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Public Finance

Education & Nonprofit Institutions / U.S.A.

U.S. College and University Rating Criteria

Sector-Specific Criteria
This report describes the operating and financial factors Fitch Ratings considers in rating the long-term debt of U.S.-based colleges and universities (institutions). Not all rating factors outlined in this report may apply to an individual rating or rating action. Each specific rating action commentary or rating report will discuss those factors most relevant to the individual rating action. This report represents a sector-specific extension to Fitchs Global Research RevenueSupported Rating Criteria, dated June 20, 2011, available on Fitchs Web site at and replaces the prior criteria report dated June 20, 2011. No changes in rating methodology have occurred since the publication of that report. Post-Secondary Institutions: Colleges and universities covered by this sector-specific criteria report include four-year colleges, nonprofit public and private colleges, two-year community colleges and junior colleges, and post-secondary trade schools. For criteria related to tuitionsupported, private primary or secondary schools, see Fitch Research on Independent School Rating Criteria, dated Aug. 24, 2010, available on Fitchs Web site at Investment-Grade Landscape: The vast majority of colleges and universities are rated investment grade. Fundamentally underpinning credit quality within the sector is societal demand for undergraduate, graduate, and postgraduate education and a funding model that enables most institutions to cover operating costs, meet financial obligations, and build reserves. Institutions with below-average credit quality are generally hampered by a weak competitive position. Enrollment-Dependent Business Model: For the vast majority of colleges and universities, financial wherewithal is tied to student demand for program offerings. While colleges and universities vary in terms of type (public or private), operating scope (regional or national), and educational focus (liberal arts, research, among others), the vast majority of revenues collected by institutions are either generated directly by enrollment (tuition and fees) or are indirectly related to it (state appropriations). Other Considerations: Fund-raising and investment income for some institutions also play an important role. The purpose of fund-raising may be to support operations, fund capital projects, or increase the size of financial assets invested over the long term, including endowment. In most years, a sizable endowment and/or pool of long-term investments yield higher levels of annual investment income.

Related Criteria
Revenue-Supported Rating Criteria, June 20, 2011 Criteria for Assigning Short-Term Ratings Based on Internal Liquidity, June 20, 2011

Related Research
2012 Outlook: U.S. Colleges and Universities, Dec. 9, 2011 2011 Median Ratios for U.S. Public Colleges and Universities, May 8, 2012 2011 Median Ratios for U.S. Private Colleges and Universities, May 8, 2012

Douglas J. Kilcommons +1 212 908-0740 Colin J. Walsh +1 212 908-0767

May 24, 2012

Public Finance
In assessing the credit quality of a post-secondary institution of higher education (institution or college and/or university), Fitch will focus on the following factors: Operational Effectiveness: Enrollment-driven revenues are the primary source of operating funds for most institutions. Consequently, a college or universitys ability to effectively manage its enrollment base and position itself vis--vis competitors is critical to maintaining or improving its financial position. Demand Flexibility: Institutions capable of achieving enrollment goals without sacrificing student quality tend to be less susceptible to changes in demand and related revenues. Fund-raising: Demonstrated fund-raising prowess may enable a college or university to reduce reliance on student-generated funding streams and fund investments in scholarships, programs, and infrastructure. Revenue Diversity and Operating Performance: A lower level of revenue concentration suggests an unexpected interruption in funding from one source will not impact an institutions ability to prudently manage expenditures in line with revenues. Balance Sheet Resources and Liquidity: Colleges and universities with a sizable financial cushion are better protected from an unexpected, material decline in core revenues and/or unexpected significant increase in costs. Debt Burden: The ability of an institution to consistently generate strong debt service coverage may help offset a high pro forma debt burden; debt burden is calculated as MADS as a percentage of unrestricted operating revenues.

Operating Profile
Fitch reviews a college or universitys historical enrollment patterns, marketing and pricing strategies, and admissions process to assess business strategy. Enrollment stability, rather than institutional size, correlates strongly with investment-grade ratings, as a sizable number of well-endowed liberal arts colleges and certain niche private institutions tend to be smaller than their public university counterparts.

Operational Effectiveness

Attribute Characteristics
Stronger Attributes Midrange Attributes Weaker Attributes Demonstrated enrollment stability over a full business cycle, fueled by highly effective competitive strategies; pipeline of prospective students is robust. Enrollment trends, while generally stable, are prone to some fluctuation during weaker economic climates; competitive strategies effective at maintaining stable demand over time. Volatile trends in student headcount; well-articulated vision and mission lacking; less effective competitive strategies enabling competitors to cherry-pick prospective students.

Institutional Attributes and Operating Environment Affect Enrollment Profile

To gauge overall trends in enrollment, Fitch reviews five years of data measured by both total headcount and full-time equivalent students (FTEs); FTEs are an absolute measure of enrollment, with part-time students formulaically converted to a full-time unit of attendance. Generally, stable to upward trending enrollment is viewed favorably; a one-year decrease or increase is not considered a trend but should be explained by the schools management.

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Given the reliance of private colleges and universities on student-generated tuition and fees, and the role headcount and credit hours play in a public universitys receipt of state appropriations, significant, unbudgeted variance in enrollment could be a credit concern, particularly if the gain or loss of students is unexpected, has a materially adverse financial impact, and, from a budgetary perspective, cannot be managed. Smaller institutions (less than 1,000 students), such as niche private colleges, generally have a more constrained ability to manage enrollment volatility, as the loss of a few students is likely to impair their ability to generate necessary operating revenues. Total headcount provides an indication of the overall demand for an institution, with FTEs highlighting shifts between full- and part-time attendance patterns. Historically, a shift to more nontraditional, part-time students exposed a college or university to enrollment and related revenue volatility. With the increased acceptance of the lifelong learning concept, fueled by robust online and distance education programs and the flexible cohort model for working professionals, part-time enrollment is less of a concern. Colleges and universities nationwide enroll students earning credits and pursuing full degrees on a part-time basis. Consequently, as long as overall enrollment is increasing, a rise in the percentage of part-time students is not necessarily viewed as a credit weakness. An increased reliance on a part-time population does demand that an institutions administration continually monitor the needs of this unique population and proactively change course offerings and delivery formats as patterns evolve. Such active monitoring is essential to minimizing potential volatility in part-time student enrollment. The mission of the institution, including educational delivery methods unique to its niche and the overall strategic plan for maintaining enrollment, provides important context in the analysis of enrollment data.

Attribute Characteristics
Stronger Attributes Global and/or national draw for students, supported by preeminent academic programs and potentially significant, renowned research and healthcare-related activities; any competitive threats are generally muted by a track record of highly favorable student outcomes that also create considerable tuition-pricing flexibility and fund-raising prowess; niche institutions tend to be market leaders in their areas of specialty. National or regional draw for students, supported by quality to high quality academic programs and potentially small, though respectable, research- and healthcare-related activities; academic performance indicators are generally in line or ahead of the competition; more limited, although still sound, tuition-pricing flexibility and fund-raising prowess, although deteriorating national or regional economic conditions could yield pressure; niche institutions are well regarded in their areas of specialty, although face some competition from the broader market. Regional or local draw for students, supported by academic programs of adequate, although not distinctive quality; academic performance indicators may be equal to or, more likely, weaker than the competition, which could be fierce; extremely limited pricing flexibility and extremely limited fund-raising capabilities; niche institutions are serving a specialty area that is not in high demand and face significant competition from the broader market.

Midrange Attributes

Weaker Attributes

Demand Flexibility
Application Trends and Recruitment Strategies
The trend in the number of students applying to a college or university is an indicator of student demand. While a sustained decline in applications would raise concern, particularly if such decline was not intended, Fitch does not necessarily view increasing application levels as reflective of strengthening demand for a particular institution. Given the increased use and ease of online application filing and the growing popularity of the so-called common application, which allows students to apply to multiple institutions with a single form, the expectation for most colleges and universities is stable to growing application levels over time. Management
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would be expected to explain the reasons for stagnation or significant and persistent declines in application levels. To provide context for application trends and better assess overall student demand, Fitch discusses with a college or universitys admissions staff its recruitment efforts, the pool of institutions to which applicants apply as alternatives, and expected changes in the competitive landscape. During this discussion, major strategic shifts in recruitment strategies or market positioning should be disclosed.

Metrics in Context
Acceptance rates demonstrate a schools ability to control future enrollment. Private colleges and universities that accept 75% or more of applications generally have less demand flexibility should applications decline. For certain niche institutions with a specialty focus (such as art or music), higher acceptance rates do not necessarily signify a weaker market position, as this type of college or university tends to attract a self-selecting population of students who will likely gain admission. In the case of state-supported colleges and universities, it is not uncommon to see even premier institutions with acceptance rates greater than 75%; statewide mandates to ensure affordable, accessible education often influence these patterns. Many community colleges are required under their chartering legislation to maintain open admissions.

Attribute Characteristics
Stronger Attributes Consistently high matriculation rates, indicative of the institutions first choice status among prospective students, and highly competitive admissions process, which provides a institution considerable flexibility to shape the profile of incoming classes. Stable matriculation rates, which may be high or low, depending upon market dynamics; admissions process is somewhat competitive, although acceptance rates tend to be fairly high, limiting enrollment flexibility. Variable matriculation rates, which are usually low; noncompetitive admissions process, with generally no ability to shape the profile of an incoming class; heavy tuition discounting to attract students is often a necessity.

Midrange Attributes

Weaker Attributes

Matriculation rate, also known as student yield rate, defined as the number of enrolling students divided by the total number of accepted students, is indicative of a schools relative position among its competitors. The higher an institutions matriculation rate, the more likely that institution is a first choice for many of its applicants. With the exception of Ivy League institutions and other highly selective private colleges and universities, most public-supported institutions, in general, will post higher matriculation rates, given the larger size of the applicant pool and their state mandate to facilitate affordable, accessible education. Matriculation rate data is most informative when used to compare and contrast institutions of a similar profile, including those with similar degree programs, student quality, and market presence. Comparisons among colleges and universities serving different student populations or offering dissimilar curricula are not appropriate. For example, an Ivy League school with a 45% matriculation rate should not be compared with a regional college having a 50% matriculation rate. If data are available for peer institutions, trends in matriculation among cross admits, or students accepted to more than one institution, these can denote a schools level of success in terms of enrolling the students it desires.

Strong Student Quality Provides Flexibility

In general, colleges and universities with strong student quality indicators are in a better position to adjust admission criteria during a period of declining applications. If an institutions

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student quality indicators are favorable, compared with those of its competitors, there is room to relax admission standards to ensure enrollment goals are achieved

Indicators of Student Demand

Indicators Number of Applicants Acceptance Rate Use of Indicators in the Rating Process Stable to growing numbers reflect continued interest in the institution. In general, the higher the acceptance rate, the less flexibility the institution has to increase future enrollment. However, for colleges and universities offering unique, targeted programs, higher acceptance rates are more common, as only qualified students apply. The higher the matriculation rate, the greater the likelihood that the institution is the student's first choice. Varies; scores are considered in conjunction with the mission of the college or university. Higher rates reflect student satisfaction. High rates reflect success providing desired program offerings. A history of a positive reputation is desired. Recent negative publicity can have an adverse effect on enrollment and future fund raising.

Matriculation Rate Standardized Achievement Scores Retention Rates Graduation Rates Reputation of/Publicity for School

Typical measures used to assess scholastic aptitude, or student quality, of incoming freshman students include standardized tests, such as the Scholastic Aptitude Test (SAT) or American College Test (ACT). Fitch acknowledges that colleges and universities are seeking alternative methods for evaluating the success of prospective students, and some institutions have altogether eliminated standardized test scores as a requirement for admission. In lieu of ACT and SAT scores, Fitch looks to other indicators, including the percentage of freshmen from the top 10% of their high school graduation class and freshmen to sophomore year retention rates, to assess quality. For specialized institutions, such as colleges of art and design, Fitch discusses with management the unique requirements of admission and compares these requirements with like institutions. As part of its analysis, Fitch compares a college or universitys quality indicators with those of its closest competitors, as well as state and national averages. As an example, standardized test scores that consistently exceed peer institutions, as well as state and national averages, provide a college or university with enhanced demand flexibility and are viewed favorably. For institutions where standardized entrance tests are deemphasized or non-indicative of student success (post-secondary technical school for example), Fitch will instead focus on the mission of the institution and other factors, including job placement rates and average starting salaries among recent graduates.

Attribute Characteristics
Stronger Attributes Weaker Attributes Consistent track record of superior student academic outcomes that enhances demand and pricing flexibility and better positions an institution to develop non-student-related funding streams, such as research and fund-raising. Quality indicators tends to lag competitors, negatively affecting recruitment and retention efforts; limited pricing and admissions flexibility exists necessitating careful, active management of enrollment and student demand; little, if any, opportunity to diversify revenue base exists. Academic outcomes generally tend to be in line with or periodically better than competitors; a moderate degree of pricing and admissions flexibility exists, influenced by trends in student achievement; ability to leverage student achievement in diversifying revenue streams is more limited.

Midrange Attributes

Pricing Strategy Affects Revenue Growth

Tuition levels are a significant factor for students or parents choosing a college or university. Tuition competitiveness is most effectively measured through a comparison of tuition and fees among peer institutions, with trends for an individual institution analyzed over a five-year period. For a college or university priced significantly ahead of its primary competitors, Fitch seeks to understand the reasons for the disparity and whether it is sustainable. As part of its analysis,
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Fitch may request post-graduation data for undergraduates, including average time to employment, average starting salaries in professional fields, pass rates for professional exams, and admissions data for an undergraduates first choice graduate school. These metrics often help a highly priced college or university justify a relatively high cost of attendance. Net tuition revenue is defined as gross tuition and fees, net of internally funded student aid. This information can be used to determine the extent to which the college or university is successfully passing along higher costs to students once the impact of tuition discounting (total scholarship and financial aid divided by gross tuition) is considered. A high level of tuition discounting without resources to support this aid could be viewed negatively and as a sign of demand weakness. While internally funded student aid may enable a school to be more tuition competitive, Fitch will review managements track record of providing a financial aid mix that buoys financial operations and helps to sustain enrollment levels.

Attribute Characteristics
Stronger Attributes Consistent, annual growth in net tuition revenue supported by stable tuition discounting policies; internal resources are readily available to meet the institutionally funded financial aid budget. Midrange Attributes Stable to slightly upward trending growth in net tuition revenue; tuition discounting polices, while generally stable, more likely to move in response to market dynamics; institutional resources could be pressured if an increase in financial aid levels is warranted. Weaker Attributes Net tuition revenue is stagnant or in decline; discounting of tuition is often significant in an attempt to attract students from competitors; institutional resources are generally insufficient to meet any increase in the financial aid budget.

The cost of attending a college or university weighs heavily in the decision-making process for most students and parents. However, Fitch recognizes that other factors do come into play. In addition to academic reputation and student quality discussed earlier, the aesthetic appearance of an institutions physical campus, the availability and competitiveness of athletic programs, and, for residential campuses, the availability of quality student housing are important considerations. As part of its analysis, Fitch discusses with management the short- and longterm strategic plans for these components of campus life, including plans to address major deferred maintenance items. Additionally, Fitch reviews the history of annual spending for buildings and maintenance and assesses the feasibility of the schools longer term master plan for facilities. Managements discipline in budgeting for and allocating resources to support ongoing physical plant investment is viewed favorably in the rating process.

Contributed Funds an Important Source of Support
Institutional development, commonly referred to as fund-raising, provides an important resource for many colleges and universities. While the proceeds of unrestricted annual giving are generally dwarfed by tuition and fee revenues, investment income, and other sources of operating support (such as research- and healthcare-related revenues), contributions provide an important source of budgetary flexibility and, over time, enable a college or university to build resources and finance necessary capital improvements. Contributions to an institution come from a variety of sources, including alumni, parents, foundations, and corporations. For most colleges and universities, alumni, parents, and board members tend to be the dominant donors. Gifts and contributions are made to an institution either on an unrestricted basis, sometimes in the form of an annual fund gift, or are restricted to a specific purpose or initiative, such as scholarships, endowed faculty chairs, and/or facilities.
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Outside annual fund giving, unrestricted gifts to most institutions are fairly limited, as donors generally prefer to give for a specific purpose. Still, restricted giving does enhance financial flexibility, as it enables an institution to free up funds it would have otherwise dedicated to a project or effort now being supported by a donor.

Donor Cultivation Not a Short-Term Process

For most colleges and universities, a robust fund-raising culture takes time to develop. Many institutions initially focus on increasing annual fund participation among alumni and parents, later building off this base to launch a comprehensive capital campaign. Such campaigns target a myriad institutional priorities including academic and recreational facilities, deferred maintenance, scholarships, endowment, and athletics. As part of its feasibility assessment of future campaigns, Fitch reviews an institutions development track record in the context of its institutional mission, operating environment, and level of fund-raising culture established. Such a review often helps to support a college or universitys rationale for launching a large, multifaceted, multiyear fund-raising effort. In general, there is a strong correlation between ratings and a college or universitys ability to fund-raise, particularly when proceeds of a capital campaign are earmarked for the endowment or will help provide budgetary support for scholarship and financial aid. Among the best institutions for development activities are public and private colleges or universities, with nationally recognized, competitive athletic programs. In addition, Ivy League institutions possess substantial fund-raising capabilities.

Attributes Characteristics
Stronger Attributes Midrange Attributes Long-standing, fund-raising culture supported by mature, well-developed infrastructure to effectively solicit donor contributions; annual giving tends to be robust, punctuated periodically by comprehensive capital campaigns. Established fund-raising culture, supported by basic infrastructure needed to solicit donor contributions; annual fund giving tends to dominate, with only a few, narrowly focused campaigns to support specific initiatives. Lackluster fund-raising culture, highlighted by a spotty track record of development activities; generally no infrastructure in place to support effective fund raising, with most donations solicited on an ad hoc basis.

Weaker Attributes

Financial Profile
Quantitative Assessment of Factors Informs Rating Process
Financial metrics contribute significantly to rating determinations. With inputs derived from audited financial statements and other supporting financial documents, Fitch calculates and evaluates quantitative assessments of revenue diversity, operating performance, balance sheet resources, and debt burden, as well as the historical trends of such measures. Expectations for future financial performance and, ultimately, the credit rating, are informed by assessments of those factors. As long as a borrowers underlying strategic position remains sound, a certain amount of variability in financial performance should not affect the rating on the bonds. Fitch analyzes both revenue and expenditure sections of the statement of activities to gauge budgetary flexibility. Significant changes in revenues or expenses from one year to another should be explained by management. The ability to generate excess revenues over expenditures on an annual basis is essential for maintaining or improving a schools long-term financial position and providing adequate debt service coverage.

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Revenue Diversity
Diversity Bolsters Credit Quality
Colleges and universities have varying degrees of revenue diversity. For private universities, student-generated revenues are the primary funding source, often representing up to 90% of an institutions unrestricted revenues. Student-generated revenues typically include tuition, fees, and auxiliary receipts, including revenues generated from student housing, parking, and dining operations. For public universities and non-tax-supported community colleges, significant operating support is often provided by the state in the form of annual appropriations. Annual appropriations for operations could represent nearly 40% of some public institutions total operating revenues. In addition, some public colleges and universities receive appropriations to offset debt service costs or to fund non-self-supporting capital projects, such as academic and research facilities. Given the importance of this funding for many public institutions, Fitch considers the trend and likely direction of state appropriations for both operations and capital as part of its analysis. During years of declining state appropriations for operations, most public universities offset the loss of appropriation dollars through increases in student-generated revenues. The ability of a public college or university to increase student-generated revenues is largely linked to its ability to raise tuition and fees and/or increase the population of students its serves. For public institutions lacking such pricing and/or enrollment flexibility, a challenged state funding environment could have negative credit implications. For community colleges that receive revenue derived from the levy of taxes, Fitch will additionally review current and projected taxing authority, including flexibility to increase current rates, the demographic and financial profile of the local tax base, and other macroeconomic trends, including housing prices. Such indicators facilitate an assessment of the stability and diversity afforded to a community college by a stream of tax-based revenues.

Stability of Enrollment-Driven Revenues May Offset Concentration Concerns

In general, the more diverse a college or universitys sources of revenue, which may include revenues derived from healthcare operations, research, annual giving, and investment income, the higher its credit rating. This stems principally from the increased financial flexibility afforded by the presence of multiple revenue sources that are often uncorrelated. Healthcare operations, for example, are not a function of enrollment or student-generated fees. Similarly, a public universitys ability to secure federal and/or private sponsorship of research (grants and contracts) and collect related, unrestricted indirect cost recovery revenues is unrelated to its annual receipt of state operating appropriations. Importantly, Fitch recognizes that sources of diversification often have their own associated risks that are considered in the rating process. In addition, while revenue concentration does increase a college or universitys vulnerability, managements ability to closely manage the drivers of that key revenue stream, such as a tuition-dependent private university closely managing its demand pipeline, may tend to mitigate the dependency risk.

Expenditure Flexibility
Flexibility May Alleviate Budgetary Pressure
Unexpected declines in student-generated revenue could severely impair the ability of many institutions to achieve budgetary balance. Consequently, Fitch reviews a college or universitys
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expenditure flexibility, including its ability to hold constant or even decrease its total operating budget. Integral to this analysis is an assessment of significant expenditures; for most colleges and universities, costs associated with faculty salaries and related benefits are its largest expense. Generally, the lower the percentage of full-time, tenure-track faculty, the more flexibility a college or university maintains to reduce headcount during a period of financial weakness. Importantly, Fitch notes the decision to reduce faculty headcount and/or replace tenured professors with adjunct or part-time professionals does have implications, particularly as related to a prospective students view of an institutions academic quality. Less favorable views of a college or universitys student quality could have a negative enrollment impact.

Operating Margin
Fiscal Balance Achieved Through Revenue and Expenditure Match
The operating margin measures an institutions ability to generate revenue from its core operations sufficient to meet annual expenditures, fund routine maintenance, and service financial obligations. While recognizing that margins may vary from year to year, Fitch expects at least break-even performance over a five-year period. By generating a consistent margin at or above a break-even level, a college or university is less reliant on its unrestricted reserves for operating support and can generally service debt from its annually available surplus.

Select Operating Performance Metrics

Indicators Diversity of Revenues Volatility of Revenue Operating Margin Use of Indicators in the Rating Process Concentration in any one revenue source could be a concern but may be mitigated by a history of stability. A revenue source that contributes at least 10% of revenues is reviewed for changes that have affected its consistency. Operating surplus divided by total unrestricted operating revenues.

Note: Both revenues and expenses are reviewed over several years, usually five, to determine the consistency of the schools financial performance.

Adjustments to Operating Margin Enhance Analysis

In computing the operating margin for a college or university, three major adjustments are made by Fitch to determine total unrestricted operating revenues. The first adjustment involves the reclassification of net assets released from restrictions for capital purposes to non-operating revenues from operating revenues, since such amounts cannot be used to fund expenditures. Depending on audit presentation, this level of detail may or may not be discernible from the financial statements but may be obtained through a conversation with management. The second adjustment affects only public colleges and universities and involves the reclassification of certain non-operating revenues, including state appropriations, noncapital gifts and grants, and investment income to operating revenues. Without the reclassification of state appropriations, very few public universities would generate an operating margin at or above the break-even level. The third adjustment involves the reclassification of realized and unrealized investment gains and losses to non-operating from operating revenues. This reclassification, which primarily affects colleges and universities with significant endowment or long-term investment holdings, eliminates
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the impact of large market value swings, both positive and negative, providing greater consistency from one credit to the next. Depending on their magnitude, market value swings could have a significant impact on reported revenues, although they are generally outside of an institutions control and not reflective of how its finances are being managed. For example, unrestricted operating revenues may be improving in all categories for the year, but a significant market value loss at year end could result in a decline in unrestricted net assets for that year.

Investment Spending Considered in Assessment of Operating Performance

Colleges and universities with large investment portfolios hold a sizable portion of long-term financial assets in nondividend and non-interest-bearing asset classes (alternative investments) structured to appreciate in value over time. Moreover, many of these institutions include in their annual operating budget an amount they expect will be distributed from total investment return, namely dividends, interest, and accumulated investment appreciation (or gains). This amount, commonly referred to as an endowment or investment payout, is formulaically determined under a spending policy typically approved by a college or universitys board of trustees. Most spending polices are based on a lagged, 12-quarter moving-average market value, with annual payouts ranging from 4.5%6.0%. A variance from this range is not necessarily viewed negatively by Fitch but will trigger further discussions. The exclusion of all gains and losses per the third adjustment described above, including that portion of an institutions annual investment payout derived from accumulated gains, will typically result in a negative operating margin. Consequently, Fitch generally calculates two operating margins to better gauge operating performance. The first calculation includes a college or universitys interest and dividend income, with no recognition of any gains or losses. Under the second calculation, Fitch includes dividend and interest income and the portion of accumulated gains recognized under the endowment spending policy to the extent this amount can be obtained from the financial statements. For institutions that budget for a portion of expenses to be supported by investment returns, Fitch views the operating margin inclusive of the full spending policy payout as a better indicator of financial health. As long as the return on long-term investments exceeds distributions made under the spending policy, reliance on the payout alone is not, in and of itself, a negative credit factor. However, the greater a college or universitys reliance on the payout, the less flexibility it maintains to ratchet back spending under the policy during times of prolonged financial market turbulence.

Balance Sheet Resources and Liquidity

Financial Cushion Provides Buffer
In analyzing an institutions resource base, Fitch examines the magnitude of financial assets and the liquidity of these holdings. In general, the size of a college or universitys resource base correlates strongly with its ability to annually operate at or above the break-even level.

Select Measures of Liquidity and Leverage

Indicators Available Funds Adjusted Available Funds Debt Service Coverage Debt Burden Use of Indicators in the Rating Process Includes cash and investments that are not permanently restricted. Available funds provide a measure of balance sheet resources. Includes cash and investments that are not permanently restricted. Also excludes financial assets deemed as alternative investments per the audited financial statements. Measures an institutions ability to service debt from annual surplus. Measures pro forma MADS as a percentage of total unrestricted operating revenues. Fitch considers a debt burden equal to or greater than 10% as high.

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For institutions with significant resources, the largest component of their investment portfolio tends to be financial assets held for the long term. These assets include endowment funds and quasi-endowment funds; quasi-endowment funds function similarly to endowment assets but have fewer restrictions, if any, related to use. In addition to long-term investments, wellendowed colleges and universities may also maintain sizable short- and intermediate-term cash and investment pools to support working capital needs and variable-rate debt programs. Generally, these investments tend to be highly liquid and available on demand, with minimal notice. To gauge the magnitude of an institutions resource base, Fitch calculates available funds, or an institutions total cash and investments not permanently restricted. For public colleges and universities, expendable, permanently restricted net assets are included in available funds to the extent the nature of the restriction is operations related. Available fund balances are compared with operating expenditures and financial leverage as measures of financial flexibility. As part of its analysis of balance sheet resources, Fitch reviews investment performance from the close of the most recent audited fiscal year and considers the potential impact that financial market movements may or may not have had on available fund metrics derived from those audited financial statements.

Balance Sheet Resources Not Necessarily a Proxy for Liquidity

Fitch acknowledges that many colleges and universities invest sizable shares of their long-term investment portfolios in alternative asset classes, including hedge funds and private equity. Held with a long-term investment horizon, alternative investments provide the opportunity for enhanced returns, although they are generally illiquid, not immediately accessible, and sometimes require subsequent commitments of capital. In addition, their valuation is based on the subjective assessment of an investment manager, not an objective, transparent financial market, and are generally reported on a lagged basis. Given these characteristics of alternative assets, which in some cases represent approximately 50% or more of an institutions total investment holdings, available funds no longer provide a sufficient proxy for liquid resources. Consequently, Fitch will also calculate an adjusted available funds metric that attempts to distill the core available funds calculation discussed above into its most liquid, most accessible components. In the adjusted calculation, Fitch typically includes traditional equity and fixed-income investments, as well as U.S. government-backed securities, mutual funds, and cash. Hedge funds, private equity, and real estate are the most common alternative investments stripped out of the adjusted metric. The calculation of adjusted available funds for some colleges and universities may suggest a much weaker level of financial flexibility than the traditional available funds metric. Importantly, Fitch recognizes the adjusted available funds calculation is conservative, giving no credit to investment holdings, which, while not immediately available, will have a value at the end of their investment horizon. Moreover, these investments are rarely intended as a source of nearterm liquidity or working capital. For these reasons, Fitch will continue to calculate both available funds and adjusted available funds as measures to assess total resources and liquid resources, respectively.

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Attributes Characteristics
Stronger Attributes Midrange Attributes Track record of positive operating performance, supported by a diverse revenue base and solid resource levels; exposure to nonmarketable, illiquid securities tempered by operating strengths and availability of other, more liquid funds. Break-even to generally positive operating performance, supported by stable, enrollment-related revenues, and adequate to healthy resource levels; modest exposure to nonmarketable securities, with a more limited ability to manage the illiquidity issues accompanying these investments. Generally negative operating performance, supported by variable, enrollment-related revenues, and adequate to fairly weak resource levels; extremely limited financial capacity to manage the risks associated with any exposure to nonmarketable asset classes.

Weaker Attributes

Asset Allocation Evaluated in Context

Fitch does not associate a target asset allocation with a particular rating level. However, a colleges or universitys investment policy will be evaluated in the context of its overall financial position and financial management practices. For institutions with significant revenue concentration, stagnant demand trends, and erratic, generally negative operating performance, an asset allocation weighted toward traditional fixed income and equity investments would be more appropriate, given the reliance on unrestricted, liquid reserves to subsidize operations. Overexposure to less liquid alternatives, or fluctuation in available fund balances, for such an institution could have negative credit implications. In contrast, institutions that are consistently able to cover annual expenditures and debt carrying charges from operating surpluses are not as dependent on balance sheet resources. Consequently, this type of institution is better equipped to handle the illiquidity risks associated with a heavy exposure to nonmarketable securities and has a greater capacity to withstand temporary, periodic fluctuations in available fund balances.

Debt Profile
Planning Documents Facilitate Assessment
When assessing financial leverage, Fitch reviews an institutions existing level of debt and future plans for debt issuance. For this reason, Fitch prefers to see that a college or university has a capital improvement plan with a documented process for assessing capital projects, a time horizon for completion, and anticipated sources of funding. Typically, capital plans cover a period of at least five years and are subject to periodic review. As part of its analysis of pro forma leverage and future debt capacity, Fitch may incorporate a planned borrowing into certain debt ratios to the extent sufficient detail relating to the financing is available. Financial leverage structured to be nonrecourse to a college or university is not covered by this sectorspecific rating criteria. As current and pro forma debt structure is an important consideration, Fitch evaluates an institutions debt policy outlining parameters for incurring leverage and any related documents, such as policies governing the issuance of variable-rate debt and use of interest rate hedges. Generally, the propensity of a college or university to manage the risks attendant to floatingrate debt and derivatives is directly proportional to its level of financial flexibility. Consequently, for an institution, particularly one rated A and lower, the potential effects on cash flow and liquidity of a failed variable-rate bond remarketing, bank bond term out, and loss of external liquidity provider will be evaluated.

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Debt Burden
Budgetary Impact of Debt-Carrying Charges
Fitch calculates a debt burden and will review historical and projected debt service coverage levels to assess an institutions ability to annually manage its financial obligations. The debt burden, calculated as the ratio of pro forma MADS as a percentage of unrestricted operating revenues, indicates the portion of current-year unrestricted operating revenues required to meet maximum principal and interest on outstanding debt and a proposed new-money financing through final maturity. In addition to carrying charges on long-term bonds, pro forma MADS also includes debt service on notes payable, capital leases, and noncancellable operating leases. To the extent debt service is not level and large bullets are utilized, Fitch assesses a college or universitys ability, measured by its rating and associated market access, to pay bullets when due or effect a timely refinancing. For upward sloping and backloaded debt structures, Fitch evaluates the reasonableness of assumptions underpinning an institutions plan for supporting higher debt-carrying charges in future years. Similar to variable-rate debt and swaps discussed above, nonlevel amortizing debt structures are more likely to yield credit pressure at lower rating levels. Fitch generally considers a debt burden at or above 10% as high and potentially cause for concern. Other factors, notably consistently strong coverage of debt service (discussed below), may help mitigate at least some of these concerns. Fitch views favorably the ability of managements to articulate a well-reasoned and achievable strategy for stabilizing or reducing a high debt burden over time.

Debt Service Coverage Calculated on a Legal and Economic Basis

For colleges and universities, Fitch calculates legal debt service coverage per the terms of transaction documents, using pledged revenues, and computes economic coverage based on an institutions net income available for debt service (net income). Pledged revenues and net income are then compared to historical carrying charges and pro forma MADS. The calculation of economic coverage enables a comparison of debt manageability metrics across the higher education sector that is not possible with legal coverage, as transaction documents tend to differ from one bond issue to the next. In net income, Fitch begins with the change in unrestricted net assets from operations (excluding realized and unrealized gains and losses) and adds back noncash items, such as depreciation and interest expensed during the year. The stronger the coverage of debt service provided by net available income, the greater the likelihood that a school will make timely debt service payments and not rely on unencumbered, liquid reserves to meet minimum coverage thresholds.

Peer Comparisons
Comparative Analysis Highlights Similarities and Contrasts
With few exceptions, colleges and universities report demand and financial data in a standardized manner. While this standardization enables a meaningful comparison of key credit variables among institutions and helps facilitate the assignment of a bond rating, other intangible, qualitative variables, such as the strength of management, play an integral role.
U.S. College and University Rating Criteria May 24, 2012 13

Public Finance
For all colleges and universities rated by Fitch, individual metrics are compared with median values exhibited at the recommended rating level. Additionally, metrics are compared with individual institutions at that rating level possessing similar operating and/or financial attributes. In marginal situations, Fitch will expand the universe of comparable institutions, including median values for colleges and universities above or below the recommended rating, to further support the rating rationale and highlight contrasts. Fitch notes that the ranges over which demand and financial metrics vary can be broad and overlap among rating categories for certain metrics may exist. Moreover, ratings are forward looking and imply an expectation of the future rather than what previously occurred. Nevertheless, an improving or deteriorating trend in an institutions demand and/or financial metrics is an important rating driver, with such trends relative to medians and peers a potential source of positive or negative rating pressure.

Financial Metrics
Ratios Remain a Valuable Analytical Tool
Financial results correlate reasonably well with credit ratings. The table on page 15 displays the core factors discussed as part of this sector-specific criteria report and provides examples of typical characteristics exhibited across the ratings spectrum. Median financial ratios will vary over time because bond ratings allow for a certain amount of performance variability and cyclicality; an absolute floor or ceiling for individual metrics are not prescribed by Fitch for a particular rating level. Strong performance in one metric may or may not compensate for poor performance in another, depending on the metrics involved and other circumstances of the institution. Also, qualitative factors and expectations for future performance often result in ratings for colleges and universities that may have one or several metrics that diverge from published medians.

U.S. College and University Rating Criteria May 24, 2012


Public Finance
Typical College and University Credit Factors by Rating Category
BBB Non-Investment Grade Generally stable headcount, Headcount subject to significant although subject to increasing volatility; admissions process is volatility; admissions process is lackluster, with competitive somewhat competitive, although strategies often reactionary; the college or university is rarely a institution is never a first choice, first choice; average academic and, in most cases, attracts reputation; niche institutions are students on affordability versus not in high demand. quality of academics. Limited to extremely limited; high Adequate; moderately high Demand Flexibility Superior; low acceptance rates Sound; moderately low acceptance rates (generally 75% acceptance rates (generally (generally below 30%) and high acceptance rates (generally or higher) and low matriculation matriculation rates (generally 50%60%) and moderately high 60%75%) and moderately low rates (at most 25%, but generally above 40%); tuition discounting is matriculation rates (generally matriculation rates (generally extremely manageable (generally 30%40%); tuition discounting is 20%30%); tuition discounting is lower); tuition discounting is likely burdensome (generally 40% or below 30%), supported by increasingly burdensome manageable (generally higher). dedicated resources. (generally 35% to potentially as 30%35%). high as 40%). Fund-Raising Superior; established fund-raising Sound; established fund-raising Adequate; fund-raising culture is Limited to extremely limited; culture and infrastructure for culture, albeit more recent than not well established, nor is there generally no fund-raising culture solicitation of robust annual fund AA/AAA rating categories; infrastructure in place to support and no infrastructure in place to and capital campaign donations; infrastructure is in place to support predictable levels of annual giving, support predictable levels of extremely loyal donor base, which robust annual giving, although although periodic gifts are annual giving; donor activity is is generally less susceptible to the history of capital campaign activity received; most donations are isolated to a few examples of fund cyclicality of the economy. may be more limited; loyal donor received by the institution on an raising for building improvements, base, although level of giving is ad-hoc basis in support of specific equipment, and supplies. susceptible to the cyclicality of the capital projects. economy. Operating Performance Generally sustained track record Generally sustained track record Generally sustained track record Generally sustained track record of positive operating margins, of positive operating margins, both of breakeven to positive operating of negative operating margins; particularly when the colleges or with and without recognition of margins; endowment payout is institution benefits from little, if universitys investment return endowment payout; the institution typically immaterial to operating any, investment return, as generated by its substantial typically has lower resource levels performance, given that resource resource levels are extremely resource base is fully recognized than its AAA and AA category levels generating an investment minimal. through endowment payout. counterparts, which generate a return are minimal. correspondingly lower level of investment return. Balance Sheet Resources Superior; available funds provide a Sound; available funds provide a Adequate; available funds provide Limited to extremely limited; and Liquidity significant financial cushion solid financial cushion (generally a reasonable financial cushion available funds provide only a (generally 3.0x and greater) minimal financial cushion 1.0x3.0x) relative to both financial (generally 0.4x1.0x) relative to relative to both financial leverage leverage and operating (generally less than 0.4x) relative both financial leverage and and operating expenditures; expenditures; illiquidity of certain operating expenditures; institutions to both financial leverage and illiquidity of certain long-term long-term investments may or may in the BBB rating category tend to operating expenditures; investments is generally offset by not be offset by short-term or have little or no exposure to illiquid institutions in the BB rating short-term or intermediate-term category generally have no intermediate-term liquid assets, investments. liquid assets. exposure to illiquid investments. which could be viewed negatively; illiquid assets tend to be a much lower percentage of total investments at the A and A rating levels. Debt Burden Moderate to moderately high Moderately high to high High (10% and greater); most Moderately low (3%6%); most (5%8%); some institutions with a (6%10%); some institutions with institutions do not have an ability institutions with a higher debt burden tend to offset the higher debt burden tend to offset a higher debt burden tend to offset to mitigate the magnitude of the magnitude of the burden with the magnitude of the burden with the magnitude of the burden with burden with coverage of pro forma strong (generally 1.4x and greater) sound (1.3x1.5x) coverage of pro consistent (1.0x1.3x) coverage of debt service at or above 1.0x from net available income; reliance on coverage of pro forma debt forma debt service from net pro forma debt service from net unencumbered reserves to meet service from net available income. available income. available income. 1.0x coverage is viewed negatively at this rating level, given the limited nature of the financial cushion. Credit Factors AAA/AA Operational Effectiveness Stable or growing headcount; dominant market position; often preeminent academic programs and significant research and healthcare related activities; niche institutions are market leaders. A Stable or growing headcount; sound market position; while often not an institution of first choice, academic program offerings are well regarded; niche institutions are well regarded, though face at least some competition.

U.S. College and University Rating Criteria May 24, 2012


Public Finance

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