American Campus' View of Rating Agency ReportsUpdated July 2012
Since the March 2010 publication of Moody’s Investors Service Special Comment Paper, “Privatized Student Housing and Debt Capacity of US Universities”, the rating agencies (Moody’s and Standard & Poor’s Corporation) have continued to rate tax-exempt bond issues used in financing student housing developments and likewise publish periodic updates on higher education and student housing credit trends. Most recently, Moody’s published a February 2012 special comment, “Credit Trends: Privatized Student Housing Financings Demonstrate Credit Stability” wherein the rating agency further outlined its credit approach and discussed trends relating to stand-alone, project-based bond transactions. In the Special Comment’s Summary, Moody’s notes that privatized student housing bonds have demonstrated stable performance and the overall credit quality of their rated portfolio has been resilient to the downturn in the real estate market and the mixed credit trends in the higher education sector. Specifically, Moody’s cites the following credit factors as core strengths for most financings:
- Strong market position resulting from competitive advantages such as location, modern floor plans, amenities and integration with university housing inventory
- Rental rate growth supporting strong debt service coverage ratios
- Resilient financial performance resulting from strong student demand for modern purpose built housing
- Strong management performance during a difficult economic downturn
American Campus believes that this update accurately reflects our experience with projects developed under both our proprietary American Campus Equity (ACE®) program and third-party developments financed with project based revenue bonds. We believe the clarity provided in Moody’s continued publication of periodic special commentaries facilitates greater understanding in the higher education market and provides for even greater opportunities for privatized on-campus student housing development.
Following is our assessment of Moody’s current position on privatized student housing development.
1. There has not been any material change to the manner in which Moody’s evaluates all privatized student housing transactions for many years.
A. All student housing transactions are evaluated and taken into consideration when assessing a university’s credit profile regardless of the structure: university general obligation bonds; 100 percent project-based debt structures including 501(c)3 tax-exempt revenue bonds; equity-based structures, subordinate bond structures, pooled borrowing structures, etc.
B. No structure, in and of itself, guarantees a certain credit impact or outcome. Whether that impact/outcome is negative, neutral or positive is determined on a case-by-case basis with many variables taken into consideration. The variables include but are not limited to; the local student housing market, university profile, product type, importance of project to the university’s core mission, transaction structure, financial qualifications and experience of transaction participants, risks associated with development and operation, operational performance metrics of the project, vested interests of the university and other parties in the project’s success.
C. Moody’s determination of a credit impact is not static and could vary during the life of a project.
D. Negative impacts to credit are more likely if:
I. The project experiences financial stress relating to:
b. Ongoing operations and occupancy
c. Funding of ongoing capital repairs and improvements
II. And, if the university is likely to provide financial and operational support to the project during times of financial stress.
2. Unless the university is providing significant credit support, most project financings are in the lower investment grade rating category of Baa3. This rating reflects the stand-alone project-based nature of the financings where there is 100 percent financing (i.e. no contributed equity), single asset collateral without land subordination, modest debt service coverage (1.20x rate covenant), full construction risk, limited financial reserves, annual lease-up risk, operating risk and competition from on- and off-campus facilities.
3. We believe that ACE transactions remain an attractive alternative and offer certain advantages over 100 percent project-based debt transactions for those institutions that are the most risk adverse and want the lowest probability of a negative credit impact over the life of a project. This is due to the following facts:
A. Equity-based transactions have a higher certainty of successful structuring and closing as they are not subject to the volatility of the tax-exempt market and availability of credit enhancement.
B. Equity-based structures have 10-15 percent lower total project cost than tax-exempt structures due to the elimination of costs associated with transaction structuring, financing costs, third-party service fees and reserve requirements.
C. Equity-based structures have less risk for the university.
I. Developer/Owner takes full risk for
1. Development and construction
2. Operating losses
3. Capital reinvestment above and beyond reserves to maintain marketability and competitiveness of the project.
D. Equity-based structures are less likely to encounter times of financial stress.
I. Equity-based structures have significantly better performance metrics than 100 percent project-based debt structures.
1. Lower loan-to-cost ratio – an equity-based structure typically has a maximum 50-75 percent debt of a lower total project cost versus 100 percent debt of a higher total project cost in a tax-exempt structure
2. Higher debt service coverage ratio – typically 1.75x-to-2.00x in an equity structure versus typical 1.20x for 100 percent project-based debt structure
3. Breakeven achieved at lower occupancy: 50-70 percent for an equity structure versus 80-90 percent for a completely project-based debt financing
4. More flexibility to reduce rental rates to build occupancy while still achieving the breakeven point
5. Equity structures typically allow lowering rents 25-35 percent versus 10-15 percent in a 100 percent project-based debt structure.
II. If events of financial stress do occur, it is less likely that the university will have to financially or operationally support a project in an equity-based structure based on:
III. In a 100 percent debt tax-exempt structure, the university is the motivated party most likely to take action.
IV. In an equity structure, the owner is highly motivated to take action as their investment is fully at risk and any debt defaults impact the owner’s credit profile.
V. The manager is fully vested as the owner in an equity deal vs. being a fee-based third-party provider in a 100 percent debt tax-exempt structure.
All the factors discussed in Item 3 above are among the factors taken into consideration by the rating agencies when they evaluate and consider these transactions in a university’s credit profile.
Our Summary ViewpointWe do not believe that Moody’s most recent Special Comment results in any material changes for the privatized student housing sector. They continue to use the same methodology in their evaluation of these transactions when assessing a university’s credit profile. They have confirmed that all projects are considered in a university’s credit profile and that each and every transaction may be viewed differently on a case-by-case basis. No structure in and of itself guarantees a credit outcome. Further, within the same classification of structure – whether 100 percent project-based, tax-exempt debt or equity-based – projects may be treated differently based on myriad factors.
From a credit impact perspective, a successful project with strong operational and financial metrics and an experienced credit worthy partner would have a more favorable impact than a struggling project with poor operational and financial metrics where a university takes action to support the project. Bottom line, institutions that are risk adverse and want the highest probability of a project that does not experience financial duress that would put them in a position of taking actions which might negatively impact their credit, will find equity structures as the most desirable option. For those institutions that have a higher risk tolerance and desire greater control and cash flow, the 100 percent project-based debt structure will continue to be the most attractive option.
ACC is uniquely qualified to assist universities with the evaluation of all forms of available financing. Because ACC is actively engaged with all methods of financing, project-based tax-exempt (senior and subordinate) bonds, equity-based partnerships, conventional bonding and university general revenue bonds, we can objectively provide administrators with current market information. Our analysis is comprehensive and unbiased, enabling each university to select the plan of finance that best meets its goals and objectives.
For additional information, readers should consult Moody’s related research:
Special CommentsCredit Trends: Privatized Student Housing Financings Demonstrate Credit Stability, February 2012
More U.S. Universities Expect Tuition Revenue Declines; Larger, Diversified Universities Favored in Tough Higher Education Market, January 2012
Privatized Student Housing and Debt Capacity of US Universities, March 2010
Industry OutlookU.S. Higher Education Outlook Mixed in 2012, January 2012
The views expressed above are those of American Campus Communities and do not claim to represent those of Moody’s Investor Service in any way. Please note that the statements made herein are based on current expectations, estimates and projections about the industry and markets in which American Campus operates, management’s beliefs, and assumptions made by management. These statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict.