OREANDA-NEWS. Fitch Ratings has affirmed the 'BB+' rating on approximately $35.6 million of the City of Anderson, Indiana economic development revenue refunding and improvement bonds issued on behalf of Anderson University (AU).

The Rating Outlook is revised to Negative from Stable.

SECURITY

The bonds are an unsecured general obligation of the university. As additional security, there is a cash-funded debt service reserve fund.

KEY RATING DRIVERS

WEAKENING OPERATING PERFORMANCE: The Negative Outlook reflects weakening operating performance driven by continued enrollment declines. AU generated a small operating deficit and weaker but still-adequate coverage in fiscal 2015. Fiscal 2016 results are expected to be materially weaker, due in part to a voluntary retirement initiative.

CONTINUED ENROLLMENT DECLINE: Total enrollment continues to decline, however, preliminary data indicate a larger fall 2016 freshman class compared to fall 2015, which declined slightly from the prior year. Management has several initiatives in place to stabilize enrollment, but AU remains in a competitive environment.

LIMITED BALANCE SHEET RESOURCES: AU's balance sheet resources provide limited financial cushion in line with the rating level. Available funds, defined by Fitch as cash and investments not permanently restricted, equaled 28.4% of fiscal 2015 operating expenses and 24.2% of debt.

MODERATELY HIGH DEBT BURDEN: The university's maximum annual debt service (MADS) equaled a moderately high 8.2% of fiscal 2015 unrestricted operating revenues (excluding affiliate activities). MADS coverage from operations was adequate for the rating category at 1.4x. AU has no plans for additional debt at this time.

RATING SENSITIVITIES

RETURN TO BALANCED OPERATIONS: Failure of Anderson University to progress toward budgetary balance or to maintain balance sheet resources over the two-year Outlook period would likely lead to a downgrade.

STABILIZING ENROLLMENT: Level or increasing incoming classes leading to stabilized enrollment are necessary to maintain the current rating level.

CREDIT PROFILE

Founded in 1917, Anderson University is a small Christian university located in Anderson, IN (35 miles northeast of Indianapolis). AU was founded by and affiliated with the Church of God (Anderson, IN) (COG) and is the only college affiliated with COG in the Midwest. The university offers around 60 undergraduate majors as well as graduate programs in business, music, nursing, and theology. The university also maintains a Department of Adult Studies that offers bachelor and associates degrees and non-credit programs for adult students.

WEAKER OPERATING PERFORMANCE

AU's operating performance has weakened due to continued enrollment declines and ongoing expense pressures. GAAP-based operating results were effectively breakeven for two years, including a 0.6% deficit margin in fiscal 2015. AU has been successful in recent years in maintaining net tuition revenue, which is down only 1.9% over the fiscal 2011 to 2015 period, and preserving operating balance through expense management despite FTE enrollment declines totaling 11.9% over that period.

However, AU's budget is becoming increasingly challenged. The university expects a sizeable operating deficit in fiscal 2016 reflecting flat net tuition and some growth in expenses. The expected deficit will be increased by a voluntary retirement initiative. AU will record a one-time expense of about $2.5 million in fiscal 2016 (cash will be disbursed over two years) in order to generate roughly $1 million of annual savings going forward. Management expects improved but still deficit operations in fiscal 2017, but expects stable enrollment and expense cuts to result in budgetary balance by fiscal 2018. Failure to progress toward budgetary balance over the two-year Outlook period would likely lead to a downgrade.

Affiliate operations, primarily the Flagship Enterprise Center (FEC), a regional incubator and business center created through a partnership between AU and the City of Anderson, are profitable. Affiliate activities are consolidated on AU's financial statements based on AU's ability to appoint a majority of the FEC's board. However, FEC resources are not directly available to support AU operations, nor are AU's resources legally available to meet FEC obligations. Fitch evaluates AU's operating performance primarily based on direct university activities, excluding affiliate activities.

ENROLLMENT EXPECTED TO STABILIZE

AU's headcount enrollment has fallen 11% from a peak of 2,611 in fall 2011 to 2,325 in fall 2015. The trend reflects a competitive environment, increasing price sensitivity and AU's primary overlap with nearby public institutions that are lower cost. Under a new marketing and admissions team, the university is pursuing several strategies to bolster enrollment including student retention initiatives, enhance marketing efforts, targeted student aid, curricular changes to accommodate more transfer students, and programmatic adjustments to align with market demand.

AU expects a larger fall 2016 incoming class based on applications, admits and deposits that are all ahead year-over-year for both freshmen and transfers. The incoming class size has been fairly stable from fall 2013 to fall 2015, following materially larger classes in prior years. Continued flat or growing matriculation would result in stable enrollment by fall 2017 below the historical peak but at a level Fitch believes would be sufficient for AU to achieve budgetary balance. However, inability to stabilize enrollment over the next two admissions cycles would further pressure the rating.

LIMITED BALANCE SHEET RESOURCES

AU's balance sheet resources provide limited financial cushion in line with the rating level. Available funds equaled 28.4% of fiscal 2015 operating expenses and 24.2% of debt. AU's permanently restricted endowment is not included in Fitch's calculation of available funds, but it supports the university through annual distributions. While certain permanent funds in the $34.2 million (net) endowment remain underwater due to recession-era losses, the 4% policy draw for operations is still conservative and manageable on a net basis.

MODERATELY HIGH DEBT BURDEN

The university's debt burden is moderately high, with MADS equal to 8.2% of fiscal 2015 unrestricted operating revenues (excluding affiliate activities). MADS coverage from university operations has declined but remains adequate at 1.4x. However, coverage may be susceptible to some deterioration with weaker margins in fiscal years 2016 and 2017. The university remains in compliance with financial covenants. AU has no plans for additional debt at this time, and Fitch does not believe the university has additional debt capacity at the current rating level.