Public/Private Partnerships: Understanding the Rating Agency’s Perspective

Increasing demands for capital expansion combined with a continued weak economy make partnerships with private entities an attractive option for financing new campus facilities. But before forming partnerships, an institution must review the possible trade-offs, including implications of those partnerships on the institution's risk profile, debt capacity, and credit rating.

To learn more about how a rating agency will evaluate the credit impact that any given public/private (P3) project will have on the affiliated university, we interviewed Karen Kedem, the vice president, senior analyst, and co-manager of Moody's U.S. Higher Education and Not-for-Profit Team. Kedem spoke with Academic Impressions recently about how Moody's analyzes the credit risks associated with these transactions, as well as how institutions can work more effectively with the agency as they prepare to enter into a P3 partnership.

Increasing demands for capital expansion combined with a continued weak economy make partnerships with private entities an attractive option for financing new campus facilities. But before forming partnerships, an institution must understand various structures and options, as well as possible implications of the partnerships on risk profile, debt capacity, credit rating, and even town-gown relations.

Here are several key points Kedem shared with us this week.

 

AI. What does Moody's look for when evaluating potential impacts on an institution's credit rating?

Kedem. We're looking for a number of things:

How exposed is the institution legally -- what are their legal obligations in this transaction?

Next, how strategic is this project to the university? Regardless of legal obligation or accounting treatment, how important is the project? For example, is it part of a strategic plan to expand housing and attract more out-of-state students? From a credit risk perspective, we are looking at: in a situation in which the project is not going forward according to pain, what is the likelihood of the institution stepping in? The institution's management and governance team need to be in accord on what they would do if the project doesn't go according to plan, and this means thinking through the implications of this specific project to their larger goals. The rating agency will ask them to articulate that.

We also look at the partners in the transaction -- are these individuals and companies experienced in their field? With more developers getting into these projects, we would be inquiring about the expertise of the partner and their track record for like projects.

Finally, we want to know whether both the management and governance teams of the institution are going into the transaction with their eyes open. We will look at what specific benefits the institution is gaining through the transaction, and what they are giving up. The most likely cost to a university would be the forgone surplus revenue, as housing tends to be a profitable enterprise. Housing surpluses could be used to cross-subsidize educational programs or other strategic initiatives. While there tends to be net revenue sharing available in privatized student housing transactions, it is usually less than the amount of surplus the university would retain if it financed and managed the project itself. Therefore, high reliance on student housing could have an impact on the university's bottom line.

Universities can derive benefits from these transactions by selecting an experienced developer who will finance and build attractive housing at a faster pace than the university could. Having a project available sooner could be important to maintaining or strengthening the university's overall competitive position, especially as public universities seek more out-of-state student revenue to replace lost state funding. In the short term, the structure could allow the university to avoid investing in housing management and maintenance. Over the long term, however, the interests of the private company and the university may diverge if they do not agree on the level of capital investment in the project or pricing strategy.

 

AI. Could you describe the rating agency's role in the process of approaching a P3 transaction?

Kedem. We are there initially to serve as a resource and to explain our analytical approach. We can discuss any published ratings for universities that have entered similar types of transactions; we are able to discuss any reports that have been published, in order to clarify the picture of what the credit risk associated with the transaction might be. At an early stage, we can provide general feedback on how we would evaluate the proposed transaction within our analytical framework. To provide feedback on a specific project, we would need to see documents -- but we are happy to talk generally about our rating approach and our analytics, at an early stage.

 

AI. Are there benefits to the institution in bringing the rating agency into the conversation early?

Kedem. Sometimes an institution's leaders and business officers may be reticent to tell the rating agency about the project while the discussion of it is still very preliminary; there may be a worry that this would impact their rating. So we tend to be involved later. The benefit to contacting the rating agency earlier is to understand the agency's analytical approach early, so that the institution doesn't pursue discussions with the developer too far down a certain path, and then feel later that they have wasted time and effort on proposing a transaction that will not lead to the outcome with the rating agency that they would want. It's good to get early indicators of what the impact of the transaction would be on the institution's credit rating.

 

AI. Does the type of facility being developed have an impact on the rating?

Kedem. We look at each project on a case-by-case basis. The type of project can influence the debt capacity impact on a university.  Here is a visual representation of this point, from Moody's June 2008 report, Public-Private Partnerships in Higher Education.

 

Impact of Facility Type on Credit Rating

 

AI. Thanks, Karen! Before we close, can you talk a little about what would be covered in your session at the upcoming Financing Campus Facilities through Public/Private Partnerships conference?

Kedem. Sure. The session will provide an opportunity to learn about the analytical approach we use in more depth -- a close look at how Moody's evaluates credit rating and the impact of public/private partnership transactions. It's also an opportunity to ask questions of us, one-on-one, in a relatively intimate setting.

Increasing demands for capital expansion combined with a continued weak economy make partnerships with private entities an attractive option for financing new campus facilities. But before forming partnerships, an institution must understand various structures and options, as well as possible implications of the partnerships on risk profile, debt capacity, credit rating, and even town-gown relations.