Rating removed from review status; outlook is now stable at lower rating
New York, October 26, 2012 -- Moody's Investors Service has downgraded The Pennsylvania State
University's (Penn State's) long-term rating to Aa2
from Aa1. The rating outlook is stable at the lower rating level.
SUMMARY RATING RATIONALE
The downgrade of Penn State's rating to Aa2 from Aa1 reflects our
anticipation of the substantial financial impact on the university from
the ultimate cost of future settlements and possible judgments,
stemming from sexual abuse claims made by victims of convicted former
assistant football coach, Gerald Sandusky. The university's
board has taken actions to provide an expedited settlement process,
including hiring a nationally known law firm with expertise in settling
high profile multiple claim cases, which offer prospects of settling
substantial numbers of claims within a year or less. However,
the total number of claims and the ultimate full cost to the university
is unknown and may not be known for years, but could be significant.
Investigations by the State Attorney General and the US Department of
Justice remain active and further charges could emerge.
The rating action also reflects governance and institutional culture challenges
facing the university. Substantial reforms reflecting best practices
are now underway and intended to overturn a university culture cited in
the Freeh Report as being highly dependent on a few senior managers operating
with inadequate board oversight. The reforms include creation of
a chief compliance and ethics officer reporting to the board, the
election of a new board chair, and a board decision that the next
president will not be a Penn State insider. These planned steps
suggest significant future improvement in university governance and management,
but it could take time for the strong internally focused culture of Penn
State to fully implement and embrace the recommendations of best practices.
The stable outlook reflects our expectations that the ultimate resolution
of victims' claims, though possibly substantial, will
be manageable at the lower Aa2 rating. We expect that Penn State
will remain a leading US public university with favorable student demand,
positive operating performance, high donor support and a strong
research position.
CHALLENGES
*Possibly significant financial impact over the next several years,
possible court judgments and ultimate number of claims related to the
settlement of claims from Sandusky child sexual abuse victims as well
as criminal charges of perjury and "failure to report" against
Gary Schultz, the chief financial officer now retired, and
Timothy Curley, former athletic director on administrative leave.
There remains the possibility of other charges and costs emerging from
ongoing state and federal investigations.
*Evolving governance and management changes as the board moves to
implement the Freeh Report recommendations, including enhancement
of its oversight responsibilities and other changes including adoption
of recommendations of best practices that will stretch the university's
strong culture to become more accustomed to external disclosure and oversight
of emerging risks.
*Enrollment and tuition pricing challenges from the ongoing demographic
decline in Pennsylvania high school graduates which particularly weakens
the university's regional campuses located throughout the Commonwealth
that compete directly with community colleges and the lower cost Pennsylvania
State System of Higher Education (see report dated October 23, 2012).
Penn State's flagship research and land-grant campus at University
Park is expected to retain strong demand from in-state and non-resident
students.
*Substantial and growing costs stemming from retiree health care benefits
and rising pension payments. The unfunded retiree health care liability,
known as OPEB, was $1.86 billion at fiscal year-end
(FYE) 2012 and contributions to be paid from unrestricted operating cash
flow are projected to rise from $37.8 million in FY 2011
to $65.5 million in FY 2017. The university closed
its plan to new employees in 2010 and is weighing other alternatives to
address the rising healthcare liability. Payments to state pension
plans for university staff and faculty are also rising, increasing
by 10% in FY 2012 to $131 million. Further material
increases in pension contributions are expected in coming years to both
the Pennsylvania State Employees' Retirement System and The Public
School Employee's Retirement System.
*Exposure to the healthcare sector and potential operating challenges
related to The Milton S. Hershey Medical Center, accounting
for 26% of total operating revenues in FY 2011.
STRENGTHS
*Major multi-faceted role played in the state by Penn State's
main University Park campus as Pennsylvania's flagship public and land
grant university with 84,411 full-time equivalent (FTE) students
and $700 to $800 million in research grants annually.
Penn State is one the largest university research enterprises in the US,
ranking 14th according to the National Science Foundation. Also,
its favorable location near major east coast population centers allows
recruitment of higher paying non-resident students, who represent
a significant 36% of total undergraduate and 72% of total
graduate and professional students at the main campus. Penn State's
agricultural research services affect nearly every county of the state
and are widely recognized outside of Pennsylvania as well.
*Board's commitment to act quickly to resolve abuse claims and
outstanding litigation, retaining a nationally recognized law firm
specializing in settlement of high profile cases with large number of
claimants to help facilitate possible settlements of outstanding and anticipated
civil litigation. Related board actions to implement best practice
reforms recommended by the Freeh report.
*Consistently favorable operating performance and cash flow generation,
resulting in a 7.9% three-year average operating
margin for FYs 2009-2011 and 9.1% for FY 2011 alone;
operating cash flow is strong at 17.5%. The favorable
performance mitigates patient care risk and continued reductions to Commonwealth
appropriations. FY 2012 results are anticipated to be lower due
to rising OPEB costs.
*Substantial liquidity, with $3.7 billion of unrestricted
monthly liquidity in FY 2011, up from $2.4 billion
in FY 2009, and translating to 358 monthly days cash. Preliminary
FY 2012 results indicate higher unrestricted liquidity.
*Continued fundraising success, with no noted impact from the
recent sexual abuse scandal. Penn State reported $236 million
of gift revenues for FY 2011, including an $88 million gift,
with three-year average gift revenues of $200 million.
Penn State has raised over $1.64 billion against the $2
billion goal in its "For the Future" campaign, with
a targeted campaign end of June 2014. FY 2012 was successful,
with Penn State announcing that it had raised $208.7 million
for the year, its second highest annual gift level.
*Low reliance on state funding, with Commonwealth appropriations
of $334 million representing only 7.3% of FY 2011
total operating revenues, resulting in minimal decline in revenues
from announced or expected budget reductions. FY 2012 appropriations
were reduced to $268 million but increased slightly to $279
million for the current FY 2013.
OUTLOOK
The stable outlook reflects expectations that the ultimate resolution
of victims' claims will result in no further diminishment of unrestricted
cash and investments than currently estimated. Further, Penn
State is expected to continue to enjoy favorable student demand,
positive operating performance and cash flow, high donor support
and strong research position -- all providing positive cash flow
and rebuilding of its balance sheet resources over time.
WHAT COULD MAKE THE RATING GO UP
Not likely for the near-term. An upgrade could be driven
by favorable resolution of legal claims at substantially lower than expected
cost and little diminishment of balance sheet financial resources;
strengthening of student demand and stable enrollment at the regional
campuses, leading to greater pricing elasticity; evidence of
successful implementation of improved governance practices and culture;
significant growth in financial resources through increased private gifts
and maintenance of operating surpluses.
WHAT COULD MAKE THE RATING GO DOWN
Significant increase in the number of legal claims or unanticipated negative
developments in the settlement process or the ongoing investigations;
failure to successfully implement governance and management best practices,
including recommendations of the Freeh Report; material and sustained
reduction in student demand, fundraising results or research awards;
weakening of operating performance for patient care enterprise.
PRINCIPAL RATING METHODOLOGY
The principal methodology used in this rating was U.S. Not-for-Profit
Private and Public Higher Education published in August 2011. Please
see the Credit Policy page on www.moodys.com for a copy
of this methodology.
REGULATORY DISCLOSURES
The Global Scale Credit Ratings on this press release that are issued
by one of Moody's affiliates outside the EU are endorsed by Moody's
Investors Service Ltd., One Canada Square, Canary Wharf,
London E 14 5FA, UK, in accordance with Art.4 paragraph
3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies.
Further information on the EU endorsement status and on the Moody's
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Diane F. Viacava
VP - Senior Credit Officer
Public Finance Group
Moody's Investors Service, Inc.
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Dennis M. Gephardt
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Moody's downgrades Pennsylvania State University's long-term rating to Aa2 from Aa1, affecting $893 million of outstanding rated debt
