DALLAS – The University of Kansas will start the year by issuing $350 million of lease revenue bonds for a major expansion of its Lawrence campus using a new public-private partnership model.
With final maturity in 2051, the bonds will arrive through the conduit issuer Public Finance Authority in a negotiated deal Jan. 6 and 7. The bonds are exempt from federal but not state income tax.
A legal snag led KU to bypass its usual issuer, the Kansas Development Finance Authority, said Theresa Gordzica, chief business and financial planner for the university.
To issue through the KDFA would have required legislative approval. Legislators have reviewed the plan through two committees, officials said, and the university has full authority to issue the bonds.
The Wisconsin-headquartered Public Finance Authority has closed more than 100 bond issuances representing more than $2.65 billion in financings throughout 36 states since inception in 2010. Several universities from other states were included in those issues.
Moody's Investors Service placed a negative outlook on its Aa2 rating ahead of the deal.
The negative outlook "reflects operating and liquidity risks associated with the large capital expansion financed with the bonds," Moody's analyst Michael Osborn wrote in a Dec. 7 report. "Substantial progress towards completing the projects on-time and on-budget combined with strengthened cash flow to support increased debt service could return the outlook to stable."
Standard & Poor's also had a negative outlook on its AA rating.
Alan Jaffe, executive director at JPMorgan, leads the underwriting syndicate that includes Barclays, Bank of America Merrill Lynch & Co., George K. Baum & Co., and Wells Fargo Securities.
The financial advisors from Public Financial Management are managing directors Lisa Daniel and June Matte.
The deal includes current interest serial bonds maturing from 2018 through 2036, and term bonds with sinking fund payments due in 2041, 2046 and 2051. The bonds are callable in 2026.
Gordzica said she had originally planned to issue the bonds in December, but documentation demands nudged the deal into the new year.
With a dearth of new money issues in the market and few from Kansas, the deal is expected to attract a mix of retail and institutional investors, Gordzica said.
This issue marks the first use of P3 for classroom buildings for KU, in addition to dorms and dining facilities, Gordzica said.
The university created the nonprofit KU Campus Development Corp. as the obligor for the bonds. Edgemoor Infrastructure and Real Estate, a Maryland company, is the project's private developer. Edgemoor has worked on 10 public-private projects valued at $1.5 billion.
Interest on the bonds is not subject to the alternative minimum tax. Bond proceeds will be used to design and build a project known as the Central District.
The district will include a 285,000 square foot integrated sciences building, housing for 1,200 students, a 50,000 square-foot student union, 2,000 parking spaces, a central utility plant and other utility and infrastructure improvements. Construction is expected to be complete in June 2018.
"We're moving pretty quickly," Gordzica said. "Other universities in Kansas have had P3 projects for housing. This is more unique in that it includes, in addition to housing and parking, the integrated science building."
The project is expected to generate about $9.2 million in annual net revenue from housing, parking and student fees, according to Shannan Nelson, head of campus operations for the KUCDC.
KU's existing science building was built in the 1950s and is not a good candidate for remodeling, Gordzica said. Proponents have noted that even Kansas high schools have more up-to-date science facilities.
The ambitious project was developed as part of KU's Bold Aspirations strategic plan meant to keep the university competitive. Originally scheduled to be developed over a longer period of time, the project's timing was stepped up in hopes of attracting more out-of-state students.
"Non-resident enrollment continues to grow (10% over the last five years) as resident enrollment declines, with international enrollment growth near 15% over the last couple of years," according to Moody's.
The financing plan did not come without a challenge.
Kansas lawmakers questioned whether the state could be left holding the bag if the P3 project failed to meet financial expectations.
"At the end of the day, the whole state would probably get a black eye if there was a default, so I'm sure the state would have to come in and back all this up," said Rep. Marvin Kleeb, R-Overland Park.
Gordzica assured the legislative committee that the financing plan is sound and the state will not be liable for bond payments or for maintenance costs for the facilities after the bonds are paid off. She estimated annual payments for the project at about $21.5 million per year.
Moody's said rising fixed operations and debt service costs from the large campus expansion will pressure already thin operating cash flow.
"While some of the facilities will be revenue generating, such as housing, costs will precede revenue," Osborn wrote. "In addition, a significant increase in depreciation, a non-cash expense, will create a drag on annual operating margin."
The university plans to cover 37% of increased costs from a reallocation of current expenses and 63% from new revenue, Moody's said.
International student recruitment, from which 31% of added costs are expected to be covered, is a highly competitive market and future growth will be challenging, analysts wrote.
"Already thin operating margins leaves little room for flexibility absent a successful reallocation of current expenses," Osborn said.
As the state's flagship university, KU enrolls more than 28,000 students. KU generated operating revenue of $1.2 billion in FY 2015 and had total cash and investments of $2.1 billion.
This fall, 40% of the incoming freshman class were non-residents of Kansas compared to 31% in fall 2010.
Historically strong capital support from the state government has resulted in low financial leverage, Moody's said, providing capacity for the university to double its debt with the current borrowing.
For major universities such as KU, the coming year should be one of continued stability, according to Fitch Ratings in its 2016 outlook report.
Student demand and enrollment, financial resources, and operating performance will be the primary credit drivers according to Fitch.
"There is some risk that institutions heavily dependent on investment earnings to support operations could see negative rating actions if financial markets deteriorate and endowment spending rates become unsustainable," wrote Fitch senior director Joanne Ferrigan. "However, most institutions have multiyear spending policies that help smooth periodic market fluctuations."