S&P - Public Finance Criteria (2007). - The Global Clearinghouse

Education And Non-Traditional Not-For-Profits■ History of financial operations including coverageof pro-forma maximum annual debt service;■ Scope of the pledged revenue stream; and■ Legal provisions, including rate covenants andadditional bonds tests.Analysis of these factors, in combination withinstitutional demand, long-term viability, and underlyingcreditworthiness, helps to determine the rating.Modified rating approach foron-campus privatized housingThe issuance of dormitory revenue bonds is not anew development in higher education finance.Many of the dormitory revenue bonds rated byStandard & Poor’s date back to the 1960s. Theiruse, like bonds used to finance parking, dining,and athletic facilities, was almost universally limitedto public universities because debt constraintsor other statutory limitations were not experiencedby private colleges and universities. Privatecolleges have not been prohibited from issuingdebt for any reasons other than the former cap ontax-exempt bonds. Private colleges and universitiesalways pledged their general obligation becausethey could do so.However, beginning in the 1990s the environmentbegan to change. Colleges experienced a surgein demand for modern, updated apartment stylehousing, and needed to respond more quickly tomarket demands. The concept of using developers’expertise and separately created 501©3 issuers tohelp issue the debt for these projects rose in popularity.The motivation for most institutions wasobvious. For public institutions, the ability to circumventtraditional financing guidelines can cutyears off a construction project and significantlyreduce construction costs.Private colleges and universities, meanwhile, facetheir own growing capital needs and are lookingfor ways to preserve their debt capacity and yetremain competitive. Colleges and universities pursuingthe option of privatized housing often want toknow two things: (1) whether using off-balancesheet debt for residential facilities will affect theirexisting credit profile and debt capacity; and (2) thedegree to which they need to support a project toensure a lower cost of capital for their students’housing. Standard & Poor’s criteria for off-balancesheet housing addresses these concerns and largelyrests on the “credit-risk” relationship model.The credit-risk relationship modelIf a college transfers credit strength to an affiliatedentity or project, then the corresponding risks ofthat enterprise will almost always transfer back tothe college. The greater the linkage between thesponsor institution and the project, the more likelythe debt financing will affect an institution’s creditprofile, whether the financing is “off-balance sheet”or not. However, a closer link to an institution’scredit strengths and the possibility of subsidizationof debt service will usually mean a higher standalonerating and a lower cost of capital. A newhousing project with very little link to a sponsoringinstitution will probably not benefit from the institution’screditworthiness. On the other hand, theinstitution can probably safely assume that theissuance of the related debt will not affect its ratingat or after the time of the transaction.Nonetheless, debt related to an entity’s business isalways of concern, especially when the primary customersare the institution’s students. Even a projectthat does not require immediate subsidization mayrequire management effort or time. Future accountingrules could also change, requiring debt that wasoff balance sheet to be consolidated in subsequentfinancial statements. A project related to an institutioncan also represent competition; if future housingoccupancy drops on campus, an importantquestion is whether students will occupy newerfacilities related to the campus, but not the university’sown housing facilities. Issuing additional debt,even if off-credit, could represent credit dilution forexisting bondholders of dormitory revenue bonds.Because of these issues, Standard & Poor’s uses twostandards in evaluating the “credit-risk” relationship:economic interest and control. Does the universityor school have an economic interest in theproject; and does it control who uses the facilitiesbeing financed, project budgets and rate setting, andwho manages the property (control).Comparing traditional dormrevenue bonds and privatized housingWhen rating on-campus privatized housing facilities,Standard & Poor’s first focuses on the differencesbetween these projects (often calledoff-balance sheet debt) and traditional universitydormitory revenue bonds. The chief distinctionbetween off-balance sheet debt and traditional auxiliarybonds is the absence of university oversightand ownership. Traditional dormitory revenuebonds are, in nearly every instance, sold directlyunder the university’s name, controlled by the university,and revenues and expenses of the projectand related debt are consolidated in the university’sfinancial statements. Because of the absence ofownership, Standard & Poor’s does not rely on itshistoric method of shading ratings on dormitoryrevenue bonds using the institution’s GO equivalentrating as a starting point.Instead, for project-based, privatized housing,Standard & Poor’s will use a university’s long-termrating as a proxy for long-term viability and poten-186 Standard & Poor’s Public Finance Criteria 2007