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MOODY'S ASSIGNS Aa3 RATING TO SOUTHERN METHODIST UNIVERSITY'S (TX) $117.0 MILLION OF SERIES 2010 BONDS; OUTLOOK IS STABLE

04 Oct 2010

UNIVERSITY WILL HAVE $392.7 MILLION RATED DEBT INCLUDING THE CURRENT OFFERING

Southwest Higher Education Authority, TX
Higher Education
TX

Moody's Rating

ISSUE

RATING

Higher Education Revenue Bonds, Series 2010

Aa3

  Sale Amount

$117,000,000

  Expected Sale Date

10/07/10

  Rating Description

Private University Revenue

 

Opinion

NEW YORK, Oct 4, 2010 -- Moody's Investors Service has assigned a Aa3 rating to Southern Methodist University's (SMU or the University) Series 2010 Higher Education Revenue Bonds to be issued through the Southwest Higher Education Authority. At this time, we are also affirming SMU's Aa3 long-term rating on other outstanding debt as listed below under RATED DEBT. The rating outlook is stable. Following issuance of the Series 2010 bonds, the University will have $413.3 million of direct debt outstanding, of which 5% is in a variable rate mode with a put feature.

RATINGS RATIONALE

USE OF PROCEEDS: Bond proceeds will be used to fund construction, renovation, and equipping of University facilities, particularly new student housing as part of the Residential Commons project and associated projects and infrastructure; fund capitalized interest; and pay costs of issuance.

LEGAL SECURITY: Loan payments under the Loan Agreement constitute a general obligation of the University. Additional bonds tests require debt with a maturity of more than one year to be no more than 2 times the sum of net unrestricted and temporarily restricted net assets and the amount of variable rate debt to be no more than 0.5 times the sum of net unrestricted and temporarily restricted net assets.

INTEREST RATE DERIVATIVES: None.

STRENGTHS

*Consistently positive operating results produce solid operating cash flow margin to support debt service. SMU's annual operating margin for Fiscal Year (FY) 2010 (ended May 31, 2010) was 6.5%, which contributed to a three-year annual average operating margin of 8.4% (FY 2008-2010). Operating cash flow margin in FY 2010 was 16.2%, and the three-year average debt service coverage was 1.5 times. Debt service was elevated in FY 2009 and 2010 by repayments of notes payable used to finance property acquisitions in recent years.

*Strong market position as a large, diversified, private university in the demographically vibrant City of Dallas. SMU's trend in improvement in student demand at the undergraduate level (65% of total enrollment) in recent years has been notable, and first-year demand rebounded from slight weakening for fall 2009, with record applications, selectivity at 54% of freshman applicants, and matriculation steady at 31%.

*Stable debt structure with 95% of pro-forma debt in a fixed rate mode provides for stability in operating expense and predictability in budgeting.

CHALLENGES

*Lack of balance sheet growth due to capital spending in recent years and investment loss in FY 2009 results in leverage position that is low for the Aa-rated private college and university category. Expendable financial resources for FY 2010 cover pro-forma debt by 1.2 times and operations by 1.3 times, which compare unfavorably with peer medians of 2.3 and 2.2 times, respectively, for FY 2009. Peer ratios have likely strengthened with investment returns for FY 2010. Potential additional borrowing of approximately $100 million within the next two years could pressure the current rating if financial resources do not grow commensurately.

*Relatively weak liquidity position compared to peers and potential liquidity needs. Based on Moody's methodology for analyzing monthly liquidity, SMU held $176 million in unrestricted monthly liquidity, which translated into 175 monthly days cash on hand (days cash on hand from investments liquid within one month) compared to the Moody's Aa-rated private university median of 376 monthly days cash on hand for FY 2009. The University supports the tender feature of its $19.2 million Series 1985 bonds with its own self-liquidity and had $229 million of unfunded investment commitments at fiscal year end 2010.

*Sustained expansion of research enterprise may prove challenging. SMU is seeking to increase its grants and contract revenue to a sustained level of $30 million annually by FY 2015. While the University has seen success as its grants and contracts revenue nearly doubled to $30 million in FY 2008 from $16 million in FY 2005, revenue from this activity fell to $25 million in FY 2010. Moody's believes higher levels could be difficult given limited growth in federal research funds and the competitive pressure for sponsored research funding.

MARKET/COMPETITIVE STRATEGY: MARKET POSITION BOOSTED BY REBOUND IN FIRST-YEAR DEMAND AND CONTINUED GROWTH IN NET TUITION PER STUDENT, THOUGH AT SLOWER PACE

In Moody's opinion, SMU's overall improvement in student demand at the undergraduate level since the beginning of the decade remains notable and reflects a positive return on the University's strategic spending on capital and programs. Approximately two-thirds of the University's total full-time equivalent (FTE) enrollment of 9,282 students for fall 2010 is undergraduates. Graduate enrollment is diversified with largest enrollment in the Schools of Law (963 FTE), Business (808 FTE students), and Engineering (390 students). Established in 1911, SMU is located in the Dallas metropolitan area. SMU remains affiliated with the Methodist Church. At the same time, a limited 11% of the University's student population identifies itself as Methodist.

After experiencing a slight weakening in undergraduate demand for fall 2009 that resulted in a modestly smaller incoming class, SMU enjoyed record applications (9,024) and matriculation (1,479) for fall 2010. Freshman selectivity remains near recent levels at 53.8% for fall 2010 and matriculation of 30.5% is slightly below the recent record of 34.4% for fall 2005. Moody's notes that selectivity has improved significantly from 75% for fall 2001. We believe the matriculation rate reflects continued competition with lower-cost public institutions in Texas, the home of approximately 45% of first-year students in fall 2010, as well as SMU's efforts to boost its academic profile. The University has been successful in recruiting more highly qualified students, with the average SAT score for first-year students increasing to 1,243 for fall 2010 compared to 1,202 for fall 2004. SMU is undertaking a two-year effort to more effectively reach this pool of potential students beginning with applications for fall 2011. The University aims to increase its national profile and competitive position as well as first-year retention in large part with a new sophomore residency requirement being facilitated by the housing projects to be funded with the current bond issue. Graduate and professional enrollment has increased 10% since fall 2006, with decreased FTE counts in the engineering and theology schools offsetting growth in the full-time MBA program and school of education and human development.

Net tuition per student continues to grow, reaching $23,546 in FY 2010, which represents an increase of 24% since 2006, and has become competitive with the median level for other Aa-rated private colleges and universities ($22,899 in FY 2009). However, the pace of growth in net tuition per student has slowed to an annual average of 3.5% in FY 2009 and 2010 from an average of 6.6% in FY 2006-2008. The slower growth represents both reduced increases in tuition and fees (6.0% average increase in FY 2009 and 2010 versus 7.3% for the prior three years) and additional financial aid. For FY 2010, SMU's overall tuition discount rate had grown to 33.2% from 27.0% in 2000. The 2010 figure is slightly below the Aa-rated median for FY 2009 of 34.8%.

In February 2008, SMU was selected as the location for the George W. Bush Presidential Center, which will include a library, museum, and policy institute. The University is providing a site for the center under a ground lease with an initial term of 99 years and six optional renewals of 25 years each thereafter. The George W. Bush Foundation, a private entity, is raising a targeted $300 million to establish the Center, and the National Archives and Records Administration, a federal government agency, will operate the Center after opening. Groundbreaking is scheduled for November 2010, and opening is expected in 2013. SMU's fundraising efforts are separate from those of the Bush Foundation and the University will have no operational obligations for the Center.

OPERATING PERFORMANCE: ABILITY TO GENERATE CONTINUED POSITIVE OPERATING RESULTS IS A CREDIT STRENGTH

The University has consistently produced positive operating results during this decade under Moody's methodology, ranging from 2.3% to 10.3%. For FY 2010, SMU's operating margin was 6.5%, which generated an operating cash flow margin of 16.2% and debt service coverage of 1.1 times. Debt service in FY 2010 was elevated due to the repayment of notes payable, primarily used for property purchases, during that year. Annual debt service has represented a relatively high share of expenses at an annual average of 13.3% in FY 2008-2010 due to repayment of notes payable in both 2009 and 2010. The 10.3% operating margin produced in FY 2009 reflects a high $53 million in gifts for operations received that year.

While SMU has displayed good management of operating expenses during a period of uncertainty, we expect operating margins may narrow in future years if the rate of growth in net tuition per student is maintained at the slower pace. Student charges represent 61% of operating revenues as calculated by Moody's, which is higher than the FY 2009 Aa-private median of 55%. Additionally, SMU is dedicating a portion of its annual tuition increase beginning in FY 2010 to fund the Residential Commons housing projects also being funded with proceeds of the current bond issue, which could reduce the share of tuition revenue available for operating purposes.

In response to investment losses and economic uncertainty, in spring 2009, the University implemented expenditure controls. For FY 2010, the University reduced its budget by 1.75% in the academic and 2% in the administrative areas

and had planned to draw on reserves to fund approximately $10 million in general expenses. Actual performance was significantly better, and the University added $13.6 million to reserves. The budget for FY 2011 continues the close management of expenses and conservative fiscal practices. The University enjoys good diversity in revenue sources, with key sources in FY 2010 composed of student charges (61%), investment income (17% utilizing Moody's methodology that assumes spending of 5% of the three-year average cash and investments balance), gifts (8%), and grants and contracts (6%).

SMU is seeking to increase its grants and contract revenue to a sustained level of $30 million annually by FY 2015. While the University has seen success as its grants and contracts revenue nearly doubled to $30 million in FY 2008 from $16 million in FY 2005, revenue from this activity fell to $25 million in FY 2010. Moody's believes continued higher levels could be difficult given limited growth in federal research funds, the competitive pressure for sponsored research funding, and SMU's lack of a medical school, which often attracts a greater amount of grants. SMU's federal awards are from a diverse set of agencies, including the Departments of Education and Defense along with the National Institutes of Health and the National Science Foundation.

BALANCE SHEET POSITION: LIMITED GROWTH IN FINANCIAL RESOURCES INCREASES LEVERAGE AND LIQUIDITY IS RELATIVELY LOW; CONTINUED BORROWING COULD PRESSURE CURRENT RATING

In Moody's opinion, the University's leverage position after the current debt issuance could make it difficult for SMU to absorb additional debt anticipated at the Aa3 rating level, particularly if financial resources do not grow commensurately. SMU has lagged its peers in balance sheet growth; total financial resources of $1.0 billion in FY 2010 are flat compared to FY 2005, while Aa-rated private colleges and universities experienced a median 7.5% growth in total financial resources from FY 2005 through 2009 and will likely grow in FY 2010 as a result of positive investment returns. With the current debt issue, expendable financial resources of $510 million cover pro-forma debt by 1.2 times and operations by 1.3 times. These ratios compare to the Aa-rated private medians for FY 2009 of 2.3 and 2.2 times, respectively.

SMU's growth in financial resources has been muted by spending on capital projects and an investment loss of 24.0% in FY 2009. SMU's annual capital spending ratio (capital purchases divided by depreciation) averaged 301% and capital purchases totaled $345 million in FY 2006-2010. We note that financial resources are depressed slightly by a postretirement health benefit liability, which stood at $34 million as of May 31, 2010. Following issuance of the Series 2010 bonds, the University expects to issue additional debt of approximately $100 million by 2012 to complete the Residential Commons project. The University is bolstering financial resources with additional gifts being raised in its current capital campaign. The $750 million campaign began in a quiet phase in 2006 and the completion date was recently extended to 2015. SMU has raised $453 million in pledges, of which $264 million has been received in cash.

We believe the University's liquidity position is relatively weak for the Aa rating category and compared to its potential liquidity needs. Based on Moody's methodology for analyzing monthly liquidity, SMU held $176 million in unrestricted monthly liquidity and $177 million in unrestricted annual liquidity as of May 31, 2010, which translated into 175 monthly and annual days cash on hand (days cash on hand from investments liquid within one month and one year) compared to the Aa-rated private median of 376 monthly days cash on hand and 404 annual days cash on hand for FY 2009. In addition, the University maintains a $15 million operating line of credit with Bank of Texas (not rated) that expires June 23, 2011 under which no amount is currently drawn. While most debt is fixed rate, SMU's Series 1985 bonds totaling $19.2 million outstanding are weekly reset variable rate bonds for which the University provides support for potential unremarketed tenders with its own self-liquidity (Moody's maintains no rating on these bonds). At fiscal year end 2010, SMU had $229 million of unfunded investment commitments. While the capital calls are likely to be distributed over multiple years, this amount exceeds the University's annual available liquidity.

SMU reported an investment return of 7.8% for the fiscal year ended May 31, 2010. As of July 31, 2010, investments are allocated across absolute return (27%), equities (23% total, including 13% domestic and 10% international), real assets (21%, including 11% oil and gas, 8% real estate, and 2% timber), private equity and venture capital (20%), fixed income (8%), and cash (1%). The highest allocation to a single manager is 10.4% held across four funds. We note that all fixed income investments are held with one manager.

The University benefits from a stable debt structure. With the current issuance, 95% of all outstanding debt will be in the fixed rate mode with no debt-related derivatives employed. In our opinion, this structure provides for stability in operating expense and predictability in budgeting, although we note that debt service in FY 2009 and 2010 represented a high share of operating expenses (average of approximately 15% each year) and pro-format maximum annual debt service would be 12% of FY 2010 expenses.

Outlook

The stable outlook is based on the University's continued healthy operating performance and improvements in student market position. The stable outlook incorporates our expectation that any additional borrowing will be commensurate with growth in financial resources.

What could change the rating-UP

Growth in financial resources over time from operating surpluses, philanthropic support, and investment returns combined with further strengthening of undergraduate student demand

What could change the rating-DOWN

Additional borrowing without commensurate growth in financial resources; sustained deterioration of operating performance; failure to grow financial resources; ongoing weakness in student demand

KEY INDICATORS (FY 2010 financial data and fall 2010 enrollment data)

Total FTE Enrollment: 9,282 students

Total Pro-Forma Direct Debt: $413.3 million

Expendable Financial Resources: $509.8 million

Total Financial Resources: $1.0 billion

Expendable Financial Resources to Pro-Forma Direct Debt: 1.23 times

Expendable Financial Resources to Operations: 1.29 times

Monthly Liquidity: $176 million

Monthly Days Cash (unrestricted funds available within 1 month divided by operating expenses excluding depreciation, divided by 365 days): 175 days

Total Financial Resources per Student: $107,996

Average Operating Margin: 8.4%

RATED DEBT

Series 2009, 2010: Aa3

Series 2002, 2003, 2007: Aa3; Ambac insured (Ambac's current financial strength rating is Caa2 under review for possible upgrade)

CONTACTS

Southern Methodist University: Chris Casey, Vice President for Business and Finance, 214-768-1178

Financial Advisor: Laura Alexander, First Southwest, 817-332-9710

METHODOLOGY AND LAST RATING ACTION

The principal methodology used in rating Southern Methodist University, TX was Moody's Rating Approach for Private Colleges and Universities rating methodology published in September 2002. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found on Moody's website.

The last rating with respect to Southern Methodist University was on September 11, 2009 when the Aa3 rating with a stable outlook was affirmed. The rating was subsequently recalibrated to Aa3 on May 7, 2010.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, public information, and confidential and proprietary Moody's Analytics information.

Moody's Investors Service considers the quality of information available on the credit satisfactory for the purposes of assigning a credit rating.

MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODY'S is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Analysts

Laura C. Sander
Analyst
Public Finance Group
Moody's Investors Service

Amy Tanaka
Backup Analyst
Public Finance Group
Moody's Investors Service

Contacts

Journalists: (212) 553-0376
Research Clients: (212) 553-1653


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MOODY'S ASSIGNS Aa3 RATING TO SOUTHERN METHODIST UNIVERSITY'S (TX) $117.0 MILLION OF SERIES 2010 BONDS; OUTLOOK IS STABLE
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