Credit Ratings In Higher Education

1. Credit Ratings In Higher Education Presented by: Laura Sander Vice President and Senior Analyst 617-204-5636 Laura.Sander@Moodys.com

2. Agenda 1) Moody's Overview, Portfolio Overview, Background on Ratings 2) Rating Process and Factors 3) Dislocation in the Auction and VRDO Markets 4) Non-Traditional Financing/P3s

3. Moody’s Background

4. Moody’s Business Model Issuers Ratings Financial Instruments Intermediaries Financial Instruments Research, Data & Opinion Products Investors

5. Moody’s Higher Education Team • Nine analysts, 650+ site visits over 10 years • 273 private colleges and universities • 65% of student enrollment • 205 public colleges, universities, and systems • 90% of student enrollment • 100 museums, foundations, & other NFPs • 56 independent schools • Approximately 200 institutions rated based solely on some form of credit enhancement • Letter of Credit, Insured-Only • Growing trend of these organizations seeking stand-alone ratings

6. Moody’s Long-Term Ratings Insurers often make decisions here at A3/Baa1 border RATING FINANCIAL SECURITY • Aaa:Exceptional • Aa1,2,3: Excellent • A1,2,3:Good • Baa1,2,3: Adequate • Ba1,2,3:Moderate • B1,2,3: Weak • Caa-C: Default Letters of Credit & Swaps can contain rating triggers here Speculative Grade

7. Rating Distribution Of Moody’s-Rated Private And Public Colleges And Universities(excludes Insured-only, LOC-backed & Privately rated)

8. Rating Process And Factors

9. Key Rating Factors Capital Needs, Debt and Other Liabilities Student Demand Management and Governance Operating Performance Financial Resources Legal Structure

10. Key Credit Factors • Market Position:Education, residential services, research, health care • Operating Performance: Margins and debt service coverage, revenue and expense drivers, budgeting practices • Financial Resources: Amount, level of restriction, investment, fundraising, future growth prospects • Debt and Capital Profile: Capital intensity, sources of funds for capital investment, current and projected debt strategy/leverage, debt structure and legal analysis • Management and Governance: Diversity of expertise and experience, accountability and reporting, renewal of personnel

11. Key Credit Ratios • Market Position:FTE enrollment, selectivity & yield, net tuition per student • Operating Performance: Operating margin, cash flow margin, debt service coverage, share of revenue from tuition and auxiliaries • Financial Resources: Total cash and investments, expendable financial resources to debt and to operations, average gift revenue • Debt and Capital Profile: Debt service to operations, debt to revenue, MADS coverage • Management and Governance: Various—operating performance, ability to forecast results, reaction to surprises

12. Key Credit Trends Facing Sector • Dramatic Changes in the Population of Prospective Students • New Public Policy Proposals and Political Oversight • Weaker Economic Outlook and Housing Pressures • Operational Efficiency and Effectiveness Will Grow Increasingly Important • Balance Sheet Management Improving, But Becoming More Complex

13. Dislocation in the Auction and VRDO Markets

14. Dislocation in Auction Rate Market • Rising interest rates • Average Rates on 7 Day Auctions --January 2008 3.890% --February 27th 6.590% • Dealers unwilling or unable to make a market • Failed auctions • Failures extended beyond the troubled guarantors and even beyond insured debt • Future of auction rate product in doubt

15. Auction Rate Market -Impact on Municipal Issuers • Higher debt service costs as interest rates rise either to clear market or as a result of failed auctions • Liquidity issue for issuers with narrow coverage or significant amounts of variable rate debt • Swaps no longer provide effective hedge -Basis risk can create liquidity problems because auction rates rise while swaps are paying based on LIBOR which remains low • Liquidity issues can become credit issues

16. Dislocation in Variable Rate Demand Obligation Market • Widespread ‘put’ of insured floating rate obligations - Liquidity linked to insurer • Failed remarketings –Inability to place VRDOs that have insurance from certain FGs • Dealers increasingly choosing not to hold VRDOs in inventory –Smaller remarketing agents first, then widespread –Decisions to hold made on a case-by-case basis • Banks holding “bank bonds” –Taxable rates –Ability to terminate facility and accelerate repayment with notice

17. VRDO Market -Impact on Municipal Issuers • Higher debt service costs as interest rates rise either to clear market or as a result of bank bonds • Liquidity issue for issuers with narrow coverage or significant amounts of variable rate debt • Swaps no longer effective hedges • Banks may send termination notices resulting in accelerated debt repayment putting added liquidity strain on issuers • Liquidity issues can become credit issues

18. Issuers Working Quickly to Address Risks Posed by Troubled ARS and VRDOs • Long-Term Solutions –Converting or refunding to: • Fixed rate mode • May be complicated by presence of swap • Variable rate demand bonds with self-liquidity, uninsured VRDOs, insured VRDO (adding liquidity facility) or LOCs • Long put mode • Most bond documents are multi-modal –Restructuring insured bonds with a letter of credit • Obtain LOC that pays principal, interest and purchase price • First source of payment becomes the letter of credit • Moody’s can re-rate the bonds based upon the highest of (1) the LOC provider’s rating; (2) the underlying rating of the obligor and (3) the insurer’s rating

19. Issuers Working Quickly to Address Risks Posed by Troubled ARS and VRDOs – Long-Term Solutions continued –Amend existing standby bond purchase agreement • Short-term ratings of insured floaters are based on the short-term credit quality of the bank and the likelihood of termination of the liquidity facility • Can eliminate automatic termination events-only notice events • Short-term rating reflects short-term rating of bank only • Can make automatic termination events linked only to issuer’s rating • Short-term rating reflects short-term rating of the bank and long-term rating of the issuer • Can amend to have automatic termination events linked to both the issuer’s and the financial guarantor’s ratings • Short-term rating reflects short-term rating of the bank as well as both the issuer’s rating and the financial guarantor’s rating

20. Issuers Working Quickly to Address Risks Posed by Troubled ARS and VRDOs – Long-Term Solutions continued –Deposit auction rate bonds into custodial agreement • Enhance custodial receipts with a letter of credit • Establish interest calculation and payments (either fixed or variable) of custody receipts • Issuer still has obligation to pay deposited bonds, however custodian will “hold’ auction rate bonds, therefore fixing the rate the issuer pays • Custody receipts rated based on rating of letter of credit provider

21. Issuers Working Quickly to Address Risks Posed by Troubled ARS and VRDOs - continued • Short-term solutions –Bank financing –CP mode –Related government entity purchasing ARS –Adding optional tenders to auction rate bonds –Temporary amendments to SBPAs • Obtaining new underlying rating or requesting publishing of previously indicative ratings • Some waiting to see what happens

22. Market Developments: SEC • Auction Rate Securities –SEC issued ‘no action letter’ on March 14 –Issuers, conduit issuers or broker dealers can participate in bidding process for auction rate securities provided that this activity is adequately disclosed

23. Market Developments: Liquidity Banks • Banks are getting inundated with requests for LOCs & SBPAs –Slowing issuers’ ability to “fix” their deals –Other players backlogged as well • Some willing to amend SBPA documents and some are not • Banks have limited capacity –Limiting how many new deals they will do and with which issuers –Banks willingness to hold bank bonds uncertain and depends on underlying credit • Some banks are getting out of the business of providing liquidity for municipal securities

24. Off Balance Sheet Structures

25. Moody’s “Big Picture” Approach • Accounting treatment is less important than economic motivations • Off-Balance Sheet does NOT equal Off-Credit • Legal requirements are often surpassed by universities if it’s strategically and financially important to them • Indirect support of a project more likely than direct payment of debt service

26. Privatized Student Housing: Often ON CREDIT* • Housing is core to operations, market position and mission of most institutions • Projects usually on university land, often on core campus; Universities don’t move & treat land as “endowment-like” • University often has some operational role (marketing, management, referrals, etc.) • University owns the building after financing *See Moody’s: “Privatized Student Housing & Debt Capacity”, Oct. 2006

27. Privatized Housing: Opportunity Costs • University foregoes a typically high-margin business of student housing • University foregoes an element of pricing flexibility and future competitive pricing ability • University foregoes some control of a component of campus life that provides competitive differentiation

28. Academic Buildings Student Housing Research Buildings Tech Research Parks Market-Rate Housing Campus Parking Student Village/Retail Retirement Community Sports Facilities Measuring Impact On Debt Capacity Core $ Gain $ Cost Debt Capacity Impact Rises Non-Core

29. Key Questions Moody’s Will Ask • Is this a financialtransaction or a strategic project? (short-term vs. long-term) • How “core” is the project to the mission, market position, and operation of the University? • What benefits does the University gain from the proposed structure of the financing? • What would the University likely do if the project were to struggle/fail?

30. A Note On Moody’s Existing Ratios • Direct, Indirect and Comprehensive Debt • Indirect Debt includes: • Capitalized Operating Leases • Difference b/t PBO and Fair Value of Defined Benefit Pension Plans • Debt associated with projects not directly issued by university (i.e. privatized student housing)

31. Q&A Presented by: Laura Sander Vice President and Senior Analyst 617-204-5636 Laura.Sander@Moodys.com