Fitch Rates University of North Carolina at Chapel Hill's $250MM General Revs 'AA+'

Fitch Ratings assigns an 'AA+' rating to the following series of general revenue bonds issued by The University of North Carolina Board of Governors on behalf of University of North Carolina at Chapel Hill (UNC-CH):

--$125 million The University of North Carolina at Chapel Hill general revenue bonds, series 2009A;

--$125 million The University of North Carolina at Chapel Hill taxable general revenue bonds (Build America Bonds), series 2009B.

The bonds are expected to be sold on or about Nov. 17 via negotiated sale. Bond proceeds will be used to refinance up to $110 million of outstanding commercial paper (CP) bonds and fund various capital improvement projects.

In addition, Fitch affirms the following:

--$864,555,000 fixed-rate general revenue bonds at 'AA+';

--$79,030,000 variable-rate general revenue bonds at 'AA+/F1+';

--$2,485,000 housing system revenue bonds at 'AA'.

General revenue bonds (GRBs) are secured on a parity basis by available funds of UNC-CH, which exclude state appropriations, tuition, and restricted funds. UNC-CH also expects to receive a cash subsidy payment from the United States Treasury equal to 35% of the interest payable on the series 2009B bonds which it expects to designate as Build America Bonds for purposes of The American Recovery and Reinvestment Act of 2009. This subsidy payment will constitute pledged revenues and will be applied by UNC-CH to the payment of debt service. The Rating Outlook on all long-term debt is Stable. Fitch does not rate UNC-CH's $500 million tax-exempt and taxable CP program, $400 million of which is authorized for UNC-CH, with the remainder authorized for North Carolina State University.

The 'AA+' rating reflects UNC-CH's substantial balance sheet resources and liquidity; sound operating performance, supported by diverse funding streams; exceptionally strong student demand and academic quality; and an experienced management team. The 'AA' rating reflects the aforementioned credit strengths, though it recognizes the more narrow nature of the pledged revenue stream securing the housing bonds (net revenues of the housing system). The 'F1+' reflects the availability of highly liquid, immediately available funds ($712 million on Sept. 30, 2009) to support the potential failed remarketing of outstanding variable rate bonds ($79 million) or failed rollover of commercial paper ($50 million maximum daily maturity limit).

Primary credit concerns include recent investment portfolio losses related to turbulence in global financial markets; economic pressures at the state level (state general obligation bonds rated 'AAA' by Fitch) which lead to an appropriation reduction in fiscal 2009; and the size and scope of UNC-CH's rolling capital improvement program (CIP), significant portions of which are supported by debt. In the case of the CIP, Fitch recognizes that much of the borrowing issued to support the $2.3 billion CIP (fiscal 2000 through fiscal 2009) has already been incurred, with the overall magnitude of the borrowing manageable given UNC-CH's prudent management practices, diverse revenue base, and ability to fundraise.

UNC-CH's primary financial strengths are the size of its resource base and its ability to generate break-even to positive operating performance in most fiscal years. Between fiscal 2004 and fiscal 2008, available funds, or cash and investments not restricted, represented a solid 50.7% and 75.6% of operating expenses, respectively and 66.4% and 124.5% of pro-forma debt, respectively (including the bonds). For fiscal 2009, based upon unaudited results, Fitch estimates UNC-CH's available funds declined to approximately $1.1 billion, representing 51.7% of operating expenditures and 85.2% of long-term debt. Importantly, Fitch notes that much of balance sheet pressure is a function of the performance of UNC-CH's long-term financial assets which were down 19.6% between fiscal 2008 and fiscal 2009. While illiquid, non-marketable alternative assets, including private equity and hedge funds, have risen to 61.7% of total investments, these funds are invested with a long-term horizon and are not relied on to meet near term potential liquidity needs. UNC-CH maintains a temporary investment pool and, by statute, an investment in the state treasurer's short-term investment fund for this purpose, with the assets in both funds more conservatively invested.

UNC-CH's strong balance sheet has benefited from its track record of generally break-even to positive operating performance. Between fiscal 2004 and fiscal 2008, the operating margin ranged from 0.6% (fiscal 2007) to 3.5% in fiscal 2008. For fiscal 2009, primarily the result of state funding reductions (-4.6%, exclusive of state aid from federal recovery funds), and excluding realized and unrealized gains and losses, Fitch estimates UNC-CH's operating margin will equal -0.7%. In response to the fiscal 2009 appropriation cuts, and in anticipation of additional near term reductions, UNC-CH has implemented various budgetary restraints, including a campus wide 10% reduction in operating costs. Management reports that such a reduction, in combination with other proposed operating efficiencies, should enable it to handle any additional funding reductions. While state appropriations represent less than 25% of UNC-CH's total budget, such funds provide an important offset to costs associated with faculty, programs, and facilities.

Following the issuance of the bonds, UNC-CH's debt burden, without amortization of large bullet associated with outstanding series 2005 and series 2007 bonds, equals a moderately high, though manageable 6.7%. If the bullets were amortized over the remaining years to final maturity on both issues, the debt burden would decline to approximately 4.4%. While the size and scope of UNC-CH's operation, which is heavily research oriented, will necessitate on-going physical plant investment, the risk of overleveraging is mitigated by management's prudence in planning for projects and use of non-debt funding sources when possible, including fundraising. UNC-CH fundraising prowess is evidenced by its recent completion of a $2.3 billion comprehensive capital campaign, Carolina First, which exceeded its state goal by approximately $400 million. To date, approximately $1.6 billion has been collected, with the majority of funds being allocated to scholarships, professorships, and facility construction/renovation.

Established in 1789, UNC-CH is a member of the 17-member University of North Carolina System and is the state's flagship university. For fall 2009, UNC-CH enrolled 28,914 students, of which 62% were undergraduates. UNC-CH's demand indicators continue to reflect its market position as a highly selective, research oriented public university.

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