Fitch Upgrades CDFI Phase I, LLC's (TN) Sr. Revs to 'BBB' & Sub Revs to 'BBB-'; Outlook to Stable

Fitch Ratings has upgraded the long-term rating to 'BBB' from 'BBB-', on approximately $60.89 million of outstanding Health, Educational and Housing Facility Board of the City of Chattanooga revenue refunding bonds, senior series 2005A issued on behalf of the CDFI Phase I, LLC (the project). At the same time, Fitch upgrades the rating to 'BBB-' from 'BB+' on approximately $19.48 million of outstanding subordinate series 2005B bonds.

The Rating Outlook is revised to Stable from Positive.

SECURITY

The senior and subordinate series bonds are a general obligation of the project, secured by and payable solely from the revenues of CDFI's phase I, II and III student housing facilities. Additional security for the life of the bonds is provided by annual contributions made by the University of Chattanooga Foundation (the foundation) to be used, if needed, to meet the bonds' rate covenant requirement. Additional bond security includes a cash funded debt-service reserve fund.

The subordinate series 2005B bonds were additionally secured by annual transfers by the foundation to a trustee held security fund. However, there was a 2013 sunset on this provision.

KEY RATING DRIVERS

PROJECT STRENGTH MERITS UPGRADE: The upgrade reflects the project's ability to generate strong coverage, with no contribution from the foundation needed since fiscal 2009. The risk of the stand-alone project is partially mitigated by the project's essential role in the University of Tennessee at Chattanooga's (UTC) residential life program.

SELF-SUSTAINING PROJECT: The project's self-supporting nature is the result of continued strength in occupancy and UTC's prudent management of facility expenses. Sunsetting of the foundation support securing the subordinate bonds through fiscal 2013 is mitigated by sound debt service coverage by project revenues.

CONSTRAINED FLEXIBILITY: Counterbalancing rating factors include dependence on student rental payments as the project's primary revenue source and the somewhat limited pricing flexibility given the project's high rates relative to other on campus housing alternatives.

HIGH CONNECTIVITY WITH UTC: Key officers of the project are also officers of the foundation reflecting the importance of the project to UTC. The project is managed as part of UTC's 3,146 bed housing system (the system) and represented approximately 55.2% of available beds in fiscal 2013.

ENROLLMENT GROWTH DRIVES OCCUPANCY: UTC's steady enrollment growth drives strong project occupancy and growth in project revenues.

RATING SENSITIVITIES

PROJECT PERFORMANCE: The inability of the project to grow rental income and sustain current debt service coverage levels, in the absence of foundation support, could negatively impact the rating.

ADDITIONAL PARITY DEBT: While not anticipated, the issuance of additional student housing debt on parity with the project bonds could have negative rating implications.

FUTURE PROJECT COMPETITION: While demand is presently strong, competition from new university housing projects and other housing alternatives could put pressure on project occupancy levels. This will be monitored by Fitch.

CREDIT PROFILE

CDFI Phase I, LLC. is a subsidiary of Campus Development Foundation Inc. (CDFI), which was formed by the foundation to acquire real estate and to construct, manage, and operate housing for UTC students. CDFI constructed the 1,737 bed project in three phases, with the final phase opening in 2004.

PROJECT'S ESSENTIALITY

The project is non-recourse to the university and the foundation. However, UTC manages the project as part of its housing system and sets project room rental rates. In Fitch's view, management of the system and the project as a collective whole ensures the project plays an integral role in residential life on UTC's campus and that rates and charges are set competitively. However, UTC does not direct students to this project on a first fill basis.

FOUNDATION SUPPORT NOT REQUIRED

A security fund was established by the foundation under the bond documents, which the project has been required to annually draw upon since its inception. While the project continued to receive the subsidized payments from the security fund through fiscal 2013, the draw has not been required by CDFI to meet the legally required debt service coverage ratio on the subordinate bonds since fiscal 2010 and ultimately those payments have been returned by CDFI with year-end surplus funds to the foundation. The foundation also previously provided supplemental support to the overall project, however, since fiscal 2009, these contributions have not been necessary.

DEMAND FUELS PROJECT OCCUPANCY

The system's strong 98.5% occupancy in fall 2013 is consistent with prior years, but project occupancy is stronger at 100%. Essentially full occupancy necessitated management to house approximately 210 students in a hotel for the beginning of the fall 2013 semester versus 200 in the prior year. As is typical, this figure drops as beds are vacated, reducing housing overflow to 126 students for fall 2013 versus 36 in the prior year.

Fitch views favorably both the project's full occupancy and the system-wide overflow housing which reflects strong demand and assures that vacancies can readily be filled.

LIMITED PRICING FLEXIBILITY

Pledged revenue is almost entirely reliant on rental income. This reliance on a single revenue stream highlights the importance of maintaining strong project occupancy. This risk is partially mitigated by increased coverage levels without needing foundation support. Further, project rates are more than adequate to manage the required coverage levels set forth in the bond documents.

Given the project's strategic location, modern facilities and amenity package, UTC has historically priced project beds at a premium relative to other options within the system. While rental rates for the project are higher than other campus housing options, they are on par or lower than market rates according to staff reports. The University of Tennessee System implemented rent increases of 3.5% in both fall 2013 and fall 2012. This is lower than the 5% increase in fall 2011, which management deems necessary in order to maintain the system's competitive standing. Rental rate increases are expected to be slightly lower at 3% in fall 2014.

Limited revenue diversity for a project of this nature is not viewed as unusual by Fitch and this element is partially mitigated by the project's high demand despite higher rent levels than alternative campus housing. Further, management's ability to lower the rate of rental increases and grow rental income while still achieving sound debt service coverage is indicative of further strengthening of project performance. In addition, the foundation will provide funds to supplement debt service if there is a shortfall under the coverage requirement. As of June 30, 2013, the foundation had resources of $179 million, which are largely restricted.

ADEQUATE PERFORMANCE

CDFI's operating margins are historically negative. CDFI ended fiscal 2013 (on a GAAP basis) with a negative 6.7% margin, after achieving breakeven results in fiscal 2012, due to an increase in interest expense. The one-time increase in interest expense in fiscal 2013 is not related to the project, but related to the parent CDFI and interest on contributions made by the foundation in previous years but not recorded. Interest expense on the project decreased in fiscal 2013. Favorably, growth in rental income, improved collections, lower management fees and better cost controls allow for improved project debt service coverage levels.

Net revenues available for debt service reached $7.95 million in fiscal 2013. Bond documents require debt service coverage of 1.2x for senior bonds and 1.1x for both senior and subordinate bonds. In fiscal 2013, coverage was sound at 1.76x for the senior bonds and adequate at 1.31x for the senior and subordinate bonds, compared to 1.8x and 1.34x in fiscal 2012, respectively, for a stand-alone project of this nature. These coverage levels are notably higher relative to prior years and include the funding subsidy provided by the foundation for the subordinate bonds. Coverage levels excluding the funding subsidy remain sound at 1.72x and adequate at 1.28x, respectively.

Management is conservatively budgeting 1% growth in project operating revenues in fiscal 2014, versus 2.7% actual revenue growth in fiscal 2013 and 5.6% in fiscal 2012, with expected coverage of 1.73x and 1.27x for the senior and subordinate bonds, respectively, excluding the funding subsidy. Fitch's expectation that the project can sustain these coverage levels, without foundation support, drives the rating upgrade.

DEMAND FOR UTC HOUSING

Due to strong demand for housing at UTC, its campus master plan includes the potential construction of additional auxiliary housing in fiscal 2016-2017. The university's residency requirement for freshmen and growth in undergraduate headcount drive demand for housing. Overflow housing in fall 2013 reached 126 versus 36 in the prior year reflecting there is always backfill to keep occupancy levels high. Further supporting demand, currently there are approximately 30% of full time equivalent students that reside on campus. Management indicated there are approximately 900 students turned away in fall 2013 needing beds, of which approximately 500-600 are upperclassmen that prefer the amenities of project housing.

Fitch expects UTC to maintain the project's solid occupancy levels and generate net revenues necessary to support associated debt service, if and when additional beds are added. According to management, any additional student housing debt is not expected to be on parity with the bonds which is viewed favorably by Fitch.

UTC is a metropolitan university, located near downtown Chattanooga. UTC's fall 2013 total headcount enrollment grew to 11,664, largely flat over the prior year. However, over the past five years total headcount grew 11% reflecting strong overall demand. A decline in graduate enrollment, as seen by Fitch nationwide, accounted for the shortfall in fall 2013. Favorably, UTC's ability to increase undergraduate headcount helped offset the decline in graduate enrollment in fall 2013.

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

Applicable Criteria and Related Research:

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

--'Fitch Affirms CDFI Phase I, LLC's (TN) Sr. Revs at 'BBB-' & Sub Revs at 'BB+', Outlook Revised to Positive' (Feb. 7, 2013).

Applicable Criteria and Related Research:

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=814135

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