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Fitch Rates University of Oklahoma's Revs 'AA-'; Outlook Stable
[October 27, 2016]

Fitch Rates University of Oklahoma's Revs 'AA-'; Outlook Stable


Fitch Ratings has assigned a 'AA-' rating to approximately $62.77 million tax-exempt series 2016B and $21.88 million taxable series 2016C general revenue and refunding bonds (GRBs) issued by the Board of Regents of the University of Oklahoma (BOR) on behalf of the University of Oklahoma (OU).

The bonds are expected to sell via negotiation the week of Nov. 2. Bond proceeds will provide about $15 million of new money for various academic projects, refund portions of outstanding GRBs for savings, and pay issuance expenses.

Fitch has also affirmed the 'AA-' rating on approximately $921 million of GRBs issued by the BOR on behalf of OU.

The Rating Outlook is Stable.

SECURITY

The bonds are on parity with outstanding GRBs, secured by all legally available revenues of the OU Norman campus. The pledge specifically excludes revenues appropriated by the legislature from tax receipts.

KEY RATING DRIVERS

OPERATING STRESS: OU's fiscal 2016 operating deficit of negative $46 million (-5.1%) is a credit negative. This was caused partly by state appropriation cuts in an Oklahoma economy dependent on oil and gas revenues. While OU's tuition increases helped balance appropriation cuts, other expense cuts and accruals (including the effect of a voluntary retirement program) were largely deferred. On an institutional basis, fiscal 2016 pro forma MADS coverage was only 0.7x compared to 1.5x in 2015.

HIGH LEVERAGE: OU's high debt leverage is weaker than its public university peers but remains representative of the 'AA-' rating category. OU's credit strengths include stable enrollment as a co-flagship public university; strong demand and student quality; slim but adequate balance sheet resources; and strong fundraising.

STABLE ENROLLMENT: Stable enrollment remains an OU strength, with undergraduate growth balancing declines in graduate enrollment. Enrollment has grown modestly since fall 2012. Tuition increases in both fiscal 2016 (about 4.8%) and 2017 (7%) did not negatively impact enrollment.

HIGH BUT MANAGEABLE DEBT BURDEN: Pro forma maximum annual debt service (MADS) is 8.2% of fiscal 2016 operating revenues. Fitch considers this moderately high to high but recognizes that OU's debt is conservatively structured, and university policies require designated revenues to support each bonded project. Fitch considers OU to have limited new debt capacity given existing debt leverage and the large fiscal 2016 GAAP operating deficit.

SLIM BALANCE SHEET RATIOS: Balance sheet ratios for OU, as calculated by Fitch, are slim for the rating category relative to expenses and pro forma debt.

RATING SENSITIVITIES

MARGIN DETERIORATION: Failure of the University of Oklahoma (OU) to steadily reverse GAAP operating deficits in fiscal years 2017 and 2018 would trigger a rating downgrade. Fitch expects OU to manage effectively through the current state economic cycle, and grow balance sheet resources and budget flexibility over time.

ADDITIONAL DEBT: OU's bonded projects are projected to be revenue self-supporting, which has been incorporated into the rating. However, Fitch believes OU has limited debt capacity at the current rating given current GAAP operating deficits.

CREDIT PROFILE

OU is a co-flagship public university in Oklahoma (IDR 'AA+'/Negative Outlook), established in 1893. It is a comprehensive doctoral degree granting organization with headcount of 27,937 students in fall 2016-5 (23,060 FTE); about 77% of students are undergraduates, and most attend full-time. Students enroll in 16 colleges on the 3,500-acre flagship campus in Norman, OK. Professional degrees include architecture, engineering, business, and law. The OU Health Sciences Center ('AA'/Stable Outlook) is financially autonomous from OU with a separate and distinct management team but shares the same president and board.

STABLE ENROLLMENT

Enrollment is a credit strength for OU. Total headcount has been stable in recent years, with modest annual increases. Fall 2016 headcount was 27,937, up modestly from 27,518 in fall 2012. Growth in undergraduate enrollment has helped balance modest declines in graduate and law students. OU has seen near-record freshman classes in the last three years, including fall 2016, ranging from 4,176 to 4,200. Another strong entering class is expected for fall 2017. Student quality remains well above the national average; the fall 2016 average freshman ACT was 26.5. In addition, management reports that the freshman-to-sophomore retention rate recently achieved a very strong 90%.

STRESSED OPERATIONS

OU's fiscal 2016 GAAP operations were a deficit $46 million, a significant decline from recent years with slim but positive margins. The fiscal 2015 margin was close to break-even at negative $3.3 million; the 2014 operating margin was $15.6 million or 1.8%; and the fiscal 2013 margin was 1.4%.

Fiscal 2016 results were driven in part by state oil and gas related revenue short-falls resulting in state operating appropriation cuts to OU of a significant 12.9% cut ($19 million), including mid-year reductions. Until fiscal 2016, appropriations since fiscal 2010 had been relatively stable at about $143 million. OU began fiscal 2017 with another initial $120 million appropriation, down 6.25% from fiscal 2016, with the possibility of another mid-year reduction still pending.

For fiscal 2016, a 4.8% tuition increase (and stable enrollment) generated revenue to help offset state appropriation cuts. However, while OU's overall operating revenues (as adjusted by Fitch) increased about 1%, overall expenses increased nearly 6%, resulting in the $46 million GAAP deficit. Management reports that audited revenues do not include $15 million of budgeted general reserves or $14 million of athletic gift transfers, neither of which are considered operating revenues in GAAP accounting. In addition, scheduled salary increases of about 4% went into effect in fiscal 2016. OU did offer a voluntary retirement plan, with long-term budget benefits estimated at about $10 million per year; this did not impact fiscal 2016 operations, and related one-time plan expenses (and savings) are expected to be absorbed in fiscal 2017 and 2018. The university does not budget for depreciation expense (an amount similar to annual debt service).

For fiscal 2017, OU's budget includes a 7% tuition increase, and use of about $5.4 million of reserves. Management projects another GAAP deficit but expects it to be more moderate than 2016. OU has several large revenue-producing projects nearing completion, including parking and housing facilities, which are expected to be fully operational in fiscal 2018.

Fitch expects public universities to generate at least balanced operations over time, and to manage effectively through state revenue cycles. To maintain the current rating, Fitch expects OU to steadily reverse its GAAP operating deficit and build budgetary cushion.



OU's tuition remains competitive with its Big-12 conference peers, a credit strength. Undergraduate in-state tuition for the 2016-2017 academic year is $8,631. The university increased tuition 7% for fiscal 2017, compared to 4.8% for both fiscal 2015 and 2016, with no negative impact on enrollment. Fitch believes OU retains some pricing flexibility.

OU's revenue base reflects the long national trend of lower state funding combined with higher reliance on student fee income. Fiscal 2016 operating revenues are diverse, with student generated tuition and fees (including auxiliary and athletic revenues) constituting a substantial 53% of operating revenues (as adjusted by Fitch), followed by governmental grants (21%) and state appropriations (18%). Fiscal 2017 revenue diversity is expected to be similar.


SLIM LIQUIDITY

In fiscal 2016 OU's available funds (AF), defined by Fitch as cash and investments less restricted non-expendable net assets, totaled $211 million, down from $312 million in fiscal 2015. The fiscal 2016 AF was adjusted for $188 million of un-spent bond proceeds. AF was equal to a slim 22% of operating expenses and 21% of pro forma debt (about $1.026 billion). If $190 million of planned off-balance sheet projects are included in the debt figure, AF-to-pro forma debt weakens to 17%. Fitch views these ratios as weak for the rating category.

Not included in OU's AF ratios are assets of various legally separate 501C3 organizations and state agencies which hold most of OU's endowment. Related amounts are substantial. As of June 30, 2016, these entities (including the OU Foundation, the State Regents, and the Land Commission) held about $1.52 billion of endowment assets benefiting OU.

DEBT LEVERAGE

Post issuance debt is about $1.026 billion, including $60 million of capital leases. Most OU debt is parity general revenue bonds. All debt is fixed rate with serial maturities and a conservative declining debt service structure (no bullets). Pro forma MADS is about $74.8 million (in 2017). The pro forma debt burden is 8.2% in fiscal 2016, which Fitch views as moderately high to high for its rated peer group and per our criteria. While fiscal 2015 institutional MADS coverage was a solid 1.5x, fiscal 2016 operating results generated MADS coverage of only 0.7x. Fitch expects positive MADS coverage in fiscal 2017 and going forward.

OU's debt calculations include Oklahoma Capital Improvement Authority (OCIA) associated liabilities/leases. Although the state has historically satisfied OCIA related debt service via general fund appropriations, the obligations remain the ultimate responsibility of OU.

CAPITAL PROJECTS

OU's debt leverage increased significantly with the $255.7 million series 2015CD bonds; management projects revenues related to bonded housing, athletic and parking projects to cover related debt service. To date, projects are on time and on budget, and related project revenue is expected to be fully realized starting in fiscal 2018. In addition, management reports that fundraising for the phase I stadium project is ahead of projections. Planning for the phase II stadium project, possibly as much as $240 million, has not started; project timing is to be driven by future fundraising.

OU has long used a conservative internal policy of approving capital projects (they must be financially self-supporting). However, at this time, Fitch views OU as having limited new debt capacity, given substantial fiscal 2016 operating deficits and slim balance sheet reserves.

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

Related Research:

--'Fitch Rates $18MM Oklahoma ODFA Bonds; Outlook Negative', dated Oct. 10, 2016.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/site/re/750012

U.S. College and University Rating Criteria (pub. 12 May 2014)

https://www.fitchratings.com/site/re/748013

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1013862

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013862

Endorsement Policy

https://www.fitchratings.com/regulatory

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