District Of Columbia Howard University; Private Coll/Univ - General Obligation

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1 June 9, 2009 District Of Columbia Howard University; Private Coll/Univ - General Obligation Primary Credit Analyst: Liz Sweeney, New York (1) ; liz_sweeney@standardandpoors.com Secondary Credit Analyst: Susan Carlson, Chicago 1 (312) ; susan_carlson@standardandpoors.com Table Of Contents Rationale Outlook Current Financial Challenges Howard University Hospital: A Key Strategic Challenge The University: Unique Position Enrollment And Demand: Good Profile Financial Resources, Endowment & Fundraising Debt And Swaps Related Research 1 Standard & Poor's. All rights reserved. No reprint or dissemination without S&P's permission. See Terms of Use/Disclaimer on the last page

2 District Of Columbia Howard University; Private Coll/Univ - General Obligation Credit Profile District of Columbia, District Of Columbia Howard Univ, District Of Columbia District of Columbia (Howard Univ) (wrap of insured) (AMBAC & BHAC) (SEC MKT) Unenhanced Rating A+(SPUR)/Negative Affirmed District of Columbia (Howard Univ) Unenhanced Rating A+(SPUR)/Negative Affirmed Long Term Rating A+/A-1/Watch Pos On CreditWatch Positive District of Columbia (Howard Univ) rev ref bnds ser 1998 Unenhanced Rating A+(SPUR)/Negative Affirmed Many issues are enhanced by bond insurance. Rationale Standard & Poor's Ratings Services revised its rating outlook to negative from stable on the District of Columbia's bonds issued for Howard University (Howard), reflecting operating losses, declining unrestricted resources and endowment, and long-term strategic challenges for Howard's hospital. At the same time, Standard & Poor's affirmed its 'A+' long-term rating and underlying ratings (SPURs) on Howard University's debt. Howard is currently struggling with operating losses at both the university and hospital, and although the hospital has made great strides this fiscal year in reversing its operating losses, the hospital remains a key strategic challenge due to its relatively small size, low acuity, and aging facility. Management reduced costs and enhanced revenue at the university for fiscal year 2009, although it still expects an operating loss. Key drivers of the rating over the next few years will be management's success in restoring operating balance, the resolution of the long-term questions about the hospital, and articulation of a long-term facilities plan and its financing sources. More specifically the rating reflects Howard's: Unique niche as one of two federally chartered higher education institutions, one of the most prestigious historically black colleges and universities in the U.S., and its impressive array of professional programs and research activity; Stable enrollment overall and a good demand profile; Substantial levels of federal operating support which, at $231 million in 2008, was 28% of adjusted operating revenues, although the appropriation has failed to grow in several years while the university's expense base has grown; Successful completion of its first major capital campaign in fiscal 2008, with a total of $276 million raised in the 10-year campaign; Standard & Poor s RatingsDirect June 9,

3 Endowment of approximately $380 million as of March 31, 2009; and A low debt burden of about 2.3% of revenue. Offsetting factors include: Negative operating performance, with an operating loss of $42 million in fiscal 2008 and with another deficit expected in 2009; Low levels of financial resources for the rating level, with $150 million of unrestricted resources as of June 30, 2008, equal to 79% of outstanding debt and 17% of expenses. Furthermore, unrestricted resources is expected to fall lower in fiscal 2009; and Operating deficits at the hospital in 2007 and 2008, although fiscal 2009 results for the first three quarters are break-even from operations. Howard University has $185 million of long-term bonds and notes; Standard & Poor's rates $167 million of those securities. Howard has two interest rate swaps, and a Debt Derivative Profile (DDP) score of '1.5' on a scale of '1' to '4', whereby '1' represents the lowest risk and '4' the highest, reflecting our view that the risk related to Howard's swaps is very low. Outlook The outlook is negative. If management can demonstrate continued and measurable progress toward achieving operating stability over the next one to two years, while articulating a strategic plan for the hospital and capital needs for the university as a whole that are consistent with the current rating, the outlook could return to stable. The rating will decline if student demand softens in this challenging economy, the operating gap remains sizable, or if capital needs, which are currently not clearly articulated, come into focus at a level that causes further pressure on debt ratios. Current Financial Challenges Howard's operations produced a $42 million deficit in fiscal 2008 (about 4.8% of expenses), compared with close to breakeven in fiscals 2006 and Contributing to the shortfall in fiscal 2008 was a $14 million operating loss at Howard University Hospital, the university's wholly owned acute-care facility. Other reasons include increased institutional support expense, which includes a number of recurring and nonrecurring items including re-engineering the finance office staffing in response to auditor comments, consulting fees related to restructuring of various departments, bad debt write-offs related to grants, and costs related to implementation of a new enterprise resource planning software system, among other smaller items. The bottom-line change in unrestricted net assets was negative $84 million in 2008, half due to the operating loss and the other half due to negative nonoperating income resulting largely from investment losses. Management expects that the operating loss will narrow to about $30 million for fiscal 2009, partly due to significant improvement at the hospital, which broke even from operations through March 31, Other improvement is due to nonrecurrence of some of the one-time items in 2008, as well as a number of management actions to control expenses, including a salary freeze for nonunion workers, staff furloughs, reduced overtime and travel expenses, and a reduction in part-time faculty, nonstaff-related savings including purchasing and utilities, and other activities. 3

4 Management is in the process of finalizing its budget for fiscal 2010 and expects to include a 7.5% increase in tuition for undergraduates, followed by larger increases in future years. Management also is in the process of doing programmatic reviews of certain academic programs to insure adequate demand and quality, and may make some changes over the next one or two academic years, although changes are not expected to be dramatic. The university also implemented an early retirement program, which 340 employees accepted, providing annual expense savings of $19 million for fiscal The university's revenue mix is a credit strength, with 2008 consolidated revenues including 28% federal appropriations (most of which is unrestricted), 27% tuition, fees and student charges, 32% hospital and patient income, 7.7% grants and gifts, and 0.8% endowment spending. Howard has a sustainable endowment-spending draw of 5% of the rolling three-year average of market value. The university's federal appropriation amount has been very stable in recent years and was $231 million in 2008, a $3 million decline from At this time, university management expects the 2010 appropriation to be flat. Although the stable and sizable federal appropriation is a positive credit factor, it has failed to grow in recent years and as expenditures have risen, Howard has struggled to maintain break-even operating results. About $30 million of the federal appropriation is designated for the hospital typically. Howard's tuition discount rate is moderate and stable at 28%. Howard University Hospital: A Key Strategic Challenge Howard University Hospital (HUH) is an acute-care facility that serves as a source of health care in the D.C. area where it is located, as well as a teaching and research facility serving the entire D.C. metropolitan area. There are 482 licensed beds, of which 274 are in service. The hospital serves as the principal clinical teaching site for the colleges of medicine and dentistry. Most of the hospital's facilities are located in a six-story structure that opened in HUH has significant capital needs, which are currently being studied. The hospital is relatively small for an academic medical center with about 13,000 admissions, and acuity is low, as evidenced by a 1.14 overall case mix. The payor mix is constrained, with Medicaid representing 55% of total hospital revenues. In the past two years, a whole new management team has been installed at the hospital, and significant improvements have been made in patient flow, admissions, and revenue cycle, all leading to a significant financial turnaround from a $14 million operating loss in fiscal 2008 to a projected $1 million gain in fiscal Still, a key challenge for hospital and university management will be to decide what to do to with the hospital facility, given its size and age, while maintaining the teaching programs of the health sciences departments. The University: Unique Position Howard, founded in 1867, is a comprehensive private university located in Washington, D.C., and is one of the leading African-American higher educational institutions in the U.S. The university offers a broad range of undergraduate, graduate, and professional programs, including law, business, medicine, dentistry, pharmacy, engineering, architecture, and a school of divinity. The university also owns and operates a teaching hospital, which in 2008 represented nearly 32% of consolidated operating revenue. Howard is one of only two non-military schools in the nation that are federally chartered (the other is Gallaudet University), and receives an ongoing direct appropriation from the federal government. Mandated by a 1928 congressional act, Howard's annual appropriation Standard & Poor s RatingsDirect June 9,

5 can be terminated only by an act of Congress. Howard also has a research presence, and recorded $39 million of research expenses in Enrollment And Demand: Good Profile Enrollment has been fairly stable in recent years, and the total headcount was 10,733 in fall Approximately two-thirds of Howard's students are undergraduates, and of those, about 93% attend on a full-time basis. Freshman demand, measured by the number of applications received, grew to a historical high of 9,750 applicants in fall 2008, a more than 38% increase from fall 2003 levels. Management attributes the increase primarily to marketing efforts, the ease of use of its updated online application process, and the university's strong reputation. However, applications statistics in general have been quite volatile, and it is unclear if Howard has experienced a sustainable increase in applications. For example, freshman applications grew 28% for fall 2008, after falling 12% for fall 2007 and falling 9% for fall 2006, so the 28% increase to 9,750 applications just brought the applicant pool a little above the fall 2005 level. Freshman selectivity is good with Howard accepting 48% of applicants in fall The matriculation rate has remained fairly stable, with 32%-35% of accepted freshman students choosing to attend Howard. Student quality is above average; with incoming freshman average SAT scores at 1,080 in fall 2008, compared with the national average of 1,020. Student tuition of $14,205 for the academic year ($22,446 including room and board) was well below that of other private institutions in the D.C. metropolitan area, granting Howard future flexibility in increasing revenues by raising tuition levels. Howard draws students primarily from Maryland, New York, and New Jersey, with the next largest cohorts being students from Georgia, Virginia, and California, and competes primarily with the large institutions in those states as well as the other historically black colleges and universities. Certain graduate and professional programs are experiencing softer demand, including business, engineering, and other graduate programs, as evidenced by declining application or enrollment. Given the volatile demand history, it isn't certain yet if the softer demand is representative of a long-term trend. Financial Resources, Endowment & Fundraising Unrestricted net assets of the university declined to $527 million in fiscal 2008 from $612 million in the previous year. Financial resource levels are extremely low for the 'A' category, with 2008 unrestricted resources of $150 million equal to 17% of operating expenses and 79% of outstanding debt. Howard's endowment had a market value of about $525 million as of June 30, 2008, was equal to a slim $51,631 per full-time equivalent student. Since June 30, 2008, endowment declined by 24% to $389 million as of March 31, The asset mix on March 31, 2009, was a conventional mix of 33% equity, 29% fixed income, and 38% alternative investments (hedge funds and venture capital). Howard has a manageable $62 million in remaining capital commitments to private equity investments. The university has been a solid fundraiser. Howard launched its first capital campaign in March 2002, and the campaign ended on Dec. 31, 2007, with $272 million, having exceeded its $250 million goal by more than $20 million. Howard will raise $12 million-13 million in its fiscal 2009 annual campaign. 5

6 Debt And Swaps Howard's outstanding debt is $185 million. Debt levels are manageable, with a relatively modest current debt service burden of about 2.3% of 2008 operating expenses. At this time, management does not have firm additional debt plans, and recent financial results has caused management to reconsider its needs. We expect that capital needs will be articulated over the next year or two. Of the $166 million of long-term bonds, all of which are rated, 75% is fixed rate, and 25% is in a variable-rate demand structure, backed by a letter of credit with Bank of America N.A., and is currently in a weekly mode. The variable-rate debt is synthetically fixed through an interest rate swap. Future capital plans will certainly include some facility improvements for HUH. A few years ago, Howard and the District of Columbia were working together on a plan to share the costs of a replacement hospital, but the district backed away from that plan in Since then, operating losses and management changes at the hospital have delayed long-term capital planning for the hospital, but that is expected to move to the front burner this year now that the hospital is stabilizing its operating performance and has new management in place. Substantially all full-time employees of the university participate in a noncontributory, defined benefit retirement plan. The plan was overfunded as of June 30, Howard has two interest-rate swap agreements with a total notional amount of $48 million with Goldman Sachs Mitsui Marine Derivative Products L.P. ('AAA/Negative') and Bank of America ('A+/Stable'). Both are floating- to fixed-rate swaps, with Howard receiving a percent of the LIBOR index and paying a fixed rate. The two swaps leave the university with no net variable-rate-debt exposure. Standard & Poor's assigned Howard a DDP overall score of '1.5' on a 4-point scale, with '1' representing the lowest risk and '4', the highest. The overall score reflects Standard & Poor's view that Howard's swaps reflect a very low risk at this time. Related Research USPF Criteria: "Higher Education," June 19, 2007 USPF Criteria: "Debt Derivative Profile Scores," March 27, 2006 USPF Criteria: "LOC-Backed Municipal Debt," July 2, 2007 Standard & Poor s RatingsDirect June 9,

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