OREANDA-NEWS. Fitch Ratings has affirmed the 'AA' rating on $59 million in outstanding Orchard Cultural Education Facilities Finance Corporation, Texas revenue bonds, series 2010A and series 2010B (the bonds) issued on behalf of Kimbell Art Foundation (KAF).

The Rating Outlook is revised to Negative from Stable.

SECURITY

The bonds are general unsecured obligations of KAF.

KEY RATING DRIVERS

OUTLOOK REVISION: The Negative Outlook reflects Fitch's concern that operations will be pressured leading to higher draws from KAF's traditional securities investment portfolio and less over-all operating flexibility.

SUBSTANTIAL BALANCE SHEET CUSHION: KAF's balance sheet resources, including oil and gas holdings but excluding art and library collections, are substantial for the rating category and continue to support the 'AA' rating.

OIL/GAS RELIANCE: Oil and gas revenues historically account for most of the foundation's operating revenues, typically about 77%. The recent reductions in oil and gas revenue to KAF, driven by lower oil prices, highlight the revenue concentration.

HIGH DEBT BURDEN: KAF's debt burden remains high but has moderated in recent years. Consistently strong debt service coverage from operations, level debt service, and no planned long-term debt or capital needs partially offset this risk.

RATING SENSITIVITIES

FINANCIAL CUSHION: Kimbell Art Foundation's (KAF) rating is primarily supported by its balance sheet resources. Material erosion to the balance sheet ratios or portfolio liquidity could pressure the rating.

OPERATING PRESSURES: An inability to manage future expenses and use sustainable endowment draws from KAF's traditional investment portfolio to supplement declines in oil and gas revenue will pressure the rating.

CREDIT PROFILE

Founded in 1936, KAF is a nonprofit corporation tasked with maintaining an institute to promote the study and appreciation of art in Fort Worth, Texas. In 1972, KAF constructed the Kimbell Art Museum (the museum) and has owned and operated it ever since. In 2013, KAF completed a museum expansion and opened the Renzo Piano Pavilion which provides space for special exhibitions, dedicated classrooms and a 289-seat auditorium. The museum contains more than 350 works of art in its permanent collection.

Attendance fluctuates depending upon the exhibition schedule. Annual attendance totaled 261,688 in fiscal 2015, down 18.6% from fiscal 2014. Fiscal 2014 was a banner year with attendance of 321,403, a 41% increase from fiscal 2013, due to popular special exhibitions including a seven-month exhibit on Samurai warriors and an exhibit loaned from the Musee d'Orsay in Paris on impressionist portraits. Continued interest in the new Piano Pavilion also supported attendance.

RELIANCE ON OIL AND GAS

The majority of KAF's revenues (about 77%) are derived from oil and gas net profit interests (NPI) and KAF's direct ownership and investment in oil and gas producing royalties (PRs) in over 20,000 geographically diverse oil and gas wells in the U.S. Capital and operating risks are borne by the property owners, with KAF receiving a share of generated revenues.

Historically, oil and gas income, plus museum activity-based income, has been more than sufficient to balance expenses and generate operating surpluses; KAF has not needed to draw income from its traditional investment portfolio. However, with lower oil and gas income in fiscal 2015 and to date in fiscal 2016, KAF is now using income from its traditional investment portfolio. To date these amounts have been sustainable, but Fitch views KAF as having less operating flexibility in the current oil and gas environment. In the fiscal year ending Dec. 31, 2014, KAF's oil and gas revenue was $31.6 million, compared to $25.9 million in fiscal year 2013. Estimated net oil/gas income is $18.7 million for fiscal 2015, and Fitch expects this number will be down again in fiscal 2016.

Activity-based revenue, including attendance fees, box office receipts, and net museum shops and food service sales are less significant funding streams but have grown in recent years.

CONSERVATIVE OIL AND GAS PROJECTIONS

KAF management reports conservative annual oil and gas income projections, which anticipated the 2015 and 2016 income declines. The museum's operating budgets incorporated those declines. Management reports that, despite depressed pricing, performance for all oil and gas PR revenues continues to exceed projections. For fiscal 2014 the base case estimate was $24.9 million with actual revenues of $27 million; for fiscal 2015, the base case estimate was revised down to $15.7 million but projected at $16.7 million.

ADEQUATE BUT NARROWING OPERATING MARGINS

The most KAF current audit is for fiscal 2014. Fitch-calculated operating margins were 5.6% and 7.5% in fiscal 2013 and 2014, respectively, down from prior year highs (22.8% in fiscal year 2012). While slimmer, Fitch views the operating margins as consistent with the rating category. Management reports that exhibition costs, depreciation expense, and costs associated with the new Piano Pavilion has contributed to lower margins.

Historically, oil and gas revenue, combined with museum activity revenue, was more than sufficient to cover expenditures and generate an operating surplus. However, in fiscal 2015, the decline in oil and gas income required a draw on the traditional investment portfolio of less than 2%, on an unaudited basis. Fitch views this amount as sustainable. For fiscal 2016, with another decline in oil and gas revenue's, it is likely KAF will draw on the traditional investment portfolio income again at approximately 5%. Per Fitch's criteria, most spending policies are based on a 4.5%-6% draw. At this time, Fitch understands that KAF has no formal policy regarding draws from the traditional portfolio. Over time, Fitch expects KAF to manage such draws to be sustainable long-term. Given recent oil and gas price volatility, which is impacting KAF's operating budget, the museum's operations are more pressured than in prior years.

SUBSTANTIAL RESOURCE BASE REMAINS

KAF's strong balance sheet continues to support the rating. Historically, oil and gas income, combined with annual operating surpluses, bolstered financial resources. KAF's available funds (defined by Fitch as cash and investments not permanently restricted) totaled $214 million at the end of 2014 and excludes $254 million in oil and gas holdings. Available funds covered fiscal 2014 operating expenses ($37.9 million) by a substantial 565% and outstanding pro forma debt ($114.6 million) by a solid 187%.

The available funds value is conservative. Including the Dec. 31, 2014 market value of gas and oil investments bolsters respective available fund ratios to 1228% of fiscal 2014 operating expenses and 408% of pro forma debt.

In addition to a volatile oil and gas investment portfolio, KAF's traditional investment portfolio has significant exposure to illiquid alternative asset classes. Private equity and alternative investments were about 47% at Dec. 31, 2014. If available funds are adjusted to exclude these investments, available funds is significantly lower in fiscal 2014 at $115.3 million which results in lower liquidity metrics. However, adjusted available fund to operating expenses is still substantial at 302%, while the adjusted available funds to pro forma debt ratio is significantly lower at 100.6% but still adequate for the rating category.

HIGH DEBT BURDEN

Pro forma debt includes $59 million of outstanding fixed-rate bonds and a $60 million unsecured line of credit, of which $53.8 million has been drawn. The bonds have level debt service of about $5.1 million starting in fiscal 2015.
Maximum annual debt service (MADS) of $5.1 million (in 2020) on the bonds, which excludes the bank facility, was a high 12.4% of fiscal 2014 operating revenues. This burden has moderated over time from 17.6% in fiscal 2012. However, it could increase further if KAF chooses to permanently finance its bank line.

Partially offsetting the high debt burden is KAF's solid debt service coverage. Coverage of MADS was 2.5x in fiscal 2014. KAF's strong balance sheet cushion and lack of additional debt plans also partially mitigate concern.

The bank line of credit was used for project completion on the Piano Pavilion and to acquire art work. The facility has a one-year renewal schedule, which has been renewed several times and currently expires on Sept. 30, 2016. At this time management expects to continue renewing the line, thus taking advantage of low interest rates. Fitch believes KAF has sufficient market access to permanently finance the bank line, as well as maintaining sufficient resources to repay the bank obligation if necessary.