Moody's Investors Service has downgraded the long-term rating of Rockefeller University to Aa1 from Aaa and has assigned a Aa1 rating to Rockefeller University's Series 2009A bonds issued through the Dormitory Authority of the State of New York. The rating outlook is stable at the new level. The rating change is based on material investment losses combined with the University's continuation of its strategic plan involving further borrowing and increased endowment spending. We have affirmed our existing VMIG 1 ratings on the University's outstanding bonds detailed at the end of this report (Rated Debt section). Moody's expects to assign long and short term ratings to the University's $100 million Series 2009B bonds in the coming weeks.
LEGAL SECURITY: The bonds are a general unsecured obligation of Rockefeller University.
DEBT-RELATED DERIVATIVE INSTRUMENTS: The University has entered into six interest rate swap agreements with a total notional amount of $424 million. Of the total, two are forward starting swaps, each with a $100 million notional amount, beginning on July 1, 2009 and July 1, 2010 related to planned debt issuance. With a total notional amount of $200 million, three of the agreements are with Morgan Stanley Capital Services (senior debt of Morgan Stanley rated A2). With a total notional amount of $200 million, two of the agreements are with the Bank of New York (The Bank of New York Mellon Corporation senior unsecured debt rate Aa2). The remaining agreement with a $24 million notional amount is with AIG Financial Products Corporation (senior unsecured debt rating of A3). As of March 10, 2009, the six swaps had a mark to market value of $133 million as a liability to the University. Collateral posting requirements thresholds under the Bank of New York and Morgan Stanley agreements for Rockefeller vary with rating level and are infinite at the Aa2/AA (threshold set by lower of ratings by Moody's or S&P, respectively) rating level or higher, moving to $20 million at the Aa3/AA- level. Collateral posting requirements under the AIG swap would be triggered by the University's rating falling below Aa3 (by Moody's) or AA- (by S&P). The University's debt-related derivative exposure is reflected in our Aa1 long term rating.
STRENGTHS
* Internationally prominent position among biomedical research institutes and graduate education with $154 million in direct research funding in FY 2008.
* Deep philanthropic support with total gifts averaging $113 million over the last three years as Rockefeller continues to make progress on its $750 million campaign, with $527 million of the total raised to date.
*Large financial resource base totaling $2.3 billion at June 30, 2008 reflecting donor support and history of above-average long-term investment returns. As of June 30, 2008, only 10% of the total financial resources were permanently restricted, pointing to relatively high degree of flexibility.
*Considerable revenue diversity including investment income (33% of FY 2008 operating revenues), grants (27%), gifts (26%) and auxiliaries (10%). Unrestricted gifts have supported healthy cash flow margins averaging 20% over the last three years.
CHALLENGES
*Investment losses combined with increased debt have dramatically impacted balance sheet leverage. Following a 2.5% loss in the long term endowment in FY 2008, management estimates a 21% loss through the first seven months of FY 2009 with a lagged reporting for some private investments. Moody's has applied a 30% reduction to financial resources as an estimate of declines through investment losses and endowment spending. Reduced expendable financial resources of $1.45 billion cushion pro forma debt by 2.8 times or 5 years of operating expenses, indicating a cushion much lower than our most recently published medians for Aaa-rated not for profits of 15 times and 16 years, even with the medians similarly reduced by 30%. Combined with another $100 million of debt planned in the next year we believe the reduced resource cushion relative to debt will continue for some time.
*Relatively high debt burden compared to revenues with pro forma debt of $525 million (including $100 million upcoming Series 2009B bonds and $40 million outstanding on a line of credit) representing 1.8 times FY 2008 revenues, combined with $382 million of pro forma debt which is subject to put risk. In addition, the University's capital intensive research activities will require ongoing plant renewal and could lead to additional debt in advance of principal retirement which is heavily weighted to bullet maturities in the years 2032 to 2040. Moody's adjusted maximum annual debt service of $42 million (as compared to projected maximum annual debt service in 2032 of $175 million) equates to 14.4% of FY 2008 operating expenses, well above our median of 5.7% for Aaa-rated not for profits.
* Reduction in liquidity from funds locked up in the Commonfund Short-Term (approximately $20.6 million as of January 31, 2009) combined with investment losses and an asset allocation strategy which has favored relatively illiquid investments. The University continues to act to maintain liquidity through proactive management of its private investment portfolio, as well as planned cash receipts related to documented campaign pledges. Maintaining liquidity remains critical relative to the University's self liquidity debt as well as funding its budgeted spending for operations from the endowment which totals $104 million in FY 2009.
* Strategic decision to increase rate of spending from endowment combined with investment losses will further pressure financial resources and lead to operating deficits based on Moody's application of pro-forma uniform spending rate from cash and investments.
* Increasing competition for federal research funding expected to dampen revenue growth. The University had two years of declines in government grants and contracts which fell to $81.8 million in FY 2008 from $91.8 million in FY 2006. While management reports a solid pipeline of future prospects for sponsored research and has been able to increase non-federal sources of research funding, we believe competition is likely to increase.
MARKET/COMPETITIVE POSITION: INTERNATIONALLY PROMINENT POSITION AMONG BIOMEDICAL RESEARCH INSTITUTES AND UNIVERSITIES; COMPETITIVE STANDING FOR GOVERNMENT AND PRIVATE RESEARCH GRANTS
We anticipate that Rockefeller's stellar reputation and ability to attract top scientific talent on a global scale will sustain its leading position among elite biomedical research institutions, with continued flow of new top scientific recruits, government and foundation research grants, and new philanthropic gifts for future research. The University does not have undergraduate students and is devoted solely to graduate education and research, primarily through research laboratories as well as through a small hospital used for research directly involving patients. Sir Paul Nurse, winner of the 2001 Nobel Prize, assumed the presidency of the University in September of 2003, and there are currently eight Nobel laureates on the campus.
Like other research institutes and universities, Rockefeller has seen increased competition for external research grants. The University had two years of declines in government grants and contracts which fell to $81.8 million in FY 2008 from $91.8 million in FY 2006. Management attributes the recent decline in federal awards to the loss of some faculty members, highlighting the importance of maintaining competitive strength in attracting and retaining lead researchers. While management reports a solid pipeline of future prospects for sponsored research and has been able to increase non-federal sources of research funding, we believe competition is likely to increase. Private research activity has been supported by funding from the Aaa-rated Howard Hughes Medical Institute. Aided by its reputation for the high quality biomedical research, we believe Rockefeller is well positioned despite increased competition for federal grants as well as top investigators. As part of the U.S. 2009 Economic Stimulus package, the National Institutes of Health plan to expand its research program by up to $10 billion over the near term and we expect Rockefeller University is well positioned relative to the many research organizations which will be seeking the funds to attract a portion of the non-recurring increase in funding.
OPERATING PERFORMANCE: DIVERSIFIED REVENUE STREAMS PROVIDE HEALTHY SUPPORT FOR DEBT SERVICE, THOUGH OPERATING PERFORMANCE EXPECTED TO TIGHTEN
We believe the University will continue to generate positive operating cash flow to cover annual debt service, supported by strong and diverse revenue streams. Rockefeller's revenues are well-diversified and include investment income (33%), grants and contracts (27%), gifts and net asset releases (26%), and auxiliary enterprises (primarily employee housing) (10%). However, the operating margin (as calculated by Moody's) has been uneven with a three year average of 3.8% at the end of FY 2008, down from 4.5% at the end of FY 2004. Operating cash flow has remained solid, however, at 20%, aided in part by the large gains in unrestricted gifts, a revenue stream we expect to be more variable. Management does not budget for depreciation expense which has grown over the last decade and will continue to grow as the campus has a $537 million capital plan through FY 2012.
In 2006, after careful consideration, Rockefeller's board approved an increase in its endowment spending rate to help fund its ongoing research enterprise. The spending rate for FY 2008 was 5.5% of a trailing average and will be increased annually by 0.25% increments until reaching 6% in FY 2010. This decision will likely dampen the prospects for wealth recovery over the next several years and lead to growing operating deficits based on Moody's application of a 5% pro-forma uniform spending rate from cash and investments.
BALANCE SHEET PROFILE: STRONG ALTHOUGH REDUCED RESOURCE LEVELS AND GROWING DEBT
Moody's expects the University's balance sheet position to remain very strong, although with recent losses the endowment is now close to its June 30, 2005 level, when the University had 76% less debt ($299 million) than the current pro forma debt of $525 million. Moody's has applied a 30% reduction to financial resources as an estimate of declines through investment losses and endowment spending. Reduced expendable financial resources of $1.45 billion cushion pro forma debt by 2.8 times or 5 years of operating expenses. Combined with another $100 million of debt planned in the next year we believe the reduced resource cushion relative to debt will continue for some time. The University has delayed a portion of its capital plans and made some portions contingent on having direct donor support in place before proceeding.
The investment portfolio is highly diversified and has favored relatively illiquid strategies. The endowment had a 2.5% loss for FY 2008, and had annualized returns of 12.9% and 11.9% respectively, for the five-year and 10-year periods ending June 30, 2008, well in excess of benchmarks. Management estimates a 21% loss through the first seven months of FY 2009 with a lagged reporting for some private investments. The portfolio is heavily oriented toward alternative investments, with actual allocations as of November 30, 2008 of 17% long equity, 25% hedged equity, 18% in absolute return, 23% in private investments, 8% in real assets, and 8% in fixed income. Consistent with the requirements of managing a portfolio of this nature, Rockefeller employs a highly qualified internal staff that performs rigorous and active monitoring of its team of external managers and funds. Investment professionals on the Board investment committee also provide strong oversight. As of December 31, 2008, 36% of the $1.2 billion long term pooled endowment was available to the University in one month or under. Management is actively assessing the right level of liquidity as it seeks to predict cash needs for operating spending, capital calls, distributions and inflow of gifts to deploy. The endowment currently has $40 million outstanding on its line of credit which has been used to manage liquidity.
With an excellent and longstanding development staff, Rockefeller has enjoyed strong success in fundraising, driven primarily by high net worth individuals including Board members and other donors with a strong interest in biomedical research. Development efforts focus primarily on the cultivation of donors who are capable of making large gifts. Gift revenue has averaged $113 million over the last three years. The University recently expanded its Campaign for Collaborative Science to $750 million, having surpassed its initial goal of $500 million ahead of schedule, having raised $527 million to date. For the first half of FY 2009 campaign gifts and pledges were tracking ahead of FY 2008. Maintaining donor support will be crucial as the University has become more reliant on unrestricted gift revenue over time. Moody's notes that the primary donor base is concentrated in New York City, and while this has proven to be a strength in the past, it could become a relative disadvantage over time.
In the beginning of FY 2009, the University transferred $109 million in investments to the recently separated and incorporated board of the Rockefeller Archive Center, a collection of papers and materials related to the Rockefeller family and its charitable work. The transfer of assets will reduce the financial resources of the University along with the elimination of a division and its related operating expenses and capital needs.
Beyond the liquidity provided by its financial resources, the University derives additional financial strength from its substantial residential real estate holdings on the Upper East Side of Manhattan, which are treated as campus plant and are not counted as financial resources. In addition to the core campus of research and other academic buildings, the University maintains an inventory of approximately 720 apartment units at eight different sites. Ownership of these housing units serves a strategic need of providing affordable housing for graduate students and staff in the Manhattan real estate market. However, in the extremely unlikely event of financial stress, these properties would clearly have value as financial assets. Recent conservative estimates of the residential facilities are in the $300 million range, while some additional properties elsewhere in New York State add another $35 million.
SHORT-TERM RATING RATIONALE: SELF LIQUIDITY PROGRAM INCLUDES RELIANCE ON HYBRID CREDIT AGREEMENT
Moody's believes that Rockefeller University's self-liquidity program offers adequate coverage for the tender features of its weekly variable-rate demand bonds of $245 million (Series 1998A, 2002A2, 2005A, and 2008A). With frequent market access and good depth in both the investment and debt management staff, we believe the University is able to manage the liquidity requirements of the variable rate debt in the event of a failed remarketing.
The obligation to make payments on tendered bonds that are not remarketed is a general obligation of the University, and the University manages its own self-liquidity program. Moody's believes that Rockefeller's self-liquidity program, which, in addition to the University's own cash and investments, also relies on the presence of a bank liquidity support agreement for same-day liquidity, provides adequate coverage for the tender features of the variable-rate demand bonds. The upcoming $100 million Series 2009B of variable rate demand bonds will have a standby bond purchase agreement with U.S Bank, N.A. and will not fall under its self-liquidity program.
The University currently has $72 million of investments with same-day liquidity including funds with two different JPMorgan money market funds (rated Aaa by Moody's), working cash deposits with P-1 rated banks of $97 million and approximately $106 million of US Treasuries and Agencies held in its name. Weekly liquidity includes a 66% discounted $31 million of exchange-traded equities.
In addition to the University's own cash and investments, the self-liquidity program currently also relies on the presence of the bank liquidity support agreement for same-day liquidity for $245 million with JPMorgan Chase Bank, NA (rated Aa1/P-1). The liquidity agreement is a component of the University's self- liquidity and can be terminated or replaced at any time without notice to bondholders. The University is the sole entity that will make draws under the agreement.
The University has the right to cancel the bank agreement and/or replace the financial institution at its discretion. The current stated expiration date is April 1, 2009, but the renewal documentation is expected in the coming days. In addition, under certain circumstances, JPMorgan can terminate its commitment immediately. There is no mandatory tender of outstanding bonds upon the expiration or termination of the liquidity agreement. Events which would cause the Agreement to terminate are directly related to the credit quality of Rockefeller University and include: 1) Rockefeller's failure to pay principal or interest on any Bonds when due; 2) the University becoming insolvent or unable to pay its debts, or a court proceeding seeking an order for liquidation of the University which is not terminated for a period of 60 days; or, 3) a provision of the Agreement relating to the Funded Amounts ceasing to be valid and binding.
In addition to these immediate termination events of the Agreement, other less severe events of default could enable the Bank to terminate the facility as soon as 15 days later. Thus, Moody's regularly monitors the University's levels of available funds which could be shifted in 15 days or less from longer-term investment strategies to investments with same-day liquidity should the bank line of credit be terminated with notice, and we believe coverage is currently sufficient.
OUTLOOK:
Our stable outlook is based on our expectation that Rockefeller will continue to enjoy a prominent position in biomedical research enabling it to attract research grants and philanthropic gifts in support of its mission. We also expect that ongoing donor support will help maintain a solid cushion of financial resources relative to debt and that operating cash flow will provide comfortable coverage of debt service.
WHAT COULD CHANGE THE RATING - UP
Material growth in financial resources relative to debt combined with maintenance of other credit strengths.
WHAT COULD CHANGE THE RATING - DOWN
Ongoing decline in expendable resources relative to debt beyond $100 million planned borrowing in 2010; weakened coverage of debt service from operating cash flow; inability to achieve long term growth in external research funding.
KEY INDICATORS (fiscal year 2008 audited financial statements)
*Ratios in parentheses represent a pro-forma 30% decline in financial resources reflecting the weak investment environment and expected endowment spending
Total Financial Resources: $2.3 billion ($1.6 billion)
Total Pro-Forma Debt: $525 million (includes upcoming $100 million of Series 2009B bonds and $40 million outstanding on line of credit)
Expendable Financial Resources to Pro-Forma Debt: 3.9 times (2.8 times)
Expendable Resources to Operations: 7.1 times (5.0 times)
Three-Year Average Operating Margin: 3.8%
Three-Year Average Maximum Annual Debt Service Coverage: 1.3 times
RATED DEBT
Series 1998, 2002A1, 2009A: Aa1
Series 1998A, 2002A2, 2005A, and 2008A: Aa1/VMIG 1 (short term rating based on self liquidity)
CONTACTS
Rockefeller University: James Lapple, Vice President for Finance, 212-327-8371
Financial Advisor: Linda Fan, Managing Director, Prager, Sealy & Co., 646-871-3455
The Rating was assigned by evaluating factors believed to be relevant to the credit profile of Rockefeller University, such as i) the business risk and competitive position of the issuer versus others within its industry or sector, ii) the capital structure and financial risk of the issuer, iii) the projected performance of the issuer over the near to intermediate term, iv) the issuer's history of achieving consistent operating performance and meeting budget or financial plan goals, v) the nature of the dedicated revenue stream pledged to the bonds, vi) the debt service coverage provided by such revenue stream, vii) the legal structure that documents the revenue stream and the source of payment, and viii) and the issuer's management and governance structure related to payment. These attributes were compared against other issuers both within and outside of Rockefeller University's core peer group and the rating is believed to be comparable to ratings assigned to other issuers of similar credit risk.
The last rating action for the general obligation debt of Rockefeller University was on March 18, 2008 when the ratings of the University were affirmed.
