Fitch Ratings has affirmed its 'BB' rating on $65.7 million private college facility (PCF) revenue bonds, series 2010 and 2012, issued by the Iowa Higher Education Loan Authority (IHELA) on behalf of Upper Iowa University (UIU).

The Rating Outlook is revised to Stable from Negative.

SECURITY

The series 2010 and 2012 bonds are general obligations of the university, payable from all legally available resources. The 2012 bonds are further secured by a first mortgage lien on two dormitory buildings. Both issues have a debt service reserve fund.

KEY RATING DRIVERS

OPERATING IMPROVEMENT SUPPORTS OUTLOOK: Substantially improved fiscal 2014 operating results, largely driven by expense controls and new management, met the debt service coverage covenant but were still negative on a GAAP basis. Fitch expects continued improvement in operating results in fiscal 2015, which supports a Stable Outlook.

STRAINED BUT IMPROVED COVERAGE: The 'BB' rating reflects UIU meeting the fiscal 2014 coverage calculation (per the bond covenants) of at least 1.25x average annual debt service (ADS). However, using a more conservative coverage calculation, maximum annual debt service (MADS) coverage from operating revenues improved significantly over fiscal 2013, but in fiscal 2014 was still 0.87x MADS and 0.95x ADS.

ENROLLMENT: Fall 2014 enrollment improved at the Fayette campus, but overall remains a concern for UIU as full time enrollment (FTE) dipped 5.5%. The enrollment decline is a concern due to UIU's very high 94% tuition dependence, as well as net tuition revenue declining slightly in both fiscal 2013 and 2014.

SLIM BALANCE SHEET: UIU's balance sheet ratios remain more consistent with the 'BB' category. In past years, Fitch considered these low liquidity ratios partially offset by previously strong operating performance.

HIGH DEBT BURDEN: Fitch considers UIU's 8.7% MADS burden in fiscal 2014 to be high, particularly given negative operating performance in 2013 and improved but still negative GAAP operations in 2014. UIU management reports no new long-term debt plans at this time.

RATING SENSITIVITIES

FAILURE TO REVERSE DEFICITS: Failure to steadily improve GAAP operations, maintain positive MADS coverage from operating revenues, or meet bond covenants, would result in a negative rating action.

ADDITIONAL DEBT ISSUANCE: Issuance of additional debt prior to stabilized financial operations, or without an increase in resources, would result in a negative rating action.

MANAGE EXPENSES AND ENROLLMENT: UIU's ability over time to manage expenses, grow net tuition revenue, and maintain stable to growing enrollment would be viewed favorably, and would support a positive rating action over time.

CREDIT PROFILE

UIU was founded in 1857 in Fayette, Iowa. Fayette is located in north central Iowa, about 37 miles northeast of Waterloo and 65 miles north of Cedar Rapids. The university offers both undergraduate and graduate level programming at its residential Fayette campus, 20 educational extension centers mainly in the Midwest, six international centers in two countries, and a distance education center.

UIU's multiple education markets have been viewed favorably in the past by Fitch but are subject to significant competition and recent volatility. This is particularly apparent as the non-traditional on-line and distance programs (about 70% of operating revenue) are essentially subsidizing full-time undergraduate students. Students attending on-line or at various regional academic centers have six distinct entry points during each academic year, allowing two full-credit courses over an eight-week term, and some student flexibility. Full-time students at the Fayette campus have a more traditional two-semester calendar (although the semester has two terms). Overall, UIU offers 42 BA degrees, four master degrees, and 16 certificate programs.

Deficit Operations

UIU reported a $2.6 million operating deficit for fiscal 2014 (negative 4.8% operating margin), which was a significant improvement over fiscal 2013's $8.2 million deficit (negative 15.6%). Fiscal 2014 results are more comparable to fiscal 2012, which had a $1.9 million deficit (negative 4.1%). The recent deficits contrast with UIU's average operating surplus of 5.8% in the prior five fiscal years (2007 - 2011). Budget stress is expected to continue in fiscal 2015 and 2016.

UIU's revenues are heavily student-fee concentrated (94% in fiscal 2014), and net tuition revenue decreased slightly for both fiscal 2013 (down 0.4%), and fiscal 2014 (down 0.8%). While gross tuition and fees increased in each of these years, so did student discounting. Fitch considers flat or declining net tuition revenue to be a credit concern. UIU projects net tuition revenue to grow in fiscal 2015. Improved operating results in fiscal 2014 largely came from expense cuts of about 6.6%, in contrast to the two prior years with 9.2% and 13.5% expense increases, respectively. UIU reports that about 87% of faculty are part-time and non-tenured, which provides some expense flexibility. Between fiscal 2014 and 2013, UIU improved its deficit operations by $5.5 million, which is substantial in one year.

Fitch views net tuition revenue growth for the traditional full-time Fayette campus students as limited by very high discount rates (over 60% for fall 2014). Thus, revenue growth is more likely to be generated by the on-line and academic center programs. Fitch views the Fayette campus operations as being significantly subsidized by revenue from these non-traditional programs.

Management Turn-Over

UIU experienced significant management turnover since calendar years 2013, which Fitch views as limiting the institution's timely response to the fiscal 2013 operating deficit. A new president started in 2013, and a new provost was appointed in 2014. In July 2014, UIU appointed a new CFO, the fourth in this position in roughly the same number of years. A new director of admissions for Fayette started in mid-2013. Additionally, UIU reports that senior staff was re-organized with more administrators reporting to the provost. The provost now has responsibility for all UIU academic programs, as well as admissions, for the Fayette campus as well as the larger non-traditional on-line and academic center programs. Fitch understands that UIU is re-starting its strategic planning process, and management is focused on improving financial performance.

Fiscal 2015 Budget

The fiscal 2015 current fund budget is balanced on a cash basis, even with overall enrollment only 94% of initial budget expectations. The university budgeted a 2% salary increase for employees, but is again deferring an employer match for retirement accounts. Tuition increases were implemented in fiscal 2015 for all programs, and the Fayette campus began charging a new student fee. Expense controls remain in place. Management reports that some vacancies were not filled, that class sizes were increased for many Fayette, on-line and academic center programs, student retention programs were enhanced university-wide, and degree offerings were reviewed, among many actions. A $1.2 million contingency (subsequently increased to $1.4 million) is part of the 2015 budget, providing some flexibility. Fitch recognizes management's actions to address the operating deficit as both difficult and prudent; the actions support the Stable Outlook.

UIU management projects fiscal 2015 budget results to be close to break-even, an improvement of at least $500,000 from the final fiscal 2014 budget results. However, Fitch notes that GAAP operating results can vary widely from budgetary results, even with budgeted depreciation expense. As a result, Fitch views achievement of balanced GAAP operating results in fiscal 2015 as uncertain. In fiscal 2014, for example, UIU's budgetary result was negative $653,000, while the audited GAAP operating result was negative $2.6 million.

PRESSURED DEBT SERVICE COVERAGE

UIU's bond covenants include a 1.25x ADS coverage covenant, which became effective in fiscal 2013. Gross operating deficits in fiscal 2013 resulted in negative 0.38x ADS coverage, well below covenant levels. Failure to achieve the coverage covenant was not initially an event of default under the loan agreement, but would be in the second full fiscal year (for UIU, fiscal 2015) following receipt of a consultant report. The required consultant report has been issued. Fiscal 2014 ADS coverage - as calculated per the loan agreement - returned to 1.45x, which Fitch considers positively.

Fitch's analysis uses a more conservative coverage calculation that is based on net operating revenue (rather than gross net revenue including non-operating operations), and MADS instead of ADS. This is particularly relevant to UIU, which has an increasing debt structure: $4.3 million is due in 2014 and 2015, and MADS of $4.7 million occurs in 2016 and remains level thereafter. MADS coverage in fiscal 2013, as calculated by Fitch, was exceptionally weak at negative 0.44x due to the large deficit. Management reported that debt service payments in 2013 were supported by unencumbered financial resources, without drawing on the debt service reserve. For fiscal 2014, MADS coverage improved to 0.87x, and annual coverage was 0.97x. Fitch notes the strong improvement, but coverage remains weak.

Weak Balance Sheet

UIU's available funds (AF, defined by Fitch as cash and investments less permanently restricted net assets) were $13.8 million at the end of fiscal 2014, essentially the same amount as fiscal 2013. This equaled a slim 24% of expenses and 18% of debt, levels that are comparable to the 'BB' rating category for private universities. As part of the AF calculation, Fitch notes that unrestricted endowment of $4 million at June 30, 2014 (part of $11.47 million total endowment) is quite low compared to peer private institutions.

Stressed Enrollment

UIU's FTE enrollment has fluctuated modestly over the last five academic years, ranging from 5,139 in fall 2012 to 5,555 in fall 2011. However, it dipped 5.5% in fall 2014 to 5,034 compared to 5,327 in fall 2013. The decline was largely related to on-line and academic center enrollment, which represents about 80% of UIU's enrollment. Management reports that overall enrollment for fall 2014 was 94% of initial budget expectations, but that expenses were adjusted to achieve balance. Management reports the decline came from multiple causes, including UIU marketing changes, increased tuition, and military students deferring enrollment due to federal funding not being released when expected. Because the decline was primarily in older, non-traditional students who tend to take more part-time classes and may enroll year-round, including about 17% military related students, there is potential in the current 2015 fiscal year for annualized enrollment to improve. For fall 2014, traditional undergraduate enrollment at the Fayette campus increased 8.5% to 1,093, and exceeded enrollment targets (but not budget targets). In addition to new undergraduate marketing initiatives, UIU reported that about one-third of the fall 2014 freshmen were international students.

Non-traditional students (both on-line and at 20 U.S. academic centers and several international centers) have multiple entry points in UIU's academic calendar, making full-year revenue projections difficult. UIU operations rely heavily on non-traditional student revenue which is subject to significant competition. Many full-time undergraduates come from Iowa or surrounding Midwest states, which have declining numbers of high school students.

High Debt Leverage

UIU debt totaled $76.7 million at June 30, 2014, including a $1 million bank line draw, $8.8 million operating leases, and $65.77 million series 2010 and 2012 bonds. The bonds are fixed rate and have an increasing debt service structure through 2016 and essentially level debt service thereafter. UIU's operating leases are primarily related to its various academic sites. The university has a $2 million bank line, with a $1 million draw outstanding at the end of fiscal 2014. Management reports the draw has subsequently been reduced, and the balance repaid in December, 2014. No further draws are expected in fiscal 2015.

Bond covenants include a 1.25x ADS coverage test, which was not met in 2013 (the year the covenant became effective), and an unrestricted net asset test of 25% of outstanding debt (which was achieved in both 2014 and 2013). Importantly, UIU met the debt service covenant test in fiscal 2014 based on loan agreement calculations. Failure to achieve pledged coverage is not an immediate event of default under the loan agreement. UIU was required to hire a consultant, and did so. The university is required to achieve pledged coverage within one full fiscal year after the consultant issues recommendations (fiscal 2015, but did so in 2014). Only if the 1.25x coverage test is not achieved in the required time does it become an event of default.

As discussed above in 'Pressured Debt Service Coverage', Fitch uses a more conservative coverage calculation in its analytical review of all higher education institutions. Under that calculation, MADS and ADS coverage improved substantially in fiscal 2014 but remained short of 1.0x. In Fitch's view this tight coverage indicates that UIU's credit quality is not presently investment grade.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Fitch Downgrades Upper Iowa University's Revs to 'BB'; Outlook Negative' (Jan. 7, 2014);

--'U.S. College and University Rating Criteria' (May 2014);

In addition to the sources of information identified in Fitch's U.S. College and University Rating Criteria, this action was additionally informed by information from the financial advisor.

Applicable Criteria and Related Research:

U.S. College and University Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=748013

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=963975

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