculty in 2014, and in 2015 was permanently appointed to the position. A new CFO, E. Craig Ness, was hired in 2015 after a national search; Mr. Ness was previously at the University of Houston. The prior CFO retired.
Enrollment Pressures Remain
TSU's headcount (9,233) and FTE enrollment (8,229) both grew about 6% in fall 2014 (fiscal 2015), partially recovering from a 9% decline in fall 2013. Fitch views TSU enrollment as volatile and operating in a competitive market, even with strong high school demographics in Texas. For fall 2015 (fiscal 2016), management expects a modest increase in enrollment. Fitch views TSU students as sensitive to tuition increases and changes in Pell grant requirements. The university increased tuition in fall 2015 by about 7%, following a 3% increase in fall 2014.
The number of TSU new freshmen applications has grown, but that growth does not necessarily predict matriculating and persisting students. For the fall 2014 enrollment cycle, management tightened enrollment and budget assumptions, and enhanced recruitment and admissions activities. The entering fall 2014 freshman class met admissions targets, and was significantly larger, at 1,532, than prior classes (1,109 in fall 2013, and 1,354 in fall 2012). However, student quality remains below the national average, as are persistence and graduation rates.
Management expects modest enrollment growth in fall 2015, and conservatively is assuming no growth for budget purposes. Fitch considers TSU's enrollment volatility a significant credit issue, and will monitor actual enrollment results for fall 2015. Failure to grow net tuition revenue could stress an already tight budget and lead to negative rating action. Further pressuring the fiscal 2016 budget is a delay in opening a new housing project.
Most of TSU's students come from Texas and the competitive Houston region. Approximately 90% of students receive some type of financial grants, loans or aid. Because much of this aid is funded from federal programs, including Pell, program eligibility changes impact TSU more than many other institutions.
TSU's operating margin has been negative on a GAAP basis in the last two fiscal years; historically it has been closer to break-even. The margin for the fiscal year ending Aug. 31, 2014 improved slightly to negative 1.5%. Fitch believes this result demonstrates good financial management in light of enrollment declines, modest state appropriation cuts and significant expense constraints during the fiscal year. Operating margins in fiscal 2013 and 2012 were negative 2.6%, and positive 2.6%, respectively. Fitch expects at least balanced GAAP operating performance for public universities.
Fiscal 2015 budget expectations remain balanced at this time, according to management. Expense controls, including a hiring freeze, some lay-offs and no salary increases, continued into the year.
Fiscal 2016 operations are expected to be stressed by construction delays for a new dormitory. The delays are largely due to regional flooding in the spring of 2015. As a result, the facility will not open for fall 2015, and may not open until fall 2016. Debt service payments under the federal Department of Education loan, however, begin in fiscal 2016. Management reports that it has reserved the entire debt service amount for the fiscal year in the budget. Fitch views this as a prudent action.
TSU's revenue diversity is similar to other regional public universities. In fiscal 2014, about 31% of operating revenues came from the state, 35% from student revenues, and 25% from government scholarships and loans. TSU does not receive significant gift, research or endowment income. State appropriations from Texas are an important revenue source, and have been relatively flat. The fiscal 2016 appropriations is about $51.9 million, up slightly from $50 million in each of fiscal years 2015 and 2014, but down from $52 million in the 2012/2013 biennium years.
Weak Balance Sheet Ratios
Available funds, (AF; defined by Fitch as cash and investments less certain restricted net assets), declined to $22 million at Aug. 31, 2014, down from $32.5 million and $66 million in 2013 and 2012, respectively. This decline is due in part to expenditure of debt proceeds, as well as use of reserves for budgetary purposes. Fiscal 2014 AF ratios were very weak at only 11% relative to both operating expenses and outstanding debt. Fitch views these balance sheet ratios as low for the 'BBB' rating category.
TSU received state 'tuition revenue bond' (TRB) authorization for a $60 million library project in Texas' 2015 legislative session. The university would issue the debt as parity RFS bonds, and repay the debt service from annual state TRB reimbursements. These TRB reimbursements are not guaranteed by the state or pledged to bondholders; however the state has a history of making such payments. Debt related to the library project would lower the fiscal 2014 AF-to-debt ratio to an even weaker 8.4%.
High Debt Leverage
TSU's financial cushion provides very slim support for the university's high debt burden, volatile enrollment and flat-to-declining net tuition revenue. Fitch does not consider TSU to have any additional debt capacity at the current rating level, with the exception of the planned TRB-supported library project.
Outstanding debt at Aug. 31, 2014 was approximately $205 million, including RFS parity bonds, about $4 million of state-supported Higher Educational Assistance Fund bonds (HEAF) and two parity loans from the U.S. Department of Education's HBCU Capital Access Program. Approximately 41% of TSU's current obligations are state-designated TRBs.
Maximum annual debt service (MADS) of about $20 million in fiscal 2017 represented a high 10% of fiscal 2014 operating revenues. This debt burden excludes both maturing HEAF debt and expected debt for the $60 million library project. Fitch notes that TSU currently has a fixed-rate debt structure that is somewhat front-loaded and matures rapidly by 2034.
Outstanding debt includes a $55 million loan from the federal HBCU Capital Access Program to construct an 800-bed residential facility on TSU's campus. As discussed previously, completion was scheduled for fall 2015, but is delayed by weather to fiscal 2016. Management expects to draw down the entire $55 million loan authorization in fiscal 2016.
Additional information is available at 'www.fitchratings.com'.
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
U.S. College and University Rating Criteria (pub. 12 May 2014)
Dodd-Frank Rating Information Disclosure Form