U.S. PUBLIC FINANCE CREDIT OPINION 23 May 2016 Update University of Louisville Foundation, KY Rating Update - Moody’s Revises University of Louisville Foundation, KY’s Outlook to Negative; Aa3 Affirmed Summary Rating Rationale Moody’s Investors Service has affirmed the Aa3 rating on University of Louisville Foundation, KY’s (ULF) revenue bonds, including rated bonds guaranteed by the foundation. At the same time, we have revised the outlook to negative from stable. The foundation has approximately $200 million of debt outstanding, including debt guarantees. Contacts Mary Kay Cooney 212-553-7815 AVP-Analyst marykay.cooney@moodys.com Dennis M. Gephardt 212-553-7209 VP-Senior Credit Officer dennis.gephardt@moodys.com Diane F. Viacava 212-553-4734 VP-Sr Credit Officer diane.viacava@moodys.com The Aa3 reflects the close and longstanding relationship between the foundation and the University of Louisville (UofL, Aa3 stable). ULF serves strategically important roles of fund raising, endowment oversight, property acquisition and management, and research development activities. The rating also incorporates the foundation’s sizeable financial reserves. Offsetting challenges include exposure to operational risks and economic vulnerabilities related to the foundation’s mission, as well as heavy dependence on gifts and investment income. Recent market volatility and higher university funding needs have eroded liquidity from prior year highs, reducing financial resources to debt measures. The outlook revision to negative is driven by declining liquidity and financial reserves, and likelihood of muted financial resource growth given weaker expected market returns and ongoing university financial needs. The stagnant to declining financial reserves will weaken leverage measures especially when accounting for the foundation's sizeable debt guarantees. Credit Strengths » Strategic and long-standing relationship supporting the Aa3-rated University of Louisville » Sizeable financial resources of $768 million at fiscal end 2015 and liquidity (340 days cash on hand) to cushion expenses » Strong philanthropic support (ULF reported average of $142 million annually over fiscal 2011-15) Credit Challenges » Likely increased support needs to the university to offset state appropriation cuts and other financial pressures » Operational risk and economic vulnerabilities due to multiple managed enterprises and limited liability ventures MOODY'S INVESTORS SERVICE » Increasing financial leverage as debt including guarantees increases faster than financial reserves » High reliance on volatile gift revenue and investment income sources (five-year average of 52% and 33%, respectively, of Moody’s adjusted operating revenues) U.S. PUBLIC FINANCE Rating Outlook The outlook revision to negative reflects expectations of near term pressure on financial operations precipitated by rising and ongoing needs from the University of Louisville, and uncertain growth in foundation resources given higher than typical endowment spending rate and capital ambitions. Factors that Could Lead to an Upgrade » Substantial growth of foundation financial resources and liquidity, with limited material new debt » Improvement in the credit quality of the University of Louisville Factors that Could Lead to a Downgrade » Decline in credit quality of University of Louisville » Erosion of financial resources and liquidity » Additional borrowing without growth of financial resources and revenue for incremental debt service Key Indicators Exhibit 1 *Debt includes guaranteed obligations. Source: Moody's Investors Service Recent Developments Incorporated with Detailed Rating Considerations. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history. 2 23 May 2016 University of Louisville Foundation, KY: Rating Update - Moody’s Revises University of Louisville Foundation, KY’s Outlook to Negative; Aa3 Affirmed MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE Detailed Rating Considerations Market Profile: Essential Support Role to University of Louisville; Mission Includes Economic Development in Louisville Metro Area The University of Louisville Foundation will continue to have a vital role providing financial support to benefit the University of Louisville (UofL). The long-term credit health of UofL (fiscal 2015 Moody’s adjusted operating revenues of $933 million and 18,586 full-time equivalent (FTE) students in fall 2015) is closely tied to the financial performance of the foundation and its component units. ULF’s role as a public university foundation is more complex than some other rated public institution foundations. In addition to philanthropic support and oversight of the university’s endowment, the foundation also provides additional financial support to UofL academic and programmatic activities. In addition the foundation operates multiple real estate and commercial activities. These commercial ventures include certain student housing facilities (University of Louisville Housing, ULH), as well as investment in economic development at the university’s three research parks/campuses to bolster the university's economic development role. Operating Performance: Weaker Cash Flow Margins Reflect Growing University Support; Multi-Faceted Operations Add Complexity The foundation’s operations are adversely pressured by the university’s need for greater financial support, coupled with recent weak endowment returns including in fiscal 2015. The operating cash flow margin (Moody’s calculated) decreased to -0.3% and 3.5% in FYs 2014-15, respectively, from an average 13% over the FY 2011-13 period. ULF’s revenue sources ($116 million in fiscal 2015) remains concentrated in the more volatile gift (average FY 2011-15 average of 52%) and investment income (33% average) streams. Auxiliary enterprises (housing) have been a relatively stable component of revenues (6%). Favorably, other revenues, sourced from new real estate ventures are providing a growing share of revenue support (13% in FY 2015, up from 6% in FY 2011). The foundation’s endowment spending policy is higher than typical, with a 5.5% rate, though management continuously evaluates potential adjustments in spending rates. ULF’s operations at its three research park campuses aim to produce incremental revenue to assist university operations, as well as further strategic economic development and research activities for both UofL and the Louisville metropolitan area. The foundation established within each campus area a tax increment financing (TIF) district. Two of the research parks have met the development thresholds (Louisville Health and Life Science TIF in 2014 and Belknap Engineering and Applied Sciences Park TIF in 2012) and are generating incremental revenue (cumulative combined $15 million since 2012). The third, ShelbyHurst Research and Office Park TIF, has had three buildings constructed through joint venture partnerships, though has not yet reached its TIF activation threshold. Continued growth and revenue generation from these projects will serve to diversity the foundation’s heavy reliance on investment income. The foundation has strategic oversight for a meaningful component of the university’s housing facilities. ULF operates four student housing facilities for UofL (1,288 beds), which are all located on the university’s main campus. In November 2015, the foundation signed a lease agreement for a private-partnership mixed-use development with American Campus Communities (ACC) to design, build, finance and manage a 532-bed facility on campus-owned land. The facility (referred to as University Pointe) is expected to open for fall 2016. Inclusive of the ACC project, on-campus housing for UofL totals 3,086 beds. UofL also has affiliation agreements with five additional externally operated facilities (total of 3,530 beds). In all, university, foundation and off-campus agreements provide 6,930 beds for UofL students, representing roughly 30% of the 22,274 fall 2015 headcount enrollment. Combined on-campus housing occupancy was 100% in fall 2015. To date, the affiliation agreements and planned ACC partnership have not translated into financial risk to the foundation or university. Wealth and Liquidity: Stagnant Growth of Financial Resources and Weakening Liquidity The University of Louisville' Foundation’s financial reserves have been relatively stagnant for the past five years, recording a sizeable 13% decline from FY 2014-15, underpinning the outlook revision to negative. A combination of use of cash for strategic investments, weak investment returns, and continued investment in real estate ventures have caused the foundation’s financial resource growth to lag peers. Although the financial cushion to operating expenses is sound (2.7 times for fiscal 2015), this figure is substantially weaker than FY 2011 (4.2 times). 3 23 May 2016 University of Louisville Foundation, KY: Rating Update - Moody’s Revises University of Louisville Foundation, KY’s Outlook to Negative; Aa3 Affirmed MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE Management reports successful fundraising efforts, with $237 million in gifts during FY 2015. The last campaign for $1 billion was successfully completed in FY 2014. The ULF endowment pool, which is managed by the foundation with assistance of an external advisor, closed FY 2015 at $675 million, recording a -0.5% return for the fiscal year, below the NACUBO median return of 2.4%. Asset allocations among funds and managers is generally diverse, with the exception of two investment managers holding more than 10% of total assets, at 11.3% and 11.1%, respectively. At June 30, 2015, ULF reported $68 million in unfunded commitments. Fiscal year 2016 returns through the first eight months of the fiscal year are down 8.9%. LIQUIDITY The foundation has good liquidity with $109 million of monthly liquidity at fiscal end 2015 translating into 340 days cash on hand. However, this level is down significantly from the $163 million in FY 2014 (490 days cash on hand) due primarily to changes to strategic investment allocations to maximize long term returns on endowed assets. Further draws on liquidity to fund strategies, particularly in light of volatile market conditions, could negatively affect the foundation’s credit. Leverage: High Leverage Inclusive of Foundation Loan Guarantees; ULF Anticipates Non-Recourse Financings for Research Campus Development The foundation is highly leveraged when including the multiple loan and debt service guarantees provided for ULF, UofL and University of Louisville Physicians affiliates. Ongoing real estate development and joint venture partnerships that the foundation and its affiliates will enter are likely to involve foundation loan guarantees and will further increase leverage. ULF aims to limit future capital investments to non-recourse loans, and restructure or reduce current debt and guarantee agreements. We will continue to monitor the self-sustaining ability of these changes and their impact on the foundation's debt capacity. Total ULF direct debt and loan guarantees were $201 million at fiscal end 2015. Spendable cash and investments covered direct by 1.5 times. If excluding guarantees from debt, coverage was a stronger 4.0 times. Direct debt at FY-end 2015 included the Series 2013 taxable revenue bonds (Nucleus project) and associated new market tax credit loans (the NMTC loans are expected to be fully funded in fiscal 2020), Series 2005A and 2005B ULH revenue bonds, and a real estate note payable. The Series 2005A and 2005B bonds outstanding in the amount of $14 million at fiscal end 2015, were paid in full with foundation funds in July 2015 (FY 2016). Guaranteed loans and notes payable include: (1) the Series 2008A and 2008B mortgage revenue bonds ($46.8 million outstanding at fiscal end 2015) issued through the Metropolitan Government of Louisville on behalf of the University of Louisville’s Athletic Association (ULAA) and used for improvements to the university’s Papa John Football Stadium; (2) the Series 2009A and 2010A revenue bonds ($29.8 million outstanding at FY-end 2015) issued on behalf of the foundation’s ULH for certain residential housing facilities; (3) $19.5 million of notes payable by the KYT affiliated organization, (4) a $7.5 million line of credit for the ULP; and (5) multiple real estate LLCs and student organization loans $22.5 million. DEBT STRUCTURE The foundation’s direct and guaranteed debt is all fixed rate and amortizing, allowing for predictability in budgeting. DEBT-RELATED DERIVATIVES None. PENSIONS AND OPEB ULF has no direct exposure to defined benefit pension or OPEB plans. The foundation does not have employees. The university has relatively modest contingent liabilities compared to peers. UofL does not participate in a defined benefit pension plan, but does have an OPEB liability. The OPEB plan is funded on a pay-as-you-go basis. The plan is not funded, and had an accrued liability of $89 million as of FY 2015. Governance and Management: Multi-Faceted Mission Complements University Needs The University of Louisville Foundation will continue to benefit from its closely integrated governance and shared mission with the University of Louisville. Favorably, management has demonstrated an ability to develop alternative revenue streams from real estaterelated projects that tie university research needs and appeal to broader regional economic activity. Additionally, the success of the $1 billion capital campaign further demonstrates the foundation’s ability to successfully execute multi-year financial plans. Going forward, 4 23 May 2016 University of Louisville Foundation, KY: Rating Update - Moody’s Revises University of Louisville Foundation, KY’s Outlook to Negative; Aa3 Affirmed MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE management is currently evaluating strengthening the foundation and affiliated entities’ policies and procedures to enhance operating performance. In a broader effort, both the foundation and the university are engaged in improving financial controls. The importance of improved planning and financial control is increasingly pressing in light of the budgetary pressures owing to growing needs of UofL given its state funding shortfalls. The foundation is governed by a 15-member board of directors, with the president of the University of Louisville serving as the president of the foundation board, four board members from the university board of trustees, and ten at-large directors, all serving staggered three-year terms. A new CFO took over in FY 2015, moving from the university to the foundation, providing a stable transition for operations. Legal Security The Series 2013 taxable bonds are a general unsecured obligation of the foundation. The foundation provides unconditional guarantees for certain bonds issued on behalf of ULH and University of Louisville Athletic Association (ULAA). Given the limited revenues and assets of both ULH and ULAA, the ratings are based on the strength of the foundation and the individual guaranty agreements. The Series 2009A and 2010A bonds are a general obligation of ULH secured by a debt service reserve fund. As security for its obligation to make loan payments, ULH will deposit revenues with the trustee weekly. The loan agreement also contains financial covenants including a rate covenant to maintain minimum annual debt service of 1.1 times. The debt service coverage ratio was 1.26 times for the Series 2009A bonds and 1.47 times for the Series 2010A bonds. The bonds are further supported by an unconditional guaranty from the University of Louisville Foundation. The guaranty agreement for the ULH bonds requires the foundation to make payments to the trustee for principal and interest. If on the date that is eight calendar days prior to any payment date there are insufficient funds on deposit, the trustee shall immediately make demand on the guarantor (foundation), with payment required within two business days. The Series 2008A and 2008B issued through the Louisville and Jefferson County Metropolitan Government are a general obligation of ULAA (affiliate organization of the University of Louisville), with a first and prior lien upon the adjusted gross revenues of ULAA, a foreclosable mortgage lien and a security interest in all equipment and other tangible personal property, and a debt service reserve fund. The bonds are further supported by an unconditional guaranty from the University of Louisville Foundation. The guaranty agreement for the ULAA bonds requires the foundation to make payments to the trustee for principal and interest, and replenishment of the debt service reserve fund. If on the date that is four business days prior to any payment date there are insufficient funds on deposit, the trustee shall draw on the debt service reserve funds. Following a draw on the debt service reserve fund, ULAA is required to replenish within 24 hours. If not made with that time, the trustee is directed to notify the foundation of the deficiency and request payment, with payment required within two business days. Use of Proceeds Not applicable. Obligor Profile The University of Louisville Foundation is an independent not-for-profit organization, established in 1970, that supports the academic mission of the University of Louisville. ULF provides support for the university’s operating and capital needs through various activities, including fund raising, endowment oversight, and real estate management. ULF aims to be an economic innovator for the Louisville metropolitan area through its development activities on the university’s three campuses: Belknap main campus, Health Sciences Center in downtown Louisville, and the Shelby research park. Methodology The principal methodology used in this rating was Global Higher Education published in November 2015. Please see the Ratings Methodologies page on www.moodys.com for a copy of this methodology. 5 23 May 2016 University of Louisville Foundation, KY: Rating Update - Moody’s Revises University of Louisville Foundation, KY’s Outlook to Negative; Aa3 Affirmed MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE © 2016 Moody's Corporation, Moody's Investors Service, Inc., Moody's Analytics, Inc. and/or their licensors and affiliates (collectively, "MOODY'S"). All rights reserved. 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