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MOODY'S ASSIGNS Aaa RATING TO HARVARD UNIVERSITY'S (MA) SERIES 2010B TAX-EXEMPT AND 2010C TAXABLE FIXED-RATE BONDS AND AFFIRMS ALL OUTSTANDING RATINGS; OUTLOOK IS STABLE

01 Nov 2010

UNIVERSITY WILL HAVE APPROXIMATELY $6.4 BILLION OF OUTSTANDING RATED DEBT ($9.1 BILLION INCLUDING COMMERCIAL PAPER PROGRAMS AT FULL AUTHORIZED AMOUNTS)

Massachusetts Development Finance Agency
Higher Education
MA

Moody's Rating

ISSUE

RATING

Tax-Exempt Revenue Bonds, Series 2010B

Aaa

  Sale Amount

$730,000,000

  Expected Sale Date

11/09/10

  Rating Description

Private University Revenue Bonds

 

Taxable Revenue Bonds, Series 2010C

Aaa

  Sale Amount

$300,000,000

  Expected Sale Date

11/09/10

  Rating Description

Private University Revenue Bonds

 

 
Moody's Outlook   Stable
 

Opinion

NEW YORK, Nov 1, 2010 -- Moody's Investors Service has assigned a Aaa rating to Harvard University's approximately $730 million of Series 2010B tax-exempt revenue bonds and approximately $300 million of 2010C taxable revenue bonds. The Series 2010B bonds will be issued through the Massachusetts Development Finance Agency. The outlook is stable. The University's other long-term and short-term ratings have been affirmed. A detailed list of rated debt is included at the end of this report.

RATINGS RATIONALE

USE OF PROCEEDS: The University will utilize bond proceeds to refinance previously issued debt, to refinance to long-term debt borrowings under the commercial paper programs, and to finance costs associated with various capital projects, including construction costs related to the Fogg Art Museum, and costs of issuance. The University's pro-forma outstanding debt will increase to $6.6 billion, up from $6.3 billion outstanding in FY 2010.

LEGAL SECURITY: Unsecured general obligation of the University

DEBT-RELATED INTEREST RATE DERIVATIVES: In order to manage risks associated with its debt, the University uses swaps and derivatives. As of June 30, 2010, the debt-related swap portfolio had a market valuation of negative $731 million to the University, and Harvard had this full amount posted as collateral to swap counterparties. During the past two years, the University has made significant modifications to its swap portfolio by terminating a large notional amount of swaps, and the University is further evaluating the possibility of terminating existing floating-to-fixed interest rate swaps. Harvard's collateral posting requirements and other obligations under the swap agreements are a key part of our analysis of the liquidity of the University and Moody's reviews stress scenarios on the portfolio to assess the potential liquidity risks the transactions pose. Moody's has determined that Harvard has sufficient liquidity to manage risk at a level consistent with the Aaa rating.

STRENGTHS

*Largest financial resource base ($30.2 billion in FY 2010) of all universities globally, with a renewed focus on building organizational liquidity;

*Extraordinary and long history of philanthropic support, with total gifts averaging $527 million annually during FY 2008-2010;

*One of the strongest market positions of any U.S. university, including very strong student demand (7% freshmen selectivity and 76% freshmen matriculation in fall 2010) and large, growing research enterprise ($776.8 million of research revenues in FY 2010);

* Robust operating performance (18.6% three-year average operating margin by Moody's pro-forma calculation) from a diversified revenue base;

* Ample liquid assets and capable management team supporting highest short-term ratings based on self-liquidity program.

CHALLENGES

* Significant investment losses in FY2009 have reduced balance sheet strength ($30.2 billion of total financial resources in FY 2010 compared to $42.8 billion in FY 2008); forced the university to undertake unexpected budget cuts because more than 40% of annual operating revenue is provided from investment income;

* Liquidity management is critical for the University because of its large portfolio of private investments and variable-rate debt and swaps which can require collateral posting; however the University retains considerable flexibility from its large portfolio of liquid holdings and external bank liquidity facility and has focused on minimizing exposure to potential, unpredicted calls on liquidity and better coordinating liquidity needs of the University and its endowment;

* In the near term, the University has reduced capital spending and is taking significant steps toward centralizing key functions and processes, recognizing the need for more efficient operations in the aftermath of balance sheet weakening and reduced revenue flow from the endowment. Over the longer term this change will likely strengthen the University's credit position;

MARKET POSITION/COMPETITIVE STRATEGY: DIVERSE ACADEMIC PROGRAMS AND RESEARCH ENTERPRISE ARE TOP-TIER GLOBALLY

As one of the world's most prestigious universities, Harvard attracts large numbers of applicants for admission to its undergraduate college and broad array of graduate and professional programs, assuring stability of enrollment (an estimated 19,269 full-time equivalent students in fall 2010). Undergraduate student demand is extraordinary, leading the national higher education market with a 7% selectivity rate and yield of 76% for fall 2010 freshmen admissions. Even these impressive numbers understate the University's market strength because many thousands of academically strong students do not bother to apply to Harvard due to the low probability of being admitted.

The University has implemented a financial aid initiative that has eliminated loans for families in certain income brackets, excludes home equity in financial aid award determinations, and provides substantial relief to families earning up to $180,000 per year. We expect this change to allow the University even greater ability to select and shape its class with a focus on socio-economic and geographic diversity. As expected, these expanded financial aid initiatives have pressured growth of net tuition revenue, with $16,987 of net tuition per student generated in FY 2010 (excluding continuing education and executive education revenue) down from $18,129 in FY 2008 as calculated by Moody's.

Harvard is also one of the nation's premier research institutions, and has a strong trend of success in garnering federal and other research grants. The largest share of funding comes from the National Institutes of Health (NIH). In FY 2010, the University's research revenues grew to $776.8 million, including growth of research funding provided through federal stimulus funding. Through FY 2010, Harvard had received 264 ARRA awards totaling $190 million of research funding. Research expenditures represented nearly 18% of Harvard's $3.73 billion expense base in FY 2010.

OPERATING PERFORMANCE: HIGHLY DIVERSIFIED REVENUE BASE CONTRIBUTES TO HEALTHY OPERATING PERFORMANCE; FOCUS ON EXPENSE CONTAINMENT TO OFFSET REDUCED ENDOWMENT DRAW

Moody's expects Harvard to continue achieving positive operating margins as calculated by Moody's, despite pressure on future endowment draws due to past investment losses. Revenues are well diversified and mitigate vulnerability to an economic downturn in any one revenue stream, and management is very focused on ongoing expense containment. Leading revenue sources are investment income (42%) grants and contracts (15%), tuition and auxiliaries (10%), and private gifts (17%) by Moody's calculation.

Operating margins averaged 18.6% during FY 2008 through 2010 according to Moody's model which normalizes endowment spending at 5% of a three-year moving average of total cash and investments. The operating margin in 2010 was 19%, and operating cash flow margin was a very strong 31%. The University's annual debt service coverage is strong, averaging 4.6 times during FY 2008-2010 (excluding refunded debt). However, the University's future debt service payments are volatile with large bullet payments scheduled for FY 2014 and 2019. Management is evaluating the possibility of paying down debt when those bullets mature as well as refunding opportunities.

The University's primary near-term operating challenge will be adjusting to losses on its endowment and the associated impact on endowment spending. By its own calculation, Harvard's endowment draw in FY 2010 declined 7% to $1.32 billion in FY 2010 and is anticipated to decline further in FY 2011. The University has responded with a number of expenditure reductions and we expect will be able to adjust appropriately.

BALANCE SHEET POSITION: WEALTH INDICATORS REMAIN EXTRAORDINARILY STRONG; INCREASED FOCUS ON ORGANIZATIONAL LIQUIDITY

Strong long-term trends in private gifts and investment gains have enabled Harvard to accumulate the largest financial base of any U.S. university, which Moody's expects to continue providing a superior cushion against potential financial stress. This financial base is used to fund a large and complex array of academic, research and student programs. Financial resources aggregated $30.2 billion as of June 30, 2010, and expendable financial resources (which exclude permanently restricted endowment corpus) provided excellent coverage of 3.7 times pro-forma outstanding debt (including Series 2010B and C) and 6.6 times annual operations. Further, the University's resource base is depressed by post-retirement liabilities, including a pension and post-retirement health plans, which represented a combined liability of over $900 million in FY 2010.

After experiencing a 27.3% investment loss during fiscal year 2009, Harvard's endowment has begun to rebound, with a reported 11% positive return achieved in FY 2010. Harvard's long-term performance remains well above benchmarks, including a 7% ten-year annualized return and a 11.9% twenty-year annualized return. Harvard's policy portfolio is highly diversified among asset classes including current policy targets of 33% in public equities, 13% private equities, 16% absolute return strategies, 23% real assets, 13% fixed income instruments, and 2% cash. The University has substantially reduced its unfunded capital commitments, partly through funding of commitments as well as accessing secondary markets to sell certain illiquid assets. Unfunded commitments in FY 2010 totaled $6.6 billion, compared to a much higher $11 billion two years ago. Although Moody's has not received full disclosure of Harvard's investment and manager allocations, based on information provided by the University, we do not believe there are any undue concentrations to external managers within the endowment.

The University also directly employs a significant amount of hedging strategies utilizing off-balance sheet derivatives. As of June 30, 2010, these investments (including debt-related interest rate swap agreements) included gross derivative assets of $612.3 million and gross derivative liabilities of $1.3 billion with a net liability of $700 million for the University. We note that this portfolio is large, its makeup can change substantially over short periods of time and collateral posting requirements could accelerate if rapid movements in investment markets occur.

The University continues to focus on strategies for building organizational liquidity to adequately cushion future liabilities and any potential unexpected or accelerated calls on liquidity. We believe the Harvard Management Company, which oversees the endowment's investment management, and the University have become increasingly integrated in assessing organizational liquidity needs. The University has established a new committee to assist with integrated risk assessment across the University and HMC. We believe that liquidity within the endowment and outside of the endowment has strengthened over the past two years and provides a strong cushion for expenses and demand debt. Notably, the University's exposure to puttable debt has declined significantly over the past two years and will decline to approximately $501 million after this refunding is completed (only including outstanding commercial paper). In FY 2010, the University reported to Moody's $9 billion of unrestricted cash and investments which could be liquidated within a one month timeframe, including large allocations to money market funds, treasury and agency securities. This unrestricted monthly liquidity would provide a very strong 954 days cash on hand in FY 2010 and cover pro-forma demand debt in FY 2010 over 18 times. In addition to its own liquidity, Harvard has established a $2 billion credit facility (authorized amounts spread across 22 liquidity providers) which could provide additional liquidity.

Harvard's level of private giving consistently ranks at or near the top of all U.S. universities. Although the University has experienced declines in unrestricted "current use" gifts (down 15% in FY 2010), the total level of giving remains very strong, with $527 million of average gift revenue during FY 2008-2010 per the financial statements. We expect an increased focus on gifts to support near-term capital needs, with a significantly slower pace of future borrowing and a reduced pace of capital spending. In FY 2010, the University's capital spending ratio (cash spent on plant divided by annual depreciation expense) declined to 1.5 times compared to nearly 3 times in FY 2007. Further, the University has paused its originally very large-scale plans for the Allston Science Complex and has been actively leasing vacant Harvard properties in Allston.

SHORT TERM RATING RATIONALE: HARVARD USES ITS OWN LIQUIDITY TO SUPPORT OUTSTANDING VARIABLE RATE BONDS AND TWO COMMERCIAL PAPER PROGRAMS

The highest short-term ratings of P-1 and VMIG1 are based on Harvard's strong internal liquidity and treasury management. As of September 30, 2010, the University held over $3.6 billion of discounted daily liquidity, including SEC 2a-7 compliant money market funds, treasury and agency securities. The University also holds nearly $2.2 billion in readily saleable equity holdings (not discounted) that could be liquidated within a week's time. This compares favorably to $131 million of daily VRDO's and $502 million of weekly VRDO's that were outstanding at September 30, 2010. In addition to its variable-rate demand bonds, the University has a $1 billion tax-exempt commercial paper program (CP) and $2 billion authorized taxable CP program. The University has established an explicit policy that no more than $250 million of commercial paper will come due on any given business day and no more than $500 million will come due within any single calendar week. Although the CP programs are authorized up to $3 billion, only $633 million was outstanding at September 30, and proceeds of the Series 2010B and 2010C bonds will pay down a portion of outstanding CP ($346 million of combined CP expected to be outstanding pro-forma).

In Moody's opinion, the University's daily liquidity provides very strong liquidity coverage of self-liquidity debt. As mentioned above, the University also maintains a $2 billion line of credit agreement that has not been drawn upon, which supplements its liquidity position. The University's operating line of credit does not meet Moody's criteria for inclusion as a source of same-day self-liquidity, so we do not formally include it in our self liquidity analysis although we believe it could serve as a source of operational liquidity.

Outlook

The stable outlook is based on Moody's expectation of Harvard's continued superior financial cushion, premier market position, and positive operating margins. We also expect the University's investment and liquidity management, capital planning and borrowing to remain consistent with its historic practices and in-line with expectations for the highest long-term and short-term ratings

WHAT COULD CHANGE THE RATING - UP

Not applicable

WHAT COULD CHANGE THE RATING - DOWN

Dramatic increase in leverage to fund capital investments without stabilization and resumed growth of balance sheet resources. Failure to sustain a strong liquidity position relative to its potential liquidity needs.

KEY DATA AND RATIOS (Fiscal year 2010 financial data; fall 2010 enrollment data):

Total Enrollment: 19,269 full-time equivalent students (current estimate)

Total Pro-forma Debt: $6.6 billion ($9.28 billion at full authorized commercial paper size)

Expendable Resources to Pro-forma Debt (CP outstanding): 3.7x

Expendable Resources to Pro-forma Debt (full authorization of CP): 2.7x

Expendable Resources to Operations: 6.6x

Total Financial Resources: $30.2 billion

Three-Year Average Operating Margin: 18.6%

CONTACTS:

University: Craig McCurley, Director, Office of Treasury Management, 617-495-1866

LAST RATING ACTION:

The last rating action was on January 8, 2010 when the University's Aaa, Aaa/VMIG1, and P-1 ratings were affirmed.

METHODOLOGY:

The principal methodology used in rating Harvard University, MA 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.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings and public 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

Kimberly S. Tuby
Analyst
Public Finance Group
Moody's Investors Service

John C. Nelson
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 Aaa RATING TO HARVARD UNIVERSITY'S (MA) SERIES 2010B TAX-EXEMPT AND 2010C TAXABLE FIXED-RATE BONDS AND AFFIRMS ALL OUTSTANDING RATINGS; OUTLOOK IS STABLE
No Related Data.
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