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MOODY'S ASSIGNS P-1 RATING TO UNIVERSITY OF MICHIGAN'S $200 MILLION OF COMMERCIAL PAPER NOTES, SERIES E (TAXABLE) AND SERIES I (TAX-EXEMPT) AND AFFIRMS Aaa, Aaa/VMIG 1, AND P-1 RATINGS; OUTLOOK REMAINS STABLE

28 Apr 2011

UNIVERSITY WILL HAVE APPROXIMATELY $1.8 BILLION OF RATED DEBT OUTSTANDING, INCLUDING COMMERCIAL PAPER AT FULL AUTHORIZED PROGRAM SIZE

Regents of the University of Michigan
Higher Education
MI

Moody's Rating

ISSUE

RATING

Commercial Paper Notes, Series E Taxable and Series I Tax-Exempt

P-1

  Sale Amount

$200,000,000

  Expected Sale Date

05/05/11

  Rating Description

Public University Commercial Paper

 

 
Moody's Outlook   Stable
 

Opinion

NEW YORK, Apr 28, 2011 -- Moody's Investors Service has assigned a P-1 rating to The University of Michigan's (The University) $200 million of Commercial Paper Notes (CP), Series E (Taxable) and Series I (Tax-Exempt). At this time, Moody's has affirmed The University's Aaa, Aaa/VMIG 1, and P-1 ratings (as detailed in the RATED DEBT section of this report). The outlook remains stable.

SUMMARY RATING RATIONALE

The University of Michigan's Aaa rating and stable outlook reflect its strong market position as a large, flagship university with one of the nation's largest research enterprises and a preeminent reputation as an academic medical center. The rating also incorporates the University's superior financial flexibility derived from its robust balance sheet, consistently positive operating performance, and history of strong philanthropic support. The University's key credit challenges include its high degree of exposure to the potentially volatile healthcare market, extensive capital plans, and exposure to the economically depressed State of Michigan. The highest short-term ratings of P-1 and VMIG1 are based on The University of Michigan's strong internal liquidity and treasury management, dedicated bank lines, and external liquidity facilities.

STRENGTHS

*Prestigious, large, comprehensive university enrolling more than 53,000 full-time equivalent undergraduate, graduate, and professional students across a diverse array of programs on three campuses. The University's ability to attract students from a broad geographic area (35% of undergraduate students from outside of Michigan in fall 2010) combined with strong selectivity and yield (50.6% and 40.6%, respectively) reflect the strength of its market position.

*Superior financial flexibility derived from a robust balance sheet and manageable leverage profile. In fiscal year (FY) 2010, total financial resources of $5.9 billion (depressed by a $1.6 billion other post-employment benefit obligation) covered pro-forma debt, including CP at the full authorized amount, at 3.3 times and 113% of The University's $5.2 billion expense base. We expect continued balance sheet strengthening over time due to a history of solid philanthropic support and diversified investment management.

*Preeminent reputation as a quaternary academic medical center, with a broad geographic area that extends across the state, partially mitigating the competitive pressures faced by hospitals with a more localized service region. The University of Michigan Hospitals and Health Centers' (rated Aa2, stable) provision of high-end specialty services as well as significant recent capital investments which will increase capacity should continue to drive solid demand.

*One of the nation's leading research organizations, with $671.5 million in research expenses in FY 2010. Research expenses have increased at an average annual rate of 7.5% over the past three years, aided by federal stimulus funding. Research areas are relatively well diversified, with the largest recipients including the medical school (45%), college of engineering (16%), the college of literature, science and the arts (10%), and the institute for social research (9%).

*Consistently positive operating margins driven by the strong performance of the University of Michigan Hospitals and Health Centers which comprises the largest share of Moody's adjusted operating revenue. Operating performance has averaged 3.6% during FY 2008-2010, providing a strong 8.9 times average annual coverage of debt service during the same time period. The revenue base consists of 44% health care-related activities, 19% student charges, 18% grants and contracts (excluding Pell grant revenue), 8% investment income, 7% state operating appropriations, and 4% from other sources. The continued positive performance in provision of health care services is important to The University's overall cash flow.

CHALLENGES

*High degree of exposure to the potentially volatile healthcare market, with much of The University's profitability and cash flow driven by hospital operations. These revenues may be substantially more pressured or uncertain than other revenue streams given pressures on State funding for Medicaid and healthcare reform. In FY 2010, patient care revenue accounted for nearly 44% of Moody's adjusted operating revenue.

*Extensive capital plan totaling $5.7 billion during fiscal years 2011-2020, with total debt issuance expected of $1.3 billion during this time period. The peak amount of debt outstanding is expected to reach $2.2 billion in 2017. The University retains considerable flexibility to adjust the timing of projects and its use of philanthropic support to finance projects.

*Exposure to the economically depressed State of Michigan (rated Aa2 with a stable outlook). However, The University derives a substantial amount of revenue from outside the State and has significant flexibility to further grow revenues from other regions of the country, especially from further diversification of student enrollment. It is also a substantial driver of economic activity in the State and is likely to be viewed as a positive investment by the State and other organizations.

DETAILED CREDIT DISCUSSION

USE OF PROCEEDS: Proceeds of the commercial paper program will be used for financing a variety of capital projects at The University and refinancing of existing commercial paper. Management anticipates use of the full authorized amount by the fall of 2011, with plans to refinance the CP with long-term debt during the first quarter of calendar year 2012. (We anticipate reaching the $200 million in the Fall and completing the long term debt issue in the first quarter of calendar year 2012)

LEGAL SECURITY: The bonds and commercial paper notes are secured by a pledge of General Revenues, which are unrestricted revenues including all receipts from tuition, fees, auxiliary revenues, indirect cost recoveries, and unrestricted investment income, but exclude state appropriations as well as hospital gross revenues, which are pledged to the University's Hospital System debt. As of March 31, 2011, the University has $64.1 million of senior lien indebtedness secured by General Revenues, maturing by 2027. The University of Michigan has covenanted not to issue new senior lien indebtedness while parity General Revenue Bonds are outstanding. In FY 2010, General Revenues totaled $2.5 billion.

INTEREST RATE DERIVATIVES: The University has entered into five interest rate swap agreements with four counterparties on the total notional amount of $285.2 million. The collateral posting requirements under the agreements at the current rating level range from $6 million to $25 million, with a minimum transfer of one million dollars. Two swaps not requiring collateral posting. As of April 27, 2011, The University is not posting collateral. Two of the obligations under the swap agreement are secured by General Revenues of The University on parity with outstanding bonds and notes, one is secured by Medical Service Plan revenues and two by Hospital Gross Revenues. Moody's has reviewed stress scenarios for collateral posting requirements and believes the risks to The University's liquidity and credit profile are minimal given its strong liquidity position and cash flow generation. As of March 31, 2011, the market value of the swaps to The University was a liability of $30 million.

MARKET/COMPETITIVE POSITION: LEADING PUBLIC UNIVERSITY WITH STRONG STUDENT DEMAND, PROMINENT RESEARCH ENTERPRISE, AND RENOWNED ACADEMIC MEDICAL CENTER

The University of Michigan maintains a prestigious market position as a large, comprehensive university enrolling more than 53,000 full-time equivalent undergraduate, graduate, and professional students across a diverse array of programs on three campuses. The University's preeminent position as a quaternary academic medical center and its extensive and diverse research profile supports its strong market position and enables The University to attract a geographically diverse student body. Approximately 76% of total full-time equivalent enrollment is located on the Ann Arbor campus, with 12% located in Dearborn and 12% located in Flint. Graduate and professional students comprise 30% of total full-time equivalent enrollment.

With its national prominence, The University attracts a significant number of non-resident students. In fall 2010, out-of- state undergraduate students accounted for 40% on the Ann Arbor campus. The University's ability to attract non-resident students is a credit strength, especially given the projected 15% decline in high school graduates in the State. More than 50% of The University's net tuition revenue is generated from students from outside the State of Michigan.

The University competes with top-ranked public and private institutions, with primary competitors including other Michigan public universities, Northwestern University, Purdue University, Cornell University, University of Pennsylvania, and Washington University. Growth of applications has enabled The University to maintain solid student demand while increasing the size of its incoming freshmen class. In fall 2010 on the Ann Arbor campus, The University accepted 50.6% of first-time freshmen applicants and 40.6% of accepted students enrolled. With the introduction of the Common Application for fall 2011 admissions, management reports an increase in applications of over 23% over the same time last year. While selectivity is expected to strengthen in fall 2011 due to the significant increase in applications, the impact on yield is unclear at this time.

The University of Michigan is one of the nation's leading research organizations, with $671.5 million in research expenses in FY 2010. Research expenses have increased at an average annual rate of 7.5% over the past three years, aided by federal stimulus funding. Research areas are relatively well diversified, with the largest recipients including the medical school (45%), college of engineering (16%), the college of literature, science and the arts (10%), and the institute for social research (9%). In FY 2010, federal funding accounted for 66% of research expenditures, with the Department of Health and Human Services accounting for the largest share of federal funding (71%). The University's purchase and planned renovation of the North Campus Research Complex (30 high-end research buildings previously occupied by a pharmaceutical company) will increase capacity and enable future research growth.

The operations of the University of Michigan Hospitals and Health Centers are consolidated within the University of Michigan's audited financial statements. Healthcare related revenue represents the largest share of Moody's-adjusted operating revenue for The University (43.6% in FY 2010). Located in Ann Arbor, it is the State and region's preeminent academic health center, operating over 900 beds with nearly 45,000 admissions in FY 2010. The health system maintains a relatively stable market position, drawing 35% locally, 46% regionally, and 19% from the far reaches of the State and out of the State. Also, the system's payer mix remains relatively stable comprised of 32% Medicare, 36% Blue Cross, 18% commercial and managed care payers and self-pay, and 14% Medicaid. Moody's believes that the structure of the health system organization, whereby a common administrator oversees the operations and capital spending for the Hospitals and Health Centers, the University of Michigan Medical School, and the Michigan Health Corporation, is a credit strength. This structure facilitates a shared strategic focus between the hospitals, physicians, medical school, and medical research. According to management, the health system is well-positioned for the implementation of healthcare reform as it piloted programs which were included in the recent legislation. The University's healthcare system maintains a stand-alone bond rating of Aa2 with a stable outlook based on debt secured by its own revenue. For more information on the University of Michigan Hospitals and Health Centers, please see Moody's rating report dated October 20, 2010.

OPERATING PERFORMANCE: CONSISTENTLY FAVORABLE OPERATING MARGINS AND CASH FLOW GENERATION HIGHLY RELIANT ON PROFITABILITY OF HEALTHCARE OPERATIONS

Moody's believes that The University will continue to generate favorable operating performance and healthy cash flow, despite near-term pressure on its healthcare operations and challenging state funding, due to its demonstrated fiscal discipline to reduce expenses and its flexibility to increase other revenue streams over time. During fiscal years 2008 to 2010, annual operating performance averaged 3.6% which provided a strong 8.9 times average debt service coverage on all debt outstanding during the same period. Management has focused on expense controls and efficiencies through the centralization of administrative services and functions, while continuing to make strategic investments in programs and facilities. In reaction to recent investment volatility, The University revised its endowment spending policy to gradually reduce the draw to 4.5% of a seven-year average from 5.0%.

The performance of The University is significantly influenced by the performance of The University's healthcare operations, which comprised 44% of Moody's-adjusted operating revenue in FY 2010. Management projects tightening of operating performance in the near-term due to escalated expenses associated with the opening of the new C.S. Mott Children's and Von Voigtlander Women's hospitals as well as the expansion of other patient care facilities. In addition, the hospitals face pressure from constrained State Medicaid funding, with potential additional pressure on future rates of reimbursement. Management reports positive, but narrower performance in FY 2011 than budgeted due to elevated expenses and lower volume, with margin remediation strategies in place to improve performance. Beyond patient care, other key revenue streams include student charges (19%), grants and contracts- excluding Pell Grant Revenue (18%), investment income (8%), and state funding (7%).

The University relies on state appropriations for a very small portion of annual revenues, although this is partially due to its large patient care and research activities. The University received over $372 million in state funding in FY 2010, including over $10 million of state stabilization funds (federal stimulus). Funding levels remained flat between FY 2009 and FY 2010, with a modest 2.8% reduction in FY 2011. We note that the State faces significant economic and budget challenges and will likely continue to face difficulty funding higher education. Management anticipates a 15% reduction in state support for FY 2012, including 5% incentive funding from the State to maintain tuition increases below 7% for in-state students. Given the State's history of funding cuts, including mid-year rescissions, The University budgets a contingency to protect against potential state funding volatility. We believe The University's well diversified revenue streams and ability to leverage its student market and philanthropic success should help offset future weakness in state funding.

Moody's maintains a general obligation rating of Aa2 with a stable outlook on the State of Michigan. The Aa2 rating is a low rating among states, incorporating the U.S. auto industry's long-term decline as well as the strengths Michigan has demonstrated in managing resulting economic and budgetary pressures. The state has maintained positive ending fund balances by relying heavily on nonrecurring solutions as well as cutting expenses and raising revenues, and it has a comparatively low net tax-supported debt burden and adequately funded pensions. For more information on the State of Michigan, see Moody's rating report dated April 6, 2011.

BALANCE SHEET POSITION: FINANCIAL FLEXIBILITY DERIVED FROM A SUPERIOR BALANCE SHEET AND MANAGEABLE LEVERAGE PROFILE; ADDITIONAL BORROWING EXPECTED TO SUPPORT EXTENSIVE CAPITAL PLAN

Moody's expects that The University will maintain superior financial flexibility derived from a robust balance sheet and manageable leverage profile. In FY 2010, total financial resources of $5.9 billion (depressed by a $1.6 billion other post-employment benefit obligation) covered pro-forma debt, including CP at full authorized amount, at 3.3 times and 113% of The University's $5.2 billion expense base. In addition, The University maintains moderate operating leverage with pro-forma debt-to-revenues of 0.3 times and debt service-to-operations of 1.4%. We expect continued balance sheet strengthening over time due to a history of solid philanthropic support and diversified investment management. While The University has an extensive capital plan totaling $5.7 billion during fiscal years 2011-2020, it retains considerable flexibility to adjust the timing of projects and use philanthropic support to finance projects. Management reports borrowing plans of $1.3 billion over the ten year period, with peak debt outstanding projected to reach $2.2 billion in FY 2017.

The University has a history of strong philanthropic support, with annual gift revenue averaging $225.2 million during fiscal years 2008 to 2010. Fundraising during this period incorporates the successful completion of a comprehensive campaign which concluded during FY 2009. The Michigan Difference campaign raised $3.2 billion in gifts, pledges, and bequests against a $2.5 billion goal. According to management, the current weak economic environment did not result in a significant delay or increase in delinquency of pledge payments. The University is in the preliminary planning stages for its next capital campaign. We expect The University's past investments in development and alumni relations will help ensure continued significant donor support, though giving may be somewhat pressured in the current economic environment particularly with the conclusion of the campaign.

The University's long-term portfolio experienced a 12.3% return during FY 2010 following a 23.4% decline in FY 2009. Fiscal 2011 returns through September 30, 2010 were positive 7.7%. As of September 30, 2010, the long-term portfolio was comprised of 25% traditional long-only equities, 18% absolute return, 16% private equity, 12% real estate, 10% energy, 9% fixed income, 9% venture capital, and 1% cash. In addition to the long-term portfolio, The University maintains short-term and intermediate-term pools which are highly liquid and have more conservative asset allocations. As measured by Moody's, The University's cash and investments maintain good liquidity. At the end of fiscal 2010, The University held $2.8 billion of unrestricted cash and investments that could be liquidated within one month, providing 3.6 times coverage of debt with a tender feature and 213 days of operating cash expenses.

The University will have approximately half of its debt, including the full authorized amount of commercial paper, issued in a variable rate mode (before swaps), a decline from nearly 80% in FY 2009. The tender feature on The University's debt is supported by self-liquidity, as described below, and standby bond purchase agreements, as noted in the Rated Debt section of the report. To hedge the interest rates associated with its variable rate debt, The University entered into five interest rate swap agreements with four counterparties on the total notional amount of $285.2 million. The collateral posting requirements under the agreements at the current rating level range from $6 million to $25 million, with a minimum transfer of one million dollars. Two swaps do not have collateral posting requirements. As of April 27, 2011, The University is not posting collateral.

UNIVERSITY OF MICHIGAN RELIES ON SELF-LIQUIDITY, INCLUDING USE OF TWO LINES OF CREDIT, TO SUPPORT THE TENDER FEATURE OF VARIABLE RATE BONDS AND MATURING COMMERCIAL PAPER

Moody's believes that The University of Michigan's self-liquidity program offers adequate coverage for the tender features of its variable-rate demand bonds and its commercial paper program following the increase of the authorized issuance of the program to $200 million from $150 million. Our evaluation of The University's liquidity incorporates a number of potential calls on liquidity, including its self-liquidity debt, overall debt structure, endowment spending requirements, private investment capital calls, and general operating needs. The highest short-term ratings of P-1 and VMIG1 are based on The University of Michigan's strong internal liquidity and treasury management as well as dedicated bank lines.

As of March 31, 2011, The University held nearly $1.2 billion in 2a-7 money market funds, repurchase agreements, as well as treasuries and agencies (applying Moody's standard discounts to treasuries to account for valuation changes and the need to liquidate a large portfolio quickly). The University also holds nearly $635 million in discounted readily saleable equity and fixed income holdings that could be liquidated within a week's time. This compares favorably to $310 million of daily and weekly variable rate demand bonds, $200 million of authorized commercial paper (CP), and $118.7 million of debt issued in a commercial paper mode.

The University has established an explicit policy that no more than half of the authorized amount of commercial paper notes will come due in any given calendar week. The University expects to have a maximum of approximately $200 million in commercial paper notes outstanding over the course of the next year. In addition to these highly liquid securities, The University has a $150 million hybrid line provided by Bank of America (expires July 15, 2011, which management expects to extend). The University also maintains a line of credit supporting liquidity of securities on loan of up to $150 million which provides same day access to funds backed by securities on loan that settle over the next several days (expires April 6, 2012).

Outlook

The stable outlook reflects The University's overall market, operational, and balance sheet positions, which should sustain its credit strength despite a challenging economic environment in Michigan and exposure to the more volatile healthcare market.

WHAT COULD MAKE THE RATING GO UP

Not applicable.

WHAT COULD MAKE THE RATING GO DOWN

Substantial weakening of Hospitals operations, dramatic increase in debt beyond expectations, or failure to continue to sustain a high degree of liquidity relative to short-term debt and other cash needs including further increases in variable rate debt absent consistently higher short-term liquidity.

KEY INDICATORS (FY 2010 financial data, FY 2010 enrollment)

FTE Enrollment: 53,361 students

Total Resources: $5.9 billion ($7.5 billion excluding the impact of OPEB liabilities)

Total Pro-forma Direct Debt: $1.8 billion (including CP at full authorized amount)

Monthly Liquidity: $2.8 billion

Expendable Resources to Pro-Forma Debt: 2.6 times

Expendable Resources to Operations: 0.9 times

Monthly Days Cash on Hand: 213 days

Monthly Liquidity to Demand Debt: 3.6 times

Average Operating Margin: 3.6%

Reliance on the State (% of Operating Revenues): 7%

State of Michigan Rating: Aa2, stable outlook

RATED DEBT

General Revenue Bonds Series 2003, 2005A, 2009A, 2009D, 2010A, 2010C, 2010D, 2010E: rated Aaa

General Revenue Bonds Series 2008A: rated Aaa/VMIG1 (VMIG1 supported by SBPA from Wells Fargo Bank, expires March 18, 2013)

General Revenue Bonds, 2009B: rated Aaa/VMIG1 (self-liquidity)

General Revenue Bonds Series 2008B: rated Aaa/VMIG1 (VMIG1 supported by SBPA from U.S. Bank, NA, expires September 2, 2011)

General Revenue Bonds Series 2002: rated Aaa/VMIG1 (VMIG1 supported by SBPA from J.P. Morgan Chase Bank, N.A., expires July 29, 2011)

Commercial Paper Notes: P-1 (self-liquidity)

Medical Service Plan Revenue Bonds 1991: rated Aa1

Medical Service Plan Revenue Bonds 1995A and 1998A-1: rated Aa1/VMIG1 (self-liquidity)

For details on University of Michigan Hospitals debt, please see report dated October 20, 2010

CONTACT

University: Milagros Dougan, Assistant Treasurer, The University of Michigan, 734-647-8297

PRINCIPAL METHODOLOGY USED

The principal methodology used in this rating was Public College and Universities published in November 2006.

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 Investors Service information.

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

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

Karen Kedem
Analyst
Public Finance Group
Moody's Investors Service

Jenny L. Maloney
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 P-1 RATING TO UNIVERSITY OF MICHIGAN'S $200 MILLION OF COMMERCIAL PAPER NOTES, SERIES E (TAXABLE) AND SERIES I (TAX-EXEMPT) AND AFFIRMS Aaa, Aaa/VMIG 1, AND P-1 RATINGS; OUTLOOK REMAINS STABLE
No Related Data.
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MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any credit rating, agreed to pay to MJKK or MSFJ (as applicable) for credit ratings opinions and services rendered by it fees ranging from JPY125,000 to approximately JPY550,000,000.

MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.

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