NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'A' rating on approximately $112.52 million of revenue bonds issued by the California Infrastructure and Economic Development Bank on behalf of The J. David Gladstone Institutes (JDGI).
The Rating Outlook has been revised to Negative from Stable.
SECURITY
The bonds are a general obligation of JDGI and are supported by a pledge of its gross unrestricted revenues.
KEY RATING DRIVERS
UNSUSTAINABLE DRAW ON ENDOWMENT: The Rating Outlook revision to Negative from Stable reflects Fitch's concern about the high level of spending from the endowment (budgeted at 7% of total investment portfolio including cash). Management has stated that there is a longer term target to reduce the draw to approximately 5% and there needs to be continued progress toward the internal goal.
GOOD FINANCIAL CUSHION: Available funds in 2014 (audited fiscal year ended Dec. 31) covered operating expenses and debt by a solid 182% and 111.4%, respectively; however, the level has remained below the peak achieved prior to the 2008 market dislocation. Fitch believes available funds growth has been hampered by the high amount of spending from the endowment.
SIGNIFICANT DEPENDENCE ON ENDOWMENT: Without the benefit of the annual payout from its investment pool, JDGI's operating margin remains negative. Management continues to budget at a near breakeven on a cash basis.
RESEARCH CONCENTRATED REVENUE BASE: There is strong reliance on the National Institutes of Health (NIH) grant funding which creates a level of vulnerability due to the federal funding environment. However, concerns are somewhat mitigated by JDGI's strong level of success and high attainment of grant receipts, in addition to its ability to attract researchers.
HIGH DEBT BURDEN: JDGI's debt burden is high, but has seen some improvement in recent years and is expected to continue to improve due to the lack of additional debt plans.
RATING SENSITIVITIES
LONGER TERM PLAN TO REDUCE RELIANCE ON ENDOWMENT SPENDING: Fitch believes J. David Gladstone Institutes' ongoing endowment spend rate is unsustainable. At the time of Fitch's last review in 2013, it was expected that this level would decline by 2017. The failure to demonstrate progress toward reducing the level of spend from the endowment would likely result in negative rating pressure.
DECLINE IN AVAILABLE FUNDS: A decline in available funds ratios would likely result in negative rating pressure given the current budgeting practice and limited flexibility to withstand negative swings in market performance.
CREDIT PROFILE
The J. David Gladstone Institutes operates as a medical research organization, with laboratories and administrative offices in the Mission Bay area of San Francisco. JDGI was created in 1972 by a charitable trust under the Will of J. David Gladstone and is directed by a three-member board of trustees with funds in the trust serving to supplement the organization's overall mission.
JDGI, which is affiliated with the University of California, San Francisco (UCSF), presently employs 29 principal investigators and is comprised of three separate institutes - the Gladstone Institute of Cardiovascular Disease, the Gladstone Institute of Virology and Immunology, and the Gladstone Institute of Neurological Disease.
BALANCE SHEET RESOURCES
JDGI's available funds, defined as cash and investments not restricted, totaled $157.3 million as of Dec. 31, 2014 - covering operating expenses and debt by a solid 182% and 111.4%, respectively; however, the level remains lower than the peak achieved prior to the 2008 market dislocation, when in 2007 available funds reached $217 million.
The trust's asset allocation shows significant exposure to alternative investments. As of June 30, 2015, the investment portfolio totaled $175.8 million, of which available funds is a subset, included 2.3% fixed income, 21% U.S. equities, 5.4% international equities, 26.7% hedge funds, 3.9% private equity, 9.8% cash, 7.1% oil and gas and 23.9% of real estate. Concerns associated with the portfolio allocation are largely mitigated by the significant experience and oversight of the management and the trustees.
OPERATING PERFORMANCE
Fiscal 2014 actual performance was ahead of budget due to better investment performance and fundraising than expected, however, JDGI continues to produce negative operating results on a GAAP basis. On a GAAP basis, operating margin was a negative 15.9% in 2014 compared to negative 16.7% in 2013 and negative 17.1% in 2012.
Internal budgeting includes approximately 7% long term return on the investment portfolio (including cash) and generally generates a breakeven bottom line on a cash basis after capital expenditures and endowment management costs are included. Fitch believes this level of spending is high and unsustainable. In addition, the lack of a defined endowment spending policy is a credit concern. Management has a long term goal to implement a more traditional spending policy, with a 5% endowment draw based on a three year average. Implementation of such a plan would be viewed favorably by Fitch.
Management is also focused on diversifying its revenue base including growing philanthropy and intellectual property licensing revenue through its translational research, which Fitch views favorably.
In addition to supporting operations, the trust serves to supplement programming. While the various grants cover the associated fixed costs of the institutes' research, the trust helps to defray start-up expenses incurred when new principal investigators join, and to fund equipment replacement and general administrative expenditures. JDGI's plans to grow to 30 principal investigators before there are capacity constraints within the currently configured laboratory space. Management indicated that there are no major capital needs and ongoing capital expenditures are approximately $3 million a year.
REVENUE CONCENTRATION
As expected of a research institute, the revenue base is concentrated in grant revenues - primarily federally sourced. In fiscal 2014, of the approximate $52.8 million of government and other private and public grants received, 63% was received from federal sources, primarily NIH.
There is some concern over the NIH reliance, in conjunction with the stressed federal funding environment. However, Fitch gains comfort in JDGI's high success rate in research grant awards, in addition to the organization's high indirect cost recovery rate (approximately 89.3%). Through monthly meetings with principal investigators and close monitoring of their respective budgets, JDGI has been able to manage this volatility.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Nonprofit Institutions Rating Criteria (pub. 05 Jun 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=866668
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
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Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=990642
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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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