Pennsylvania Higher Education Facility Authority Edinboro University Foundation; Auxiliary - System

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1 Pennsylvania Higher Education Facility Authority Edinboro University Foundation; Auxiliary - System Primary Credit Analyst: Jonathan W Volkmann, Boston (1) ; jonathan_volkmann@standardandpoors.com Secondary Contact: Carolyn McLean, New York (1) ; carolyn_mclean@standardandpoors.com Table Of Contents Rationale Outlook Enterprise Profile Financial Profile MARCH 1,

2 Pennsylvania Higher Education Facility Authority Edinboro University Foundation; Auxiliary - System Credit Profile Pennsylvania Hgr Ed Fac Auth, Pennsylvania Edinboro University Foundation, Pennsylvania Pennsylvania Hgr Ed Fac Auth (Edinboro University Foundation) Long Term Rating BB+/Stable Downgraded Rationale Standard & Poor's Ratings Services has lowered its long-term rating on the Pennsylvania Higher Education Facility Authority's series 2008 and 2010 revenue bonds issued for Edinboro University Foundation (EUF) to 'BB+' from 'BBB-'. At the same time, Standard & Poor's removed the rating from CreditWatch, where it had been placed with negative implications in January The outlook is stable. The downgrade reflects our view of EUF's projected fiscal year-end 2013 (June 30) operating results for its housing system, with weakened debt service coverage (DSC). The weak projected operating performance is due to both a flat housing fee rate from fiscal 2012 to fiscal 2013 and occupancy levels below management's projections. In addition, the downgrade reflects our view of decreasing enrollment and applications at the university, which have resulted in a decrease in dormitory occupancy for the academic year. Management has recently undertaken a number of initiatives to enhance future student recruitment, but efforts will not likely increase enrollment for the fall 2013 semester. We believe these characteristics are more in line with a non-investment-grade rating at this time. Management is not expecting to violate its 1.2x annual DSC covenant, but the covenanted calculation does not include subordinated operating expenses, which Standard & Poor's includes in its calculation. According to management's current projections, DSC will total roughly 1.00x for fiscal 2013, inclusive of all operating expenses; prior to subordinated expenses, it is projected at 1.26x. Management had been projecting DSC of 0.96x, inclusive of all operating expenses, but the university agreed to absorb $300,000 in various expenses into its budget which had previously been charged to the foundation. While we view the university's willingness to absorb expenses of the foundation into its budget as a positive credit factor, we also recognize that the university has limited financial resources and may not be able to provide such support in the future. Combined occupancy for phase I and phase II totaled 97.1% for the fall 2012 semester and 88.8% for the spring 2013 semester, resulting in total occupancy of 92.9% for fiscal In our view, an annual occupancy rate of 92.9%, which results in DSC of roughly 1.00x, represents a limited level of flexibility. MARCH 1,

3 Although management expects break-even operations, it reports that, in the event of a deficit, it has roughly $1 million combined in operating and repair and replacement reserves it can draw on to cover the deficit. These reserves are voluntary and are not required in the bond documents. Required debt service reserve funds for each series of bonds also exist and total a combined $8.5 million. The long-term rating reflects our assessment of Managements projection of roughly 1.00x DSC for the housing system in fiscal 2013, (including all operating expenses for phase II); projected DSC is 1.26x if operating expenses are subordinated; Below-target occupancy rates in fiscal 2013, with 93% annual occupancy at phases I and II, below managements projection of 97%; Weakening demographics in the state of Pennsylvania, which have contributed to enrollment decreases of 4.4% and 9.7%, respectively, in falls 2011 and 2012 at the university; Significant $115.9 million debt load (as of June 30, 2012) for a small foundation (founded in 1998) that acts as a supporting organization to a rural public institution; and Weak annual DSC covenant which does not include all operating expenses of both phases of the Highlands in its 1.2x calculation. We believe the following factors partially offset the credit weaknesses: Strong connectivity between the university and the state system as Edinboro is one of 14 state-owned institutions in the Pennsylvania system of higher education, which requires this method of financing; The importance of the replacement housing provided by the system, as much of the university's housing stock was originally constructed in the 1960s and 1970s, and only a modest level of renovations had been performed since that time; Good connectivity among the university, foundation, and system -- the university, which has both a freshmen residency requirement and a sophomore residency requirement (as of fall 2012), manages the system and actively markets the new housing under a cooperation agreement between the foundation and the university and demonstrated support of the housing system by the university in fiscal 2013; and Some adequate security features, including a debt service reserve fund, 1.2x additional bonds test, capital and operating reserves, and property insurance and business interruption. The foundation used both bond series to finance a 1,643-bed student housing development (the Highlands) on the EU campus. The series 2010 bonds represented phase II of a new housing system (847 beds) on campus. Phase I (796 beds) was funded with the series 2008 bond proceeds and was completed in fall Fall 2011 was the first semester in which both phases were operational. The series are on parity under the same indenture and are secured by the revenues of the new housing system only. The bonds are nonrecourse obligations of the foundation, payable solely from revenues of the system, funds under the trust estate, and any funds made available in connection with the trustee's assignment of various contract documents. Outlook The stable outlook reflects our expectation that DSC (including all operating expenses) will remain at or above 1x for fiscal We expect that, through a combination of increased rental rates and various expense-reducing measures, MARCH 1,

4 DSC (including all operating expenses) will be at least break-even for fiscal While enrollment could continue to fluctuate, we expect that demand for the housing project will remain at or above current levels. Credit factors that could lead to a negative rating action during the two-year outlook period include DSC (including all operating expenses) below 1x for fiscal years 2013 or In addition, further decreases in Highlands occupancy could also result in a negative rating action. We do not expect a positive rating action during the outlook period, but credit factors which could lead to one beyond the outlook period could include improved occupancy at the Highlands, which results in sustained DSC (including all operating expenses) of at least 1.2x. Enterprise Profile Highlands Housing System The foundation housing system, consisting of phase I (796 beds) and phase II (843), represents about 63% of 2,598 total available beds at the university. The new system is about 94% replacement housing; about 100 additional beds were created with the construction of phase II. Management reports that an additional 50 beds will be coming off line in fall 2013, which will result in a total of 2,548 available beds at the university. In fall 2011, the first year of operation for the phase II residence halls, combined occupancy for phases I and II totaled 97.7%, and existing university-owned housing was 81% occupied. In the fall of 2012, combined occupancy for phases I and II totaled 97.1%, and existing university-owned housing was 72.1% occupied. In the spring 2013 semester, combined occupancy for both phases decreased to 88.8%, while occupancy at the existing university-owned housing decreased to 66%. Annual occupancy at the Highlands, which totaled 93% for fiscal 2013, was initially projected at 97%. In addition to below-target occupancy rates, the foundation kept housing fees flat from fiscal 2012 to fiscal 2013, reflecting affordability concerns of many of the students at EU. The lack of a fee increase, when combined with lower-than-expected occupancy, contributed to the Highlands deficit and weak projected DSC in fiscal Management plans to increase housing fees in fiscal Housing system DSC Fiscal 2013 will be the first full year of operations that includes both phases I and II where DSC is not supported by capitalized interest. The university has pledged to subordinate the reimbursement of all operating expenses for phase II to the payment of debt service, while only indirect expenses of phase I are subordinated to debt service; however, we calculate the DSC inclusive of all indirect and direct operating expenses. Management had budgeted for fiscal 2013 rental revenues of roughly $11.9 million, based on 97% annual occupancy. Management has since revised its fiscal 2013 budget to reflect annual occupancy of 93% and now expects rental revenues of roughly $11.5 million. Based on management's current projection for fiscal 2013, DSC for the system is expected to total approximately 1.00x, inclusive of all operating expenses; prior to subordinated expenses, it is projected at 1.26x. Debt service for the combined system bonds totaled $7.61 million in fiscal 2013 and will increase gradually until 2018, when it will level off at about $8.4 million. MARCH 1,

5 University enrollment and demand Full-time equivalent (FTE) enrollment at EU has decreased for the past two academic years and is currently at its lowest since the fall 2008 semester. For fall 2012, it was 6,384, down 10.5% from 7,130 in fall University headcount enrollment has also decreased over the same period, totaling 7,462 in fall 2012, down 13.7% from 8,642 in the fall of Management credits the decrease in enrollment to declining demographics across the state of Pennsylvania and specifically the markets from which they draw the majority of their students. Management has indicated a number of initiatives to increase enrollment, including expansion into new recruiting markets, increasing the number of scholarships offered, and the addition of multiple "academic success coordinators" responsible for increasing student retention. Despite its efforts, management is projecting flat to decreasing enrollment for the fall 2013 semester, but expects enrollment to begin to rebound over the next two to three years. The university competes with both public and private institutions. Public competition includes other Pennsylvania State System of Higher Education institutions, including Clarion State and Slippery Rock universities, both also in western Pennsylvania and have newly constructed housing projects on or near their campuses. A branch campus of the Pennsylvania State University is within 20 miles of Edinboro. Private institutions that compete with the university include Mercyhurst College and Gannon University, both in Erie, approximately 20 miles away. Tuition at EU also remains competitive. For the academic year, the university's undergraduate tuition for Pennsylvania resident students was $6,428. Financial Profile EU financial profile The university's revenue base is fairly diverse, with 2012 adjusted operating revenues, which totaled $116 million, comprising net tuition and fees (35.4%), state aid (21.8%), federal and state grants (20.1%), and auxiliary income (14.5%). State appropriations in Pennsylvania tend to be cyclical -- they declined between fiscal years 2001 and 2004, increased between fiscal years 2005 and 2008, and have generally decreased since fiscal In fiscal 2012, state appropriations totaled $25.3 million, down from $27.1 million in fiscal Management reports that state appropriations remained flat in fiscal Operating performance for EU (again, excluding housing project operations) was balanced on a full accrual basis in fiscal 2012 following negative operations from fiscal years 2007 through Operating results have typically been positive on a cash basis and in fiscal 2012, were a positive $9.0 million before depreciation expense of about $8.4 million. University management reports that while tuition and fee revenue will decrease in fiscal 2013 as a result of the university's enrollment troubles, it has taken measures to reduce expenses to offset this shortfall in revenue. Management also reports that the effects those measures will have on fiscal 2013 operations is not known and thus management cannot predict the operational outcome for fiscal 2013 at this time. Recognition of significant other postemployment benefit (OPEB) liabilities at their total value on EU's balance sheet have weakened the university's financial resources. Total net assets for EU as of June 30, 2012, were $14.9 million, of which a negative $17.2 million was unrestricted. Our adjusted 2012 unrestricted net asset (UNA) calculation adds back the $59.8 million long-term OPEB liability and credits the foundation's $2.0 million UNA. The university had $ MARCH 1,

6 million of outstanding debt at fiscal year-end Combining outstanding university debt with housing system debt leads to total debt outstanding of about $152 million. The adjusted university UNA of $44.4 million equaled an improved 39% of fiscal 2012 operating expenses and 29% of outstanding debt, when including the foundation's housing system debt. Bond provisions The authority loaned the bond proceeds to the foundation to finance the construction of 1,643 beds on the Edinboro campus. A leasehold mortgage and security agreement and assignment of a ground lease between the university and the foundation is additional security for bondholders to supplement a pledge of the Highlands system revenues. The Highlands is part of the university's comprehensive housing plan, which seeks to attract and retain students by providing improved housing options. As part of the plan, several residence halls were demolished and replaced with the phases I and II housing. The university has a cooperation agreement with the foundation to strengthen demand for the foundation housing system. Per the agreement, on-campus beds (including the system) will not, in aggregate, exceed 87% of on-campus leased beds in the previous year. The university has pledged to remove additional university-owned beds if needed to satisfy the agreement. However, if the beds which would have been removed to meet the 87% agreement are fully leased by students, the university may keep them online for that semester. The university, which already had a freshman residency requirement, implemented a sophomore residency requirement at the start of the fall 2012 semester. The bond trustee does not have recourse against any of the foundation's assets for the payment of debt service beyond the foundation's interest in the system. However, the trustee does have recourse for the benefit of the bondholders through the following key security features: A mortgage that grants the trustee a first-priority mortgage lien on the foundation's leasehold interest in the real property on which the system sits; A revenue pledge associated with the project; The cooperation agreement between the foundation and the university; The management agreement; and Other contracts and agreements entered into by the foundation in connection with the project. The university collects all housing rental payments as manager, and transmits revenues to the trustee monthly. In the event of nonpayment by a student, the university puts a "hold" on the student's file, preventing issuance of transcripts, diplomas, and registration for classes in the following semester. The bond indenture provides for the creation of certain funds that compose the trust estate, which is assigned to the trustee as additional security for the bonds. The trust estate includes a debt service reserve fund, an operating reserve, and a capital reserve ($200 per bed, per year). Various insurance policies, including property and business-interruption coverage, are required. The presence of the aforementioned security features support the investment-grade rating of the series 2008 and 2010 bonds. RELATED CRITERIA AND RESEARCH MARCH 1,

7 USPF Criteria: Higher Education, June 19, MARCH 1,

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