Fitch Ratings assigns an 'AA' rating to the series 2011A fixed-rate general receipts bonds (taxable bonds) issued by the Ohio State University (OSU). The bonds are scheduled to price via negotiated sale the week of Oct. 17, 2011.
Proceeds of the bonds will fund a portion of costs related to ongoing capital plan projects, notably expansion of The Ohio State University Medical Center (OSUMC), student life facilities, utilities and campus infrastructure. The bonds will be issued as century bonds with a final maturity of June 1, 2111. Depending upon market conditions at the time of sale, the university plans to issue up to $500 million of series 2011A bonds.
In addition, Fitch affirms various OSU long-term and short-term ratings as detailed at the end of this press release.
The Rating Outlook is Stable.
SECURITY
General receipts bonds (GRBs) are secured by all unencumbered revenues of the main campus. While not formally pledged, the university receives a federal cash subsidy payment equal to 35% of interest payable on the fixed rate series 2010C bonds.
KEY RATING DRIVERS
Flagship Credit Characteristics: OSU's status as the state's flagship public university and premier research institution; its consistently positive financial performance, fueled by a fairly diverse revenue base; solid balance sheet resources and liquidity; and historically manageable debt burden underpin its 'AA' rating.
Internal Liquidity: The 'F1+' rating reflects OSU's ability to consistently meet the potential liquidity demands of its variable rate debt portfolio by a minimum of 1.25 (x).
Closely Managed Capital Plan: OSU continues to prudently implement and fund its $2.1 billion, multi-phased fiscal 2010-2015 capital plan; the bonds fund a portion of project costs slated for debt financing ($1.6 billion, approximately $893 million already funded).
Health System Financial Performance: The consistent profitability of The Ohio State OSUHS (OSUHS), the clinical care component of OSUMC and an integral part of the university, continues to be driven by healthy volume and utilization trends and favorable reimbursement rates with third party payors.
Muted State Funding Impact: OSU's more limited reliance on the state of Ohio (general obligation bonds rated 'AA+') for operating support makes it financially less vulnerable to reductions in state share of instruction and line item appropriations (collectively, state appropriations or aid).
CREDIT PROFILE
Ability to Manage Complex Capital Structure
OSU continues to leverage its fundamentally strong credit profile as it diversifies the type and duration of borrowings under its GRB program. After primarily issuing amortizing fixed and variable rate debt for many years, the university issued several series of GRB in fiscal 2010 that included large bullet maturities and back loaded amortization. The university's current GRB financing is structured as a 100-year century bond, with a single bullet payment of up to $500 million due in 100 years.
Fitch acknowledges that the university's increasing use of less traditional bond structures adds an element of risk previously not present in the credit. However, OSU's significant unencumbered reserves and superior market access help to mitigate at least some of the risk associated with a more aggressive debt profile. As specifically related to the century bond financing, Fitch viewed favorably the ability of senior financial leadership to communicate its rationale for the debt issuance and its plan to manage the borrowing on an annual basis.
In evaluating OSU's pro forma debt burden, Fitch excluded federal interest rate subsidy payments and amortized the large bullet maturities on outstanding fixed rate series 2010C ($75 million in fiscals 2030 and 2035) and variable rate series 2010E GRBs ($655 million in fiscal 2040) through their respective final maturities. For the century bond financing, Fitch amortized the bonds through fiscal 2040, which is the final maturity of all currently outstanding GRBs.
Under this approach, maximum annual debt service (MADS) equals $202.1 million (fiscal 2013), representing a manageable 4.4% of fiscal 2011 total operating revenues (unaudited). Pro forma MADS coverage would equal a solid 1.7 times (x), reflecting OSU's consistent ability to manage debt carrying charges from annual surpluses versus unrestricted reserves.
Capital Plan Progress
Following issuance of the bonds, OSU will have incurred much of the debt associated with fiscal 2010-2015 capital plan projects ($2.1 billion) originally targeted for ($1.6 billion) bond financing. Of the remaining $200 to $300 million of GRBs to be issued, the university expects to issue this debt over the next three fiscal years as amortizing obligations.
To date, capital plan projects, notably OSUMC's transformative expansion, formerly known as ProjectONE ($1.1 billion), has been progressing on budget and largely on-time. During late 2010, the university successfully secured a $100 million federal grant from the Health Resources and Service Administration. This grant will be applied by the university to build an additional floor dedicated to radiation oncology in the new OSU Cancer Care Center patient tower.
Integral Role of OSUHS
Clinical care revenues generated by OSUHS and a related non-profit physicians group represent OSU's primary source of funding (45.9% of fiscal 2011 total operating revenues, unaudited). While the level of revenue concentration in net patient care and faculty practice plan revenues exposes the university to the inherent volatility characteristic of the healthcare sector, OSUHS consistently generates strong operating margins and has improved its liquidity position.
During fiscal 2011, based upon unaudited financial data, OUHS' operating margin and operating EBITDA margin improved to 8% and 12.5%, respectively. Days cash on hand increased to 66.1 from 62.7. Outpatient visits to hospitals and clinics increased by 5.6% to just under 1.1 million, offsetting, to some extent, softening inpatient volumes associated with declines in elective surgeries.
OUHS continues to secure favorable reimbursement rates with managed care payors given the size and scope of its operation. However, in preparation for a potentially volatile reimbursement environment going forward, OUHS is budgeting for essentially no growth in rates under certain government contracts (e.g., Medicare). In addition, OUHS downsized the number of management level positions for a savings of approximately $50 million over the next several years. Fitch viewed these proactive initiatives favorably, noting the importance of profitable hospital operations to OSU's overall credit.
Impact of State Funding Cuts
As a percentage of total operating revenues, state appropriations to OSU have declined over the past five years; appropriations represented just 10.9% fiscal 2011 operating revenues (unaudited). Consequently, the university is far less vulnerable than its public university counterparts in the state and other states to reductions in aid. To date, funding cuts to higher education in Ohio have been completely offset by the use of federal stimulus funds available under the American Recovery and Reinvestment Act of 2009. However, as these funds have since been exhausted, public institutions are expecting a reduction in state operating support for fiscal 2012.
To manage an appropriation reduction of approximately 15.7% (Columbus campus only), OSU plans to raise in-state tuition and fees by the state approved maximum (3.5%); continue to grow both in-state and out-of-state enrollment levels; and aggressively pursue various non-core cost cutting initiatives (e.g., centralized purchasing) with defined savings thresholds.
Unlike many public universities, OSU is well positioned within its existing campus footprint to increase enrollment levels, particularly at Columbus, with several capital plan projects in progress to expand residence hall capacity. Over the next three years, the university plans to increase enrollment at Columbus by 2,200, with branch campus headcount slated for a more modest increase of 500. Continued favorable demand trends and competitive tuition and fee levels suggest these goals are achievable.
Positive Operations Fuel Resource Levels
OSU consistently generates a positive operating margin enabling it to steadily grow balance sheet resources. In addition to clinical care revenues discussed above, student related revenues, namely tuition and auxiliary receipts (21.1% of fiscal 2011 operating revenues, unaudited); and grants and contracts, including indirect cost recovery revenues (15.4%); represent significant sources of university funding.
During fiscal 2010, the university's operating margin equaled 1.9%, with unaudited financial statements for fiscal 2011 indicating a similar level of performance. Fiscal 2010 available funds, or cash and investments not restricted, increased to $2.1 billion, representing a solid 48.5% and 87.6% of fiscal 2010 operating expenditures ($4.3 billion) and pro forma GRBs ($2.4 billion), respectively. Available funds are expected to increase in fiscal 2011 as a result of the positive operating performance.
OSU's total investments, which include a portion of available funds, increased by approximately 23.9% between fiscals 2009 and 2010, to $2.5 billion. Unaudited financial statements indicate additional appreciation in total investments during fiscal 2011, to $3.1 billion. Approximately $550 million of this increase is attributable to unspent bond proceeds that will eventually fund capital plan projects.
Exposure to Financial Markets
As is the case with many well-endowed higher education institutions, OSU is somewhat vulnerable to volatility in global financial markets. Importantly, the university is not overly exposed to any single asset class, nor is it heavily reliant upon investment income to support operations. OSU's investment in less liquid alternative asset classes, including partnerships and hedge funds, represented 50.2% of total holdings as of June 30, 2010. These holdings are invested entirely in the university's long-term investment pool and are not a direct source of operating or debt liquidity.
Flagship Demand
Founded in 1870 as the Ohio Agricultural and Mechanical College, a land grant institution, OSU is one the 13 publicly supported state universities of higher education within Ohio. The university's main campus, which accounts for approximately 88% of total headcount, and houses the various hospitals comprising OSUHS and the medical center, is located in Columbus, the state capital. During fall 2011, the Columbus campus enrolled 57,725 students earning it distinction as the largest individual campus of any college or university in the United States. Similar to the demand profile of many flagship public universities, OSU has generally experienced rising application levels which have enabled it to implement more rigorous admissions standards, notably at Columbus, and tighten academic quality.
Fitch affirms the following ratings for OSU:
--$768 million fixed rate general receipts bonds at 'AA';
--$654.8 million fixed rate general receipts bonds, series 2010C (Federally Taxable Build America Bonds-Direct Payment) at 'AA';
--$469.7 million variable rate general receipts bonds at 'AA/F1+'.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Revenue Supported Rating Criteria', dated June 6, 2011;
--'U.S. College and University Rating Criteria', dated July 14, 2011;
--'Criteria for Assigning Short Term Ratings Based Upon Internal Liquidity', dated June 20, 2011.
Applicable Criteria and Related Research:
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637130
U.S. College and University Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=640830
Criteria for Assigning Short-Term Ratings Based on Internal Liquidity
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=637129
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