Fitch Rates Montgomery College's (MD) Series 2014 Lease Rev Ref Bonds 'AA'; Outlook Stable

Fitch Ratings assigns an 'AA' rating to approximately $22.3 million of Montgomery County Revenue Authority (MCRA) lease revenue refunding bonds (the bonds) (Montgomery College Arts Center Project) series 2014, issued on behalf of Montgomery College (MC or the college).

The fixed-rate series 2014 bonds are expected to sell via negotiation on or around Nov. 5, 2014. Bond proceeds are being issued for the purpose of currently refunding the college's outstanding series 2005A lease revenue bonds and pay costs of issuance.

At the same time, Fitch affirms the 'AA' rating on the series 2005A lease revenue bonds.

The Rating Outlook is Stable.

SECURITY

The series 2014 bonds are secured under a lease agreement with the college foundation and payable solely from the college's major facilities reserve fund fees (facilities fees). Currently, the fee is $5.00 per enrollment hour and charged to all students at the college's three campuses. The lease payments will be equal to the debt service payments on the bonds. The series 2014 bonds are additionally secured by a mortgage on the leased property.

KEY RATING DRIVERS

STABLE CREDIT CHARACTERISTICS: The 'AA' rating on the series 2014 bonds is based on the stability and sufficiency of the facility fee revenues pledged to the bonds, a sizable and diversified enrollment base which drives historically sound coverage levels, the college's independent revenue raising authority and low financial leverage given substantial capital support from the county. Offsetting factors include the narrow revenue pledge, the cyclical nature of the enrollment base, not uncommon for community colleges, and the college's low liquidity levels.

SUFFICIENT DEDICATED FEE: The long history of the mandatory fee, initially collected in fiscal 1992, and the board of trustees' demonstrated ability to raise such fee independently with no cap is viewed favorably. For fiscal 2014, the current $5.00 fee based on 603,947 enrollment hours generated $3.06 million of revenue.

INCREASING COVERAGE: Post-refunding, lease payment coverage is expected to increase due to annual debt service savings. The college is required to charge a facility fee sufficient to cover the lease payment by 1.1 times (x). Beginning in fiscal 2015, the lease payment is estimated to be lower at about $2.09 million and projected coverage is higher at 1.47x.

ENROLLMENT MANAGEMENT: The college is facing declining enrollment as the area economy improves, a trend seen nationwide, and due to shifting high school demographics in the county. The college will require careful and responsive budgeting to maintain overall operating health. Given the college serves as a feeder into the University of Maryland System, the importance in hierarchy partly mitigates concern of declining enrollment.

COLLEGE'S OVERALL CREDIT PROFILE: The rating takes into account the college's credit profile including its strong market position and key role in the state of Maryland's education planning and economic development, which drives significant operating and capital support from the state and Montgomery County (both rated 'AAA'/Stable Outlook). The consistent funding supports the college's low overall debt burden and provides reduced reliance on cyclical enrollment trends. Offsetting factors include a history of negative, GAAP-based operating margins, exposure to appropriation fluctuations, shifting enrollment and economic cycles, and the college's weakening but adequate liquidity, driven by the county's requirement to use unrestricted fund balance in its operating budget.

RATING SENSITIVITIES

DECLINING ENROLLMENT: The rating is sensitive to material shifts in enrollment hours. Adverse shifts could diminish pledged revenues and impose stress on coverage levels. The college's inability to sufficiently offset enrollment losses by adequately setting rates to generate at least the projected coverage levels presented could lead to a downgrade.

OPERATING IMBALANCE: The further deterioration of the operating margin or the college's inability to show incremental improvement in the operating deficit will likely lead to a rating downgrade.

CREDIT PROFILE

In operation since 1946, the college is the second largest higher education institution in the state, after the University System of Maryland (USM; tuition revenue bonds rated 'AA+'/Stable Outlook), and is the primary state provider of two-year associate degrees and technical certificates. The college is a feeder of transfer students to USM, and a growing source of various training and continuing education programs underscoring its key role in the state. The institution, offering 75 associate degree programs and 60 certificate programs, operates three campuses located throughout the county in Takoma Park/Silver Spring, Rockville, and Germantown. Annual headcount enrollment at the college in fall 2014 is down 2.4% to 25,518 students.

STABILITY OF MANDATORY FEE

The facility fee was initially collected in fiscal 1992 at the rate of $1.00 per student hour. The rate increased to $2.00 in fiscal 2002, followed by an increase to $4.00 in fiscal 2004 and to $5.00 in fiscal 2005. Since that time, the current $5.00 fee has provided a stable revenue source to support annual lease payments. For fiscal 2015, the fee (based on an estimated 615,825 enrollment hours) is expected to generate $3.08 million of revenue. The board of trustees of the college have the right to increase the fee without external approval and there is no maximum. The facility fee cannot be used by the college to fund operating costs and must first be used for the annual lease payment and then used for other capital improvements.

IMPROVED COVERAGE LEVELS PROJECTED

Coverage levels have typically ranged from 1.31x and 1.44x between fiscals 2008 to 2014 supported by growth in student hours during this period and based on the current $5.00 fee. Debt service coverage is projected to range from 1.47x to 1.59x between fiscal 2015 and 2019. The projections provided by the college assume no increase in the facility fee and declining enrollment hours over five years (from 615,825 in fiscal 2015 to 607,905 in fiscal 2018). This appears reasonable given the local area high school's declining graduation trend. Despite the projected decline in enrollment hours, the facility fee of $5.00 supports the increase in coverage on the bonds. In the event that enrollment hours fall below the projected levels, the board has the flexibility to increase the fee to an appropriate level.

ENROLLMENT MANAGEMENT

For fiscal 2014 (academic year 2013/2014), total enrollment hours (consisting of enrolled credit and non-credit hours) decreased 5.5% (35,349 credit hours) to 603,947. Enrollment hours in fiscal 2015 is projected to increase to 615,825, due to an increase in non-credit hours for workforce development and continuing education, followed by an incremental decline over several years. Economic recovery and declining high school graduates account for the projected drop in credit hours. According to management, a rebound in high school graduates is expected in spring 2018 which should drive growth in credit hours in fiscal 2019.

Some comfort is drawn from the college's key role in the state and its large and diversified enrollment base, with three campuses and close proximity to Washington D.C., somewhat insulating the college from drastic declines. The Takoma Park/Silver Spring Campus, with 19.5 acres is located at the edge of the Washington, D.C. metroplex. The Rockville Campus, with 84.6 acres is located north of D.C. and the Germantown Campus, with 232.6 acres is 30 miles north of D.C. in the I-270 High-Tech Corridor.

Fitch recognizes that enrollment is cyclical across community colleges and improvements in the local area economy, improved job availability, the tightening in the eligibility for financial aid, and perceived value of a college degree relative to cost are all factors that impact enrollment. While the college has created new programs and recruitment strategies for increasing enrollment, the college has hired a consultant to evaluate its overall enrollment management strategy which includes different tuition pricing scenarios. According to management, the county encourages the college to increase the number of students with IT, science and math backgrounds for the economic development of the county. The college has responded by opening the bioscience education center on the Germantown campus in September 2014 and creation of cyber-tech pathways with Federal grant funding.

Fitch will continue to monitor the college's declining enrollment and new enrollment strategies once they become finalized. The college's inability to prudently budget and respond to the declining enrollment could negatively impact pledged revenues which could pressure the rating.

WEAKENING OVERALL OPERATING PROFILE

The college's overall operating profile weakened in fiscal 2014, with the operating deficit widening to 8.3%, compared to the 3.1% deficit in the prior year, on a full accrual basis. Fitch notes that actual results are weaker than projections presented during the June review but recognizes that the projections did not include such things as the other post-employment benefit (OPEB) obligation as an operating expense or account for the increased depreciation expense which is included in actual results.

The college's growing fiscal imbalance is largely due to a significant 9.4% increase in operating expenses over fiscal 2013, which outpaced revenues and significantly exceeded budget and projections provided to Fitch. This was largely due to management's decision to improve compensation and retain talent, after four years of freezing salaries, in addition to other operating inefficiencies. The college has hired a consultant to assess the current compensation program for faculty, staff and administrators and determine if there are areas that can be refined. Management recognized that the college's compensation and equity review policy was not sustainable and was therefore terminated.

Management's inability to find a sustainable solution to control expenses and show progress towards restoring operating balance could result in negative rating action.

STRONG STATE AND COUNTY SUPPORT

Significant growth in county and state support continues, with projected increases totaling 18% and 8%, respectively, for fiscal 2015. The county's credit strength, including its large and affluent service area, together with its strong and consistent financial support to the college (under the state regulated County Maintenance of Effort) partially offset the college's weaker financial attributes.

LIMITED BUT ADEQUATE LIQUIDITY

The college's overall liquidity provides a limited cushion relative to operations, not uncommon for community colleges. However, year-end results for fiscal 2014 reflect balance sheet weakening with a 13.8% decline in available funds (AF), defined by Fitch as cash and investments less restricted net assets, to $78.7 million. AF to operations are down at 25.3% in fiscal 2014 from 32.1% in fiscal 2013. However, AF's provide sound coverage of pro forma debt at 119.6% which meets expectations for the 'AA' rating.

VERY LOW DEBT BURDEN

The majority of the college's recent capital projects have been funded by state and county appropriations resulting in a very low debt burden. Pro forma maximum annual debt service (MADS) coverage from fiscal 2014 unrestricted operating revenues was 1.9x. Pro forma MADS includes the planned issuance of transportation fee revenue bonds expected in mid-fiscal 2015. Strong local support for capital projects has limited the college's need to issue additional revenue debt secured by the facility fee allowing coverage on the bonds to remain adequate.

Fitch also rates and has recently affirmed the following ratings:

--$14.56 tax-exempt and taxable lease revenue bonds (Montgomery College Goldenrod Building Acquisition) series 2011A and series 2011 B;

--$15.09 million lease revenue bonds (Takoma Park/Silver Spring Parking Garage Project) series 2008 A.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'U.S. College and University Rating Criteria' (May 12, 2014);

--'Fitch Rates Montgomery College (MD) Lease Revs at 'AA'; Outlook Revised to Stable', dated June 5, 2014.

Applicable Criteria and Related Research:

U.S. College and University Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=748013

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=906814

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