Washington Higher Education Facilities Authority Pacific Lutheran University; Private Coll/Univ - General Obligation Primary Credit Analyst: Margaret E McNamara (Pugh), New York (1) 212-438-2007; margaret.mcnamara@standardandpoors.com Secondary Contact: Shivani Singh, New York (1) 212-438-3120; shivani.singh@standardandpoors.com Table Of Contents Rationale Outlook Enterprise Profile Financial Profile Related Criteria And Research WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 21, 2015 1 1453813 301932398 Washington Higher Education Facilities Authority Pacific Lutheran University; Private Coll/Univ General Obligation Credit Profile Washington Hgr Ed Fac Auth, Washington Pacific Lutheran Univ, Washington Washington Hgr Ed Fac Auth (Pacific Lutheran Univ) rev bnds (Pacific Lutheran Univ) (Pacific Lutheran Univ Proj) ser 2014 due 05/01/2044 Long Term Rating BBB-/Negative Downgraded Washington Hgr Ed Fac Auth, Washington Washington Hgr Ed Fac Auth (Pacific Lutheran Univ)Series 2006 Unenhanced Rating BBB-(SPUR)/Negative Downgraded Many issues are enhanced by bond insurance. Rationale Standard & Poor's Ratings Services lowered to 'BBB-' from 'BBB' its underlying rating (SPUR) on Washington Higher Education Facilities Authority's series 2006 bonds, issued for Pacific Lutheran University (PLU). At the same time, we lowered to 'BBB-' from 'BBB' our long-term rating on the authority's series 2014 revenue bonds, issued for PLU. The outlook is negative. The downgrade reflects our view of PLU's weakened overall financial profile, characterized by continued operating deficits on a generally accepted accounting principle basis, as well as a decrease in financial resource ratios, particularly expendable resources relative to debt. The downgrade also reflects several years of enrollment and demand pressure, shown by decreasing headcount and freshman applications. The university was not in compliance with its covenanted liquidity ratio related to the series 2006 bonds in fiscal 2014 and it does not expect to be in compliance for fiscal 2015. According to bond documents that Standard & Poor's has reviewed, if the university is not compliant for two consecutive fiscal years, this will constitute an event of default under the loan agreement for the series 2006 bonds. If the violation continues for a period of 60 days after written notice has been given to the university, it could cause a full acceleration of the series 2006 bonds (about $54 million outstanding as of May 31, 2015), unless PLU is able to obtain a waiver from its bond insurer. Management has indicated that it is seeking a waiver from the bond insurer; however, it cannot officially request the waiver until its fiscal 2015 audit is finalized, which it expects to occur in October 2015. We understand that if the waiver is not granted, the university has identified adequate potential liquidity sources to meet any acceleration demand. The negative outlook reflects uncertainty surrounding the university's ability to successfully obtain a waiver from the WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 21, 2015 2 1453813 301932398 Washington Higher Education Facilities Authority Pacific Lutheran University; Private Coll/Univ - General Obligation bond insurer, and its ability to liquidate funds in a timely manner to meet a potential acceleration. If PLU were not able to obtain a waiver, and an acceleration of the series 2006 bonds is triggered--and the university is unable to liquidate funds to meet this acceleration in a timely manner--we could lower the rating further. Our review of the series 2006 and 2014 bond documents does not indicate any cross-default provisions. The rating reflects our view of PLU's following credit weaknesses: • Demand pressures associated with competition from public universities, as shown by recent enrollment decreases, although the 2015 incoming freshman class showed a sizable increase; • Low expendable resources and associated ratios that have further decreased during the past two years, partially mitigated by the fact that the university has increased its net property, plant, and equipment (PPE) through self-funding of projects; • Several years of operating deficits; and • A liquidity covenant violation in 2014--we note, however, that this did not trigger an event of default, and we understand that management expects to be in violation again in fiscal 2015 Offsetting those weaknesses include our view of the university's: • • • • Low post-issuance debt service burden of 3%; Endowment of $84 million, which is above-average for the rating category; Solid, although limited, niche market position; and Some improvement in demand and enrollment for fall 2015, with a larger entering freshman class and increased applications, though overall headcount is still down. As of fiscal year-end (May 31) 2014, the university had $54 million of debt outstanding, including a note. All debt is a general obligation of the university. Subsequent to the fiscal 2014 audit, the university issued $10 million in additional debt. The series 2014 debt is fixed rate with a 30-year maturity. Post-issuance, the debt service is level at about $4.3 million (maximum annual debt service) through 2037, after which it will drop to $1.5 million through 2045. The debt burden remains low, in our view, at 3%. We understand that PLU does not plan to issue additional debt in the near future. Outlook The negative outlook reflects the uncertainty surrounding the university's ability to obtain a waiver for the series 2006 debt. Should the university not obtain a waiver and the debt is accelerated, a lower rating is likely. Conversely, if the university is able to obtain the waiver, and improve and sustain acceptable financial resource levels within the two-year outlook period, we could revise the outlook to stable. Enterprise Profile The university PLU was founded in 1890 by Norwegian Lutherans from the Puget Sound region. The school became a four-year WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 21, 2015 3 1453813 301932398 Washington Higher Education Facilities Authority Pacific Lutheran University; Private Coll/Univ - General Obligation college in 1940 and achieved university status in 1960. Located seven miles south of Tacoma, PLU is principally an undergraduate institution and attracts students mainly from Washington and Oregon. PLU primarily competes with other regional private universities and state public universities like the University of Washington and Western Washington University. Management PLU is governed by a 36-member board of regents, half of whom are nominated through a corporation comprising delegates from the region's 630 Lutheran congregations. Management is strong, in our view, and includes an experienced and relatively stable leadership team. In June 2012 Thomas Krise was named the new president; President Krise was previously a dean at The University of the Pacific (in Stockton, Calif.). The university recently completed a plan that includes detailed strategies to foster enrollment growth and to improve financial and physical resources. We understand that there has been significant turnover in management over the past year; however, we view the changes favorably, as the members have made some positive changes in the organization. Demand After a brief period of stability, headcount has decreased steadily over the past three years, with a 5.4% decline in fall 2014 and 4% decline in fall 2015. The drop in headcount is due partly to smaller entering classes that did not replace larger graduating classes. We also note that the university faces significant competition from regional public universities. Management indicated the incoming freshman class has hit a five-year high, with about 644 freshmen expected for this fall. Currently, about 91% of students are undergraduates, although the university is looking to expand its graduate program. Applications from entering first-year students rose to 3,623 in fall 2015 after decreasing for two years. Management has bolstered recruitment efforts, including utilizing the school's radio station to market programs. PLU's acceptance rate decreased for fall 2015 slightly to 75%, which is about average for the rating category. The matriculation rate is in line with the rating at 22% (about the same as in fall 2014), from 45% eight years ago. The freshman-to-sophomore retention rate and student quality have fluctuated slightly but are relatively consistent with the rating. Financial Profile Operations The school is tuition dependent, with about 83% of revenue coming from tuition, fees, and associated auxiliary income. Tuition and fees are overall below those of other comparable private universities in the area, at $37,600 for fall 2015, which is a 4% increase from the previous year. The tuition discount rate for first-year students is what we consider high at 53%, where it will most likely remain for the next few years, according to management (this is 1% point lower than last year's). Net tuition revenue increased for the third year in a row despite enrollment pressure. The university generally draws 5% of its revenue from its endowment for operations. Operating performance has been very weak the past few years, with PLU reporting three consecutive years of sizable operating deficits. In fiscal 2014, PLU posted a $4.4 million operating deficit, compared with a $4 million deficit in WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 21, 2015 4 1453813 301932398 Washington Higher Education Facilities Authority Pacific Lutheran University; Private Coll/Univ - General Obligation fiscal 2013 and a $3.3 million deficit in fiscal 2012. In fiscal years 2014 and 2013, PLU had $10.5 million and $3.1 million, respectively, in net assets released from restrictions for capital, which we classify as non-operating revenue in our analysis. We understand that weak performance is largely due to expense pressures, but that recently the university initiated a right-sizing initiative resulting in the elimination of 20 faculty and 23 staff positions. As such, management expects to realize some expense savings in fiscal 2016. Although the fiscal 2015 audit is not closed yet, we understand that management expects another operating deficit similar to those of prior years. We note that 2015 performance includes about $1.9 million in non-occurring expenses; however, we still consider performance to be weak. The 2016 operating budget is balanced on a cash basis. Financial resources We consider the university's balance sheet ratios adequate for the 'BBB' rating category. Standard & Poor's calculates financial resource ratios using expendable resources (ER), which is calculated as the audited UNA (unrestricted net assets) adjusted for long-term debt, net plant and equipment, and temporarily restricted net assets. We note that the university has historically funded a significant portion of capital from operations, and as such its expendable resource ratios are somewhat deflated as a result of the calculation. For the fiscal year-end 2014, the college's ER were $13.5 million, equal to 8.8% of operating expenses and 20.7% of pro forma debt of $64.5. Ratios based on cash and investments at the same time were much stronger, although we note that much of that is restricted endowment. Cash and investments were $99 million, equal to 65.6% of operating expenses and 153% of pro forma debt. Endowment and fundraising As of fiscal year-end 2015 the endowment market value totaled $84 million, which we consider good for the rating. Investments are not as aggressive they have been in the past--as of the end of calendar 2015, the endowment had about 47% in equities, 21% in multi-strategies, 18% in real assets, and 14% in fixed income. Management has indicated that the portfolio has become more liquid, with 30% to 40% of investments available within 30 days. PLU went through two successful fundraising campaigns, with one completed most recently in 2012. The university raised $122 million, against an original goal of $100 million. We understand that the university is planning for a new seven-year campaign with a goal of up to $150 million. Management has indicated that the campaign will support capital, endowment growth, and scholarships. Pacific Lutheran University Financial Statistics Medians for 'BBB' rated private colleges and universities --Fiscal year ended May 31-2016 2015 2014 2013 2012 2014 Headcount 3,144 3,275 3,462 3,473 3,461 MNR Full-time equivalent 3,018 3,126 3,288 3,286 3,296 3,318 Freshman acceptance rate (%) 75.4 75.0 76.8 73.6 76.6 70.6 Freshman matriculation rate (%) 23.6 22.3 24.5 24.2 29.0 24.2 Undergraduates as a % of total enrollment (%) 90.3 90.4 90.8 91.2 92.3 74.5 Freshman retention (%) 84.0 82.0 84.0 82.8 81.9 78.0 Graduation rates (five years) (%) 67.0 68.0 65.5 67.7 67.5 59.5 Enrollment and demand WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 21, 2015 5 1453813 301932398 Washington Higher Education Facilities Authority Pacific Lutheran University; Private Coll/Univ - General Obligation Pacific Lutheran University Financial Statistics (cont.) Income statement Adjusted operating revenue ($000s) N.A. N.A. 146,891 141,680 138,298 MNR Adjusted operating expense ($000s) N.A. N.A. 151,329 145,681 141,598 MNR Net operating income ($000s) N.A. N.A. (4,438) (4,001) (3,300) MNR Net operating margin (%) N.A. N.A. (2.9) (2.8) (2.3) MNR Change in unrestricted net assets ($000s) N.A. N.A. 8,898 1,050 (5,987) MNR Tuition discount (%) N.A. N.A. 41.7 40.8 40.4 33.3 Tuition dependence (%) N.A. N.A. 76.8 76.1 74.0 MNR Student dependence (%) N.A. N.A. 88.6 88.5 86.9 MNR Research dependence (%) N.A. N.A. 2.1 1.5 1.7 MNR Endowment and investment income dependence (%) N.A. N.A. 2.6 2.5 2.7 MNR Outstanding debt ($000s) N.A. N.A. 54,576 55,855 57,072 55,019 Proposed debt ($000s) N.A. N.A. 10,000 N.A. N.A. MNR Total pro forma debt ($000s) N.A. N.A. 64,576 N.A. N.A. MNR Pro forma MADS N.A. N.A. 4,324 N.A. N.A. MNR Current debt service burden (%) N.A. N.A. 2.5 2.6 2.7 3.4 Current MADS burden (%) N.A. N.A. 2.5 2.6 2.7 MNR Pro forma MADS burden (%) N.A. N.A. 2.9 N.A. N.A. MNR Endowment market value ($000s) N.A. 79,585 84,365 79,586 71,803 64,256 Cash and investments ($000s) N.A. N.A. 99,200 100,254 97,384 MNR Unrestricted net assets ($000s) N.A. N.A. 70,471 61,573 60,523 MNR Expendable resources ($000s) N.A. N.A. 13,354 18,493 25,985 MNR Cash and investments to operations (%) N.A. N.A. 65.6 68.8 68.8 75.4 Cash and investments to debt (%) N.A. N.A. 181.8 179.5 170.6 151.7 Cash and investments to pro forma debt (%) N.A. N.A. 153.6 N.A. N.A. MNR Expendable resources to operations (%) N.A. N.A. 8.8 12.7 18.4 54.5 Expendable resources to debt (%) N.A. N.A. 24.5 33.1 45.5 88.8 Expendable resources to pro forma debt (%) N.A. N.A. 20.7 N.A. N.A. MNR Average age of plant (years) N.A. N.A. 18.2 19.8 19.0 12.8 Debt Financial resource ratios N.A--Not available. MNR--Median not reported. MADS--Maximum annual debt service. Total adjusted operating revenue = unrestricted revenue less realized and unrealized gains/losses and financial aid. Total adjusted operating expense = unrestricted expense plus financial aid expense. Net operating margin = 100*(net adjusted operating income/adjusted operating expense). Tuition dependence = 100*(gross tuition revenue/adjusted operating revenue). Current debt service burden = 100*(current debt service expense/adjusted operating expenses). Current MADS burden = 100*(maximum annual debt service expense/adjusted operating expenses). Cash and investments = cash + short-term & long-term investments Expendable resources = unrestricted net assets + temp. restricted net assets - (net PPE- outstanding debt). Average age of plant = accumulated depreciation/depreciation and amortization expense. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 21, 2015 6 1453813 301932398 Washington Higher Education Facilities Authority Pacific Lutheran University; Private Coll/Univ - General Obligation Related Criteria And Research Related Criteria • USPF Criteria: Higher Education, June 19, 2007 • USPF Criteria: Assigning Issue Credit Ratings Of Operating Entities, May 20, 2015 • Criteria: Use of CreditWatch And Outlooks, Sept. 14, 2009 WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 21, 2015 7 1453813 301932398 Copyright © 2015 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. 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