Fitch Affirms 'A', Revises Outlook to Negative for Gladstone Institutes' Bonds.

NEW YORK -- Fitch Ratings affirms the 'A' rating on the California Infrastructure and Economic Development Bank's (CIEDB) $145 million revenue bonds, series 2001 (J. David Gladstone Institutes (Gladstone) Project). The Rating Outlook is revised to Negative from Stable.

Bond proceeds were used to construct a new research facility adjacent to the Mission Bay campus of the University of California at San Francisco (UCSF). The facility opened in October 2004, and project costs were approximately 10% below budget.

The revised Outlook reflects a shift in asset allocation to more exposure to alternative assets, a decline in unrestricted net assets since fiscal 2000, and an increase in debt associated with the purchase of real estate property.

At the end of fiscal 2004, Gladstone had $35 million or 32% of its marketable securities allocated to alternative assets. While Fitch expected the allocation to increase from its non-existent level in fiscal 2000, the rapid increase was not expected. Fitch will monitor the exposure to evaluate the impact on both the income statement and the balance sheet.

Unrestricted net assets as of Dec. 31, 2004 were $168.7 million. Gladstone has covenanted to maintain unrestricted net assets to a level of 75% of outstanding bonds. As of Dec. 31, 2004, the ratio was 116%. While unrestricted net assets are significant, they are approximately 11% less than the level that was projected when the initial rating was assigned. The decline in unrestricted net assets is almost entirely due to market value declines in marketable securities that occurred in fiscal years 2001 and 2002. Losses in market values during these two fiscal years were experienced by most endowment funds. Two factors distinguish Fitch's view of Gladstone's market value losses from losses experienced by other endowment funds. First, approximately one-third of Gladstone's annual expenses are paid from the endowment so a significant decline in endowment asset value could have a negative impact on Gladstone's ability to continue to fund expenses at current levels. While Gladstone does have the ability to reduce expenses during periods of weak financial markets, the magnitude of reductions is limited by the ongoing nature of research expenses. The second distinction that Fitch makes regarding market losses, realized or unrealized, is that Gladstone has not had any major fundraising capital campaign to increase the level of unrestricted net assets. However, Gladstone is in the early stages of a capital campaign. A successful campaign would be viewed favorably by Fitch.

Gladstone's total investment portfolio includes a greater exposure to real estate than more traditional endowment funds. Even though the real estate is concentrated in California, Fitch feels that the board members possess the expertise to evaluate the asset's performance. Gladstone increased its real estate holdings in February 2002 with the purchase of a property for $41.8 million with $12.9 million of cash and a note payable for $29 million. While the note payment is not on parity with the bonds, Fitch views the increased leverage as a negative.

Fitch's 'A' rating is based on Gladstone's unrestricted investments, which totaled $168 million as of Dec. 31, 2004 and increased grant funding for the three institutes of Gladstone. At the time of the initial rating on Sept. 18, 2001, projections of unrestricted net assets for fiscal 2004 were $190 million. While the actual balance of $168 million is approximately 11% lower, the balance covers the outstanding bonds by 1.16x. The investment balance includes real estate in Southern California that is on the books at cost but may have a significantly higher market value. Grant funding, the largest funding source for Gladstone, was $27 million for fiscal 2004. The actual funding met projections and reflects a 50% increase since fiscal 2000. Most of the grant funding is from the National Institutes of Health (NIH). NIH indirect cost recoveries, subject to negotiation with and regulation by U.S. officials, are expected to cover more than 50% of annual debt service in fiscal 2005, the first year of principal amortization. Credit risks focus on the high degree of initial leverage related to the series 2001 and the use of endowment revenues and balances to cover expenses.