Fitch Rates Louisiana State University's Sr. 2016A&B Lease Revs 'A'; Downgrades Aux. Revs to 'A+'

NEW YORK--()--Fitch Ratings has assigned an 'A' rating to approximately $216 million of lease revenue bonds, series 2016A, and approximately $8.5 million of lease revenue bonds, series 2016B (taxable), issued by the Louisiana Public Facilities Authority (the authority) for the benefit of Louisiana State University and Agricultural and Mechanical College (LSU).

The fixed-rate bonds are expected to price via negotiation on or about Sept. 14. Bond proceeds will finance the demolition of existing housing facilities and the construction and equipping of a mixed-use development known as Nicholson Gateway and a student housing facility known as Spruce Hall; pay capitalized interest through Jan. 1, 2019; pay a capitalized ground sublease and additional working capital; and pay the costs of issuance.

In addition, Fitch has downgraded the rating on LSU's approximately $419 million outstanding auxiliary revenue bonds to 'A+' from 'AA-'.

The Rating Outlook is Stable.

SECURITY

The lease revenue bonds are limited obligations of the Authority with LSU's obligation to pay base rental and any additional rental solely from LSU's gross auxiliary revenues. Lease rental payments are subordinate to debt service of LSU's outstanding auxiliary revenue bonds. The lease revenue bonds are secured by a mortgage on the project. A portion of proceeds will pay capitalized interest on lease revenue bonds through Jan. 1, 2019.

LSU's outstanding auxiliary revenue bonds are limited obligations of LSU, secured by and payable from a pledge of gross auxiliary revenues. Auxiliary revenues are primarily derived from athletics, housing, parking and transportation, the student union, student health center, and university stores, although athletics and housing make up about three-quarters of the total.

KEY RATING DRIVERS

AUXILIARY COVERAGE PRESSURED: The rating downgrade on auxiliary revenue bonds is driven by a significant increase in LSU's debt position from these $224 million series 2016A&B bonds, which may pressure debt service coverage of the overall auxiliary revenue system.

SUBORDINATE LEASE OBLIGATIONS: The lease revenue bonds are subordinate to the university's auxiliary revenue bond gross pledge, resulting in a rating differentiation.

HISTORICALLY STEADY DEMAND: LSU's position as the state flagship institution for higher education and research has driven steady student demand resulting in auxiliary revenue growth and consistently solid coverage of auxiliary-related debt service. Although not presently a concern for LSU, Fitch will monitor how August 2016 flooding in Baton Rouge affects fall 2016 enrollment.

UNIVERSITY CREDIT PROFILE: The university's fairly diverse revenue base, stable enrollment, adequate financial cushion, and manageable debt burden for the rating category provide some stability. However, consistently declining state funding contributes to negative operating margins on a full accrual basis. (Louisiana GOs are rated 'AA-' with a Stable Rating Outlook).

RATING SENSITIVITIES

DEMAND FLUCTUATIONS: Material enrollment declines that affect Louisiana State University and Agricultural and Mechanical College's ability to generate solid system auxiliary revenue bond coverage) could lead to further rating pressure. Support for auxiliary enterprise-related debt service relies on stable enrollment.

LSU CREDIT STRENGTH: Continued operating deficits or a material increase in debt could negatively affect the auxiliary revenue and lease revenue bond ratings over time, given the interrelationship to the university's overall credit profile.

COMPLETION RISK: The university's ratings may be pressured if project construction is not on schedule. Liquidated damages provisions and fully-capitalized interest through January 2019 mitigate some completion risk.

CREDIT PROFILE

Founded in 1853 and located in Baton Rouge, LSU is the flagship campus of the Louisiana State University System. The university is comprised of 14 colleges and institutions offering 72 bachelors, 70 masters, 46 doctoral, veterinary medicine, and law degree programs. LSU is accredited by the South Association of Colleges and Schools (SACS), having been last reaccredited in 2015 for 10 years.

Steady headcount enrollment growth by 9.6% over the past six years to 31,527 in fall 2015 supports system operations, particularly as the state continues to reduce financial support. Freshman acceptance and matriculation rates are stable at about 77% and 42%, respectively. Graduate enrollment, too, is steady. Fitch will monitor how the historic flooding in Baton Rouge during August 2016 ultimately affects fall 2016 enrollment.

AUXILIARY COVERAGE PRESSURED

LSU's auxiliary enterprise revenues have historically generated solid coverage of related debt service. Gross auxiliary revenues totaling $222 million in fiscal 2015 covered pro forma maximum annual debt service (MADS) of $32.3 million (i.e. the senior lien auxiliary revenue bonds only) by a strong 6.9x. Coverage on an economic basis using net auxiliary revenues of $56.8 million resulted in still sound coverage of 1.8x. Moreover, auxiliary revenues in fiscal 2015 increased by 9.2% over the prior year, largely as a result of enrollment growth.

However, the additional leverage as a result of series 2016 ($224 million) places stress on LSU's auxiliary operations. Fitch is no longer confident that auxiliary revenues would grow commensurate with the debt. The rating downgrade is supported by the effect of the series 2016 issuance, and the incurrence of additional debt without a commensurate increase in available financial resources could adversely pressure LSU's ratings on outstanding bonds.

Projections provided by management reflect that gross auxiliary revenues will conservatively grow at 3% annually. Financial covenants for the auxiliary revenue bonds include sum-sufficient rate covenant and a 1.75x additional bonds test over the two prior years.

LEASE OBLIGATIONS CHARACTERISTICS

Per series 2016 bond documents, LSU is obligated to make payments solely from auxiliary revenues, provided, however, such payments are subordinate and junior in all respects to the payment of debt service requirements and the pledge of auxiliary revenues as security for the outstanding auxiliary revenue bonds. Financial covenants for the lease revenue bonds include a 1.00x rate covenant, a 1.75x additional bonds test, and a provision that new, non-refunding debt under the indenture shall be subordinate and junior to outstanding auxiliary revenue bonds.

Under the terms of the lease, LSU must secure and maintain insurance for repair and full replacement of facilities in event of loss or damage by certain events (including flooding) and business interruption for a minimum of 12 months coverage. In addition, interest is fully capitalized through Jan. 1, 2019 and the project developer is subject to liquidated damages provisions.

Positively, the lease is not subject to state appropriations; and, the lease term matches the 40-year maturity on the bonds. The nature of the subordinate obligation to pay LSU's lease obligations on the university's gross auxiliary revenues supports the differentiation with Fitch's rating on outstanding auxiliary revenue bonds.

Pro forma MADS ($46 million, including auxiliary revenue bonds and lease revenue bonds) represents a moderate 5.3% of fiscal 2015 operating revenues. Gross auxiliary revenues in fiscal 2015 covered pro forma MADS (reflecting the lease revenue bonds) by a strong 5.1x. Coverage on an economic basis using net auxiliary revenues of resulted in still sound coverage of 1.3x.

LSU'S FINANCIAL PROFILE

LSU's revenue base is fairly diverse, as expected of a flagship public university. Student-generated revenues (tuition, fees, and auxiliary revenues) represent the largest funding source at 58% of fiscal 2015 operating revenues, up from 55% in fiscal 2014. Grants and contracts and state appropriations represent the second and third largest funding sources at 18.6% and 15.3%, respectively.

LSU's operating margin on a GAAP-basis remains negative, despite the strength of its pledged auxiliary revenues. The margin was -6.5% in fiscal 2015, following -2.1% in fiscal 2014, -3.2% in fiscal 2013, and -3.5% in fiscal 2012. Management reports that fiscal 2015 operating results include an increase in non-cash OPEB liability and non-cash gifts reported as expenses. However, the university's balance sheet provides adequate cushion to manage unexpected revenue reductions or increased costs.

LSU has a history of managing an extended period of state funding reductions through tuition and fee increases, expense controls, and continued enrollment growth. LSU's state general fund appropriations have decreased annually since January 2009. In addition, state funding for student grants (Taylor Opportunity Program for Students) has declined, which may affect enrollment going forward.

Available funds, defined by Fitch as cash and investments less nonexpendable (and certain expendable) restricted net assets, increased 19.4% over the prior year to $530 million at June 30, 2015. Available funds covered fiscal 2015 operating expenses ($881 million) and pro forma debt ($680 million) by 60.1% and 77.9%, respectively.

Pro forma debt includes the series 2016 lease revenue bonds, outstanding auxiliary revenue bonds (all issued as fully amortizing fixed-rate debt), capital leases, and non-cancellable operating leases. LSU may issue additional debt for its auxiliary projects in the next few years. At that time, Fitch will determine the impact of new issuances on auxiliary revenues.

Additional Disclosures: Fitch's rating relies on certain information provided by RBC Capital Markets, LLC, acting as underwriter.

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

Applicable Criteria
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

Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1011133
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1011133
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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
Sahil Khera
Analyst
+1-212-908-0868
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Joanne Ferrigan
Senior Director
+1-212-908-0723
or
Committee Chairperson
James LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations
Hannah James, New York, + 1 646-582-4947
hannah.james@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Sahil Khera
Analyst
+1-212-908-0868
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Joanne Ferrigan
Senior Director
+1-212-908-0723
or
Committee Chairperson
James LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations
Hannah James, New York, + 1 646-582-4947
hannah.james@fitchratings.com