Fitch Rates University of Massachusetts $305MM Series 2014 Project Revs 'AA'; Outlook Stable

Fitch Ratings assigns an 'AA' rating to the following bonds to be issued by the University of Massachusetts Building Authority (UMBA) on behalf of the University of Massachusetts (UMass):

--$300 million project revenue bonds senior series 2014-1 (tax-exempt);

--$5 million project revenue bonds senior series 2014-2 (federally taxable).

The bonds are expected to sell via negotiated sale during the week of Feb. 4. Proceeds of the senior series 2014-1 and 2014-2 bonds will be used to finance capital projects and to pay capitalized interest.

At the same time, Fitch affirms various long-term and short-term ratings detailed at the end of this rating action commentary.

The Rating Outlook is Stable.

SECURITY

The UMBA project revenue bonds are secured by a pledge of gross unrestricted revenue of the university and all other legally available funds.

KEY RATING DRIVERS

STABLE CREDIT CHARACTERISTICS: The 'AA' rating reflects the university's historically positive operating performance, with growth in student-generated revenues and proactive expense management efforts driving both financial performance and growing balance sheet resources which are still modest relative to debt.

FAVORABLE DEMAND PROFILE: UMass continues to exhibit enrollment-related revenue growth supported by strong freshmen matriculation and affordability. Increased higher education funding from the commonwealth, under a new funding model approved for fiscal 2014, allowed the university to freeze tuition and mandatory fees for all in-state undergraduate students in fall 2013.

INCREASING BUT MANAGEABLE LEVERAGE: UMass' leverage is expected to remain moderately high under its substantial five-year capital plan. Debt levels are closely monitored by management to ensure compliance with UMass' debt policy of maintaining debt service-to-total expenditures of no more than 10%. Current levels remain manageable given the university's steady financial performance.

RATING SENSITIVITIES

INCREASED FINANCIAL LEVERAGE: Failure of UMass to grow operating revenues, despite any decline in research related activity, and balance sheet resources to support increasing debt levels may yield negative rating pressure.

MARGIN DETERIORATION: Generation of significant or sustained operating deficits could cause a negative rating action.

CREDIT PROFILE

The university was established in 1863 and encompasses five separate campuses at Amherst, Boston, Dartmouth, Lowell and Worcester in the commonwealth. In fall 2013, the university enrolled 61,381 full-time equivalent (FTE) students. The five campuses are geographically dispersed throughout the commonwealth and possess unique and complementary missions. In addition, UMass has system-wide online education, which in fiscal 2013 offered approximately 1,500 online and blended courses.

REDUCED APPROPRIATIONS IN DOWNTURN; INCREASES IN RECOVERY

The university's fiscal 2013 operating margin is positive at 1.7%, compared to 2.0% in fiscal 2012. However, more favorable results were achieved in prior years (average margins prior to fiscal 2011 were above 3.0%). Narrowing results are partly due to reductions in federal stimulus and commonwealth of Massachusetts (GOs rated 'AA+' by Fitch) appropriations. In fiscal 2013, lower than projected research grants contributed to the decline. UMass received $150.6 million in federal stimulus funding in fiscal 2010, in addition to state appropriations, compared to $37.9 million in fiscal 2011 and received no stimulus funds in fiscals 2012 or 2013. Further, commonwealth appropriations, sharply declining in fiscal 2012, were essentially flat in fiscal 2013. This is largely the result of the commonwealth's implementation of a mid-year emergency 9C reduction of 1% ($4.2 million) after the governor released a plan to close a projected budget shortfall. Other financial pressures at the federal and state levels were demonstrated by lower than budgeted grant revenue, including a 7.2% or approximately $1 million cut to the university's Build America Bonds (BABs) subsidy for debt service. In response, each campus positioned itself to implement the necessary cost efficiencies. The university's fiscal 2014 budget conservatively reflects breakeven operating results.

The university anticipates growth in state appropriations to $552 million in fiscal 2014, compared to $519 million received in fiscal 2013. The commonwealth's adopted fiscal 2014 budget approved the first year of a plan to increase public higher education funding. This increase in appropriations allowed the university to freeze annual tuition and mandatory fees for in-state undergraduates in fall 2013. While the fiscal 2015 budget has not yet been adopted, the commonwealth has indicated its support of the plan for a second year according to the university. Fitch views the commonwealth's demonstrated support for the first year of the plan as a positive development which should continue to help alleviate fiscal pressures at the university level if the plan is adopted for a second year.

PROACTIVE FISCAL MANAGEMENT

The university managed state aid cuts in fiscal 2012 and fiscal 2013 with a 7.5% and 4.9% increase in mandatory tuition and fees, respectively, and some growth in enrollment, without requiring significant reductions in core academic and student services. With increased support from the commonwealth under the 50/50 funding proposal and as adopted in the fiscal 2014 budget on July 12, 2013, annual tuition and mandatory fees for undergraduate resident students were frozen for fall 2013 (or fiscal 2014) at fiscal 2013 levels. The formula resulted in the commonwealth paying 50% of education costs, replacing the revenues that would have been generated from an additional 4.9% mandatory tuition and fee increase that the university had approved as a contingency.

Fitch views management's careful planning favorably with the approved increase in mandatory fees intended to be used only as a backstop in the event the increase in commonwealth support did not materialize in the final fiscal 2014 budget. The university has already positioned the board for a 5% tuition increase as a backstop in the event the commonwealth does not approve the increased appropriation level in fiscal 2015.

FAVORABLE DEMAND TRENDS

Demand continues to rise as demonstrated by 1.6% growth in total headcount enrollment in fall 2013, which is in-line with prior year growth. Fitch notes that this is slightly below the 2% budgeted growth, in part due to fewer than expected transfers, but offset with strong growth in freshmen matriculation which grew 3.5%, compared to flat growth in the prior year.

Overall, fall 2013 FTE growth of 1.7% is slightly better than 1.4% growth in fall 2012, but is slightly slower than prior years. Between fall 2009 and fall 2013, FTE compounded average annual growth at UMass' five campuses was 2.4%. Fitch views favorably the university's ability to increase freshmen enrollment, which is a testament to its high-quality programs and affordability, versus the more costly private alternatives, and particularly impressive, as high school demographics in the northeast are declining.

According to management, the university has invested in faculty and physical plant to support enrollment growth and boost quality across all degree programs. UMass has plans to grow enrollment 13.5% to 70,110 FTEs by fiscal 2017.

STRATEGIC INVESTMENT PLAN SUPPORTS GROWTH

Strategic investments (new programs, aid packages, capital) are expected to continue to support enrollment growth and retention at each of the five campuses. Each campus will be required to use its own dedicated reserves to support its long-term capital plans. Management views this prudent one-time use of reserves as a strategic investment in campus-wide growth, providing new facilities, upgrades to labs, classrooms and technology. Further, the university is expanding research capacity to generate alternative revenue through federal, state, and private grants and contracts.

The university's increased focus on life sciences research is reflected in the growth of sponsored research and development funding in recent years. Research is largely federally funded (65%) and commonwealth funded (13%). However, research funding in fiscal 2013 was below estimates at $512.4 million, and is down from $536 million in fiscal 2012. This decline is attributable to cuts in federal funding. As is the case with most public research institutions, a reduction in federal funding for these programs was anticipated. However, the university projects research and development funding to grow 18% to $605 million by fiscal 2018, which is still lower than prior estimates provided to Fitch.

UMass expects the effort by the commonwealth to increase its competitive position in the life sciences industry to provide the university with significant capital investments in collaborative facilities and funding for programs. The commonwealth recently approved a $95 million life science grant for Amherst which is expected to be distributed over the next three fiscal years. Fitch will continue to monitor if increased levels of sponsored research and development funding can be achieved as projected given the current environment and the potential impact on financial performance.

SUBSTANTIAL CAPITAL PLAN

UMass plans to move forward with its updated five-year capital improvement plan (CIP) approved by the board in September 2013. The $5.5 billion five-year plan (fiscal years 2014-2018) includes $3.8 billion of approved projects expected over the next 24 months across the various campuses. The majority of the approved projects, approximately $1.8 billion, will be debt funded, with approximately $1 billion of this total already borrowed. After the current series 2014 bond issue, UMass anticipates issuing another $600 million in each of fiscals 2015 and 2016 which is expected to fund student life projects across UMass campuses. The remainder of the approved projects under the capital plan will be funded by state capital support ($898 million), federal funding and private funding ($94 million) and university local funding ($382 million). The final $600 million of projects are contingent on funding sources.

In fiscal 2013, the commonwealth provided $113 million in capital support, slightly below the $120 million anticipated, but capital support is expected to increase to approximately $140 million in fiscal 2014 under the higher education bond bill. Under this bill, the commonwealth maintains the commitment, under legislative approval, to fund $1 billion of the university's capital projects through fiscal 2018. Fitch views UMass' capital plans over the next five years as aggressive but manageable. The increasing capital support from the commonwealth is viewed favorably by Fitch, recognizing that this level of support may continue to fluctuate.

DEBT BURDEN MODERATELY HIGH

UMass' debt burden remains moderately high, with pro forma maximum annual debt service (MADS) consuming 7.7% of fiscal 2013 operating revenues, excluding the BABs subsidy, which is offset somewhat by sound pro forma MADS coverage of 1.5x. As mentioned earlier, an additional $600 million anticipated to be issued in two installments in fiscals 2015 and 2016 increases the pro forma MADS burden to nearly 8.9% of fiscal 2013 operating revenues, assuming pro forma MADS of $245.7 million in fiscal 2016 under the multi-year plan presented to Fitch.

Fitch notes the higher debt burden is not atypical of a flagship public institution and five-campus system and has a diverse source of revenue to support the increasing debt. Further, Fitch views UMass' debt management track record favorably. Importantly, UMass' CIP is flexible; future debt can be structured and the MADS calculation adjusted if it were to become too high. Fitch believes the university's conservative budgeting practices, which include a debt policy to maintain the debt burden below 10%, and a board policy of 8%, coupled with growth in enrollment-related revenue, will contribute to maintaining healthy debt coverage levels.

Fitch has also affirmed the following:

--$2.1 billion of UMBA project revenue, refunding revenue, and taxable refunding revenue, senior series bonds (excludes commonwealth-guaranteed bonds) at 'AA';

--$326 million Massachusetts Development Finance Authority (MDFA) revenue bonds (Worcester City Campus Corporation Issue - UMass project) and MHEFA (UMass issue) revenue bonds at 'AA';

--$200 million UMBA tax-exempt and taxable commercial paper (CP) bank notes at 'AA';

--$20 million MHEFA variable rate demand bonds (VRDBs) series A (UMass issue) at 'AA'/'F1+'.

The 'F1+' rating on the MHEFA VRDBs series A (UMass issue) is based on the availability of highly liquid, highly rated securities to cover potential maximum liquidity demands presented by UMass' outstanding variable rate debt portfolio. At Dec. 31, 2013, UMass' liquid assets totaled $562.3 million. After Fitch discounts based on maturity and asset type, these assets covered UMass' liquidity demands presented by its outstanding variable rate debt portfolio by a robust 28.1x. Including UMass' $100 million of bonds issued in a variable rate Window Bond mode, whose liquidity is guaranteed by the commonwealth, coverage declines but is still strong at 4.69x. For an 'F1+' rating, Fitch typically expects coverage of at least 1.25x. Fitch excluded the maximum CP authorization in its calculation, since it is not supported by self-liquidity. However, UMass' self-liquidity would still be sufficient at 1.76x coverage, including the CP program.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Revenue Supported Rating Criteria' (June 3, 2013);

--'U.S. College and University Rating Criteria' (May 10, 2013);

--'Criteria for Assigning Short-Term Ratings Based on Internal Liquidity' (June 13, 2013);

--'Fitch Rates University of Massachusetts Series 2013 Revs 'AA'; Outlook Stable' (July 2013).

Applicable Criteria and Related Research:

Fitch Internal Liquidity Worksheet
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710906

U.S. College and University Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708049

Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499

Additional Disclosure

Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=816992

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