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

Education And Non-Traditional Not-For-ProfitsAccounting IssuesHistorical additional bonds tests are viewed morefavorably than projected tests. The absence of anadditional bonds test will be viewed negatively.Reserves and insuranceA full debt service reserve should either be fundedfrom bond proceeds or through an approved reserveCurrently public and private universities follow very different accounting standardsingeneral public universities follow standards proposed by the GovernmentalAccounting Standards Board (GASB) and private universities follow standardsset by FASB. These differences in accounting rules for similar institutions makecomparisons between private and public colleges and universities difficult andrequire the use of separate analytical ratios for the two groups. However, beginningin fiscal 2002, and for early adopters, fiscal 2001, public universities producedfinancial statements in accordance with Governmental Accounting StandardsBoard Statement No. 35 (GASB 35). While these financial statements resulted indifferent-looking statements for public colleges and universities than under fundaccounting, they are similar to the current format followed by private colleges anduniversities. Perhaps the most striking effect of the change is the appearance of alarge operating loss on a university’s statements, because any state operatingappropriations are considered to be a nonoperating revenue, or subsidy, item underthe new statements. Not unlike our approach to endowment spending, we add backin state appropriations as an operating revenue item. Public colleges and universitiesare also required to expense depreciation. Operations should be balancedincluding depreciation, as failure to account for depreciation expense will lead toreduced equity over time. Since Standard & Poor’s ratios for higher education institutionsmeasure liquidity largely based on equity, this accounting issue can ultimatereduce a college oruniversity’s unrestricted equity.Measuring Operating PerformanceRecent investment losses highlight an analytical problem in the credit analysisof higher education: the absence of a standard industry measure of operatingperformance for colleges and universities. Not only do accounting applicationsvary among private and public colleges, but private colleges and universities alsorecord their financial results in very different ways. Some colleges record allinvestment income and gains as operating revenue. When investment performanceis positive, their operating results appear favorable. On the other hand, for thosewho record only endowment spending as operating revenue, even a year with significantinvestment losses can appear uneventful. Investment losses of millions ormore simply tend to fall below the line. Performance appears to vary dramaticallyfrom year to year without endowment spending as a smoothing device. Thus, inorder to place institutions on an equal footing and eliminate dramatic ups anddowns in investment markets, Standard & Poor’s adjusts for differential accountingby moving all investment income and gains (or losses) below the line for thoseinstitutions who do not record some component of endowment spending as operatingrevenue. Standard & Poor’s then adds back actual endowment spending allocationto get a measure of operating performance. If an institution does not have anendowment spending policy (a rare occurrence), realized income in the form ofinterest and dividends are often a proxy for endowment spending. A major concernsurrounding this exercise is the necessary adjustment of audited financial information.When GAAP statements are difficult to reconcile, Standard & Poor’s higher educationanalysts often ask management for internal operating statements. In these cases,internal statements do not replace the need for audited statements, they merelyprovide a supplement.substitute. A portion of net cash flow should also beretained to build up maintenance and repairreserves. Projects should include a capital (per bed)reserve funded from cash flow, sufficient to handleannual maintenance. Housing maintenance is importantto keep the facility attractive during the life ofthe bond issue and provide for unanticipated majormaintenance. Standard & Poor’s evaluates businessinterruption insurance and the provision for coverage(generally 18-24 months) in the event of damageor destruction. The single site nature of many ofthese projects creates additional risk and full insuranceand reserves are crucial.CoverageMost projects rated by Standard & Poor’s provideadequate or better cash flow protection, with amultiplier of at least 1.2x coverage of maximumannual debt service in every year.Other considerationsProjections should include a reasonable allowancefor vacancies and expense growth. Historicallymany projections provided for these projects haveused a very high occupancy rate of 95%-97%.Standard & Poor’s looks for break-even occupancythat is much lower than this level; generally ifbreak-even occupancy is less than 75%, cash flowsare viewed more favorably.Because of the untested history of these projectsand the concurrent risks of an aging facility, ashorter debt maturity is viewed more favorablythan a longer maturity, even if coverage dropsslightly with the shorter maturity.Many investment-grade projects do not includeconstruction risk. However, construction risk willbe evaluated based on Standard & Poor’s criteria,and a project with construction risk can be ratedinvestment grade. There are mechanisms availableto mitigate construction risks so that a project canbe rated prior to actual completion. Sometimes theformation of a new “privatized housing system”can offset concerns about single site project or constructionrisk. Significant university involvement inthe construction process is also viewed favorably.Credit linksAs seen from the above section, the closer the linkbetween a project and its sponsoring institution,often the higher the rating. However, the closer therelationship, the more likely it is that the housingdebt will be considered a direct or indirect obligationof the institution. Good reasons to consideroff-balance sheet, or indirect debt, as institutionaldebt are:■ The institution receives a direct economic benefit;■ The institution manages the project as if it wereany other on-campus activity;188 Standard & Poor’s Public Finance Criteria 2007