ANNUAL FINANCIAL REPORT

For the Year Ending August 31, 2017

Internal Audit 03/08/18 1 of 62 Internal Audit 03/08/18 2 of 62 UNIVERSITY of HOUSTON Table of Contents For the year ended August 31, 2017

INTRODUCTORY SECTION

Organizational Data

FINANCIAL SECTION

Independent Accountants' Review Report 5

Management's Discussion and Analysis (Required Supplementary Information) 9

BASIC FINANCIAL STATEMENTS

Statement of Net Position 18 Statement of Revenues, Expenses, and Changes in Fund Net Position 20 Statement of Cash Flows 22 Notes to Financial Statements 25

REQUIRED SUPPLEMENTARY INFORMATION

Schedule of UH's Proportional Share of Net Pension Liability - TRS 53 Schedule of UH's Contributions - TRS 54

Internal Audit 03/08/18 3 of 62 (This page intentionally left blank.) Internal Audit 03/08/18 4 of 62 INTRODUCTORY SECTION

Internal Audit 03/08/18 5 of 62 {This page intentionally left blank.) Internal Audit 03/08/18 6 of 62 UNIVERSITY of HOUSTON Organizational Data August31,2017

Board of Regents

Spencer D. Armour, Ill, Midland Term Expires August 31, 2017 Roger F. Welder, Victoria Term Expires August 31, 2017 Welcome W. Wilson, Jr., Houston Term Expires August 31, 2017 Durga D. Agrawal, Houston Term Expires August 31, 2019 Paula M. Mendoza, Houston Term Expires August 31, 2019 Peter K. Taaffe, Houston Term Expires August 31, 2019 Tilman J. Fertitta, Houston Term Expires August 31, 2021 Beth Madison, Houston Term Expires August 31, 2021 Gerald W. McElvy, Houston Term Expires August 31, 2021 Neelesh C. Mutyala (Student Regent), Sugar Land Term Expires May 31, 2018

Officers of the Board (Fiscal Year 2017): Tilman J. Fertitta Chairman Welcome W. Wilson, Jr. Vice Chairman Spencer D. Armour, Ill Secretary

Administrative Officers

Renu Khator Chancellor/President Paula Myrick Short Senior Vice Chancellor for Academic Affairs Jim McShan Senior Vice Chancellor for Administration and Finance Amr Elnashai Vice Chancellor for Research and Technology Transfer Dona H. Cornell Vice Chancellor for Legal Affairs and General Counsel Eloise Dunn Brice Vice Chancellor for University Advancement J. Richard Walker Vice Chancellor for Student Affairs and Enrollment Services Jason Smith Vice Chancellor for Governmental Relations Michael Johnson Chief of Staff Lisa Holdeman Associate Vice President for University Marketing, Comm. and Media Relations Ramanan Krishnamoorti Chief Energy Officer Chris Pezman Vice President for Intercollegiate Athletics Stephan Spann Chief Health Officer and Planning Dean for Medical School Elwyn Lee Vice President for Neighborhood and Strategic Initiatives

Internal Audit 03/08/18 7 of 62 Internal Audit 03/08/18 (This page intentionally left blank.) 8 of 62 2 FINANCIAL SECTION

Internal Audit 03/08/18 9 of 62 3 Internal Audit 03/08/18 (This page intentionally left blank.) 10 of 62 4 INDEPENDENT ACCOUNTANTS' REVIEW REPORT

To the Board of Regents of University of Houston University System:

We have reviewed the accompanying Statement of Net Position; Statement of Revenues, Expenses, and Changes in Net Position; and Statement of Cash Flows of University of Houston (UH), an Agency of the State of Texas, as of and for the year ended August 31, 2017, and the related notes to the financial statements, which collectively comprise UH's basic financial statements. A review includes primarily applying analytical procedures to management's financial data and making inquiries of management. A review is substantially less in scope than an audit, the objective of which is the expression of an opinion regarding the financial statements as a whole. Accordingly, we do not express such an opinion. Management's Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement whether due to fraud or error. Accountant's Responsibility Our responsibility is to conduct the review engagement in accordance with Statements on Standards for Accounting and Review Services promulgated by the Accounting and Review Services Committee of the AICPA. Those standards require us to perform procedures to obtain limited assurance as a basis for reporting whether we are aware of any material modifications that should be made to the financial statements for them to be in accordance with accounting principles generally accepted in the United States of America. We believe that the results of our procedures provide a reasonable basis for our conclusion. Accountants' Conclusion Based on our review, we are not aware of any material modifications that should be made to the accompanying financial statements in order for them to be in accordance with accounting principles generally accepted in the United States of America. Emphasis of Matter

As discussed in Note 1, the financial statements of UH are intended to present the financial position and the changes in financial position and cash flows of only that portion of the business-type activities of the State of Texas that are attributable to the transactions of UH. They do not purport to, and do not, present fairly the financial position of the State of Texas as of August 31, 2017, the changes in its financial position, or, where applicable, its cash flows for the year then ended, in accordance with accounting principles generally accepted in the United States of America. Our opinion is not modified with respect to this matter.

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1:llli!fil2!! Bellville Austin All Offices 3210 Bingle Rd., Ste. 300 PO. Box 826 100 Congress Ave., Ste. 2000 w,vw.texasauditors.com =: Governmental H ouston, TX 77055Internal Audit 03/08/18Bellville, TX 77418 Austin, TX 78701 info@ txauditors.com - 11Audit of 62 Quality Center 713.263.J 123 7) 3.263.1123 512.381.0222 713.263.1550 fax au Other Matters

Required Supplementary Information and Additional Supplementary Information

Accounting principles generally accepted in the United States of America require that the Management's Discussion and Analysis, schedule of UH's proportionate share of the net pension liability, and schedule of UH's TRS employee contribution's be presented to supplement the basic financial statements. Such information, although not a part of the basic financial statements, is required by the Governmental Accounting Standards Board, who considers it to be an essential part of financial reporting for placing the basic financial statements in an appropriate operational, economic, or historical context. Such information is the responsibility of management.

The introductory section is additional supplementary information presented for purposes of additional analysis and is not a required parts of the basic financial statements.

We have not audited, reviewed, or compiled the required supplementary information or additional supplementary information and we do not express an opinion, a conclusion, nor provide any assurance on it.

~ LT j]J;.RRIS ~ CHACEK, LLLP \._ _.,

Belt Harris Pechacek, LLLP Certified Public Accountants Houston, Texas March 6, 2018

6

Internal Audit 03/08/18 12 of 62 MANAGEMENT'S DISCUSSION AND ANALYSIS

Internal Audit 03/08/18 13 of 62 7 Internal Audit 03/08/18 {This page intentionally left blank.) 14 of 62 8 UNIVERSITY of HOUSTON Management's Discussion and Analysis For the year ended August 31, 2017

INTRODUCTION

The following Management's Discussion and Analys is (MD&A) section of University of Houston's (U H) annual financial report has been prepared to provide an overview of the activities and the financial performance of UH for the fiscal year ended August 31, 2017. This presentation is intended to offer a summary of significant current year activities, resulting changes, and currently known economic conditions and facts. This analysis should be read in conjunction with UH basic financial statements and the notes to the financial statements.

BACKGROUND

UH of Houston System (UH SYSTEM), serving the nation's fourth largest city and its metropolitan area, as well as the upper Texas Gulf Coast region, is part of the state-supported system of higher education in Texas. UH System is the region's largest provider of comprehensive (baccalaureate to doctorate) higher education services. The System is comprised of four universities and a supporting System Administration (UHSA). The four universities are University of Houston (UH), University of Houston - Clear Lake (U HCL), University of Houston - Downtown (UHD), and University of Houston - Victoria (UHV); all of which are located along the Texas Gulf Coast. UH is the flagship institution of the UH System, its principal doctoral degree-granting institution, and is a comprehensive research university. UH also has a sig nificant presence through off-campus teaching centers located throughout the Houston metropolitan area. From these facilities, UH is able to reach many students in Houston and beyond through extensive online programs, as well as through classroom instruction. UHSA is responsible for coordinating the off-site operations, as well as providing select centralized services. Among universities nationwide, UH remains a model of diversity and a reflection of the city and region it serves.

The System's Board of Regents and Chancellor have led a comprehensive strategic planning process through which new mission statements, goals, principles, and accountability measures have been developed for the UH System and its universities. In addition, UH has developed enrollment and research projections for the current decade and has developed academic and facilities master plans. These plans are intended to identify the programs, faculty, staff, and infrastructure needed to achieve enrollment and research projections, as well as the resources needed to accomplish them. UH is also working collaboratively on four system-wide initiatives - international education, health sciences research and education, pathways for faculty collaboration among institutions, and pathways for student transfer among institutions. Central to all of these planning activities are the primary goals - student access and success, national competitiveness, and community advancement - all of which further Texas's goals for higher education, as well as th e social and economic well-being and development of the Houston metropolitan area. UH has continued to improve performance on most of its key progress measures with enrollment increases, total degrees awarded increases, and total research expenditures increases. UH is a major player in UH System's current record-setting $1 billion fundraising campaign, the largest total in the institution's history. More than half this goal has already been pledged. This achievement tells an encouraging story of fundraising success which surpasses all prior years for UH System.

OVERVIEW OF THE FINANCIAL STATEMENTS

The financial statements for fiscal year 2017 have been prepared in accordance with accounting pronouncements promulgated by the Governmental Accounting Standards Board (GASS). Additionall y, these statements conform to reporting requirements of the Texas Comptroller of Public Accounts and to guidelines issued by the National Association of College and University Business Officers. GASS requires UH to include three financial statements in the annual financial report. They are (1) the Statement of Net Position; (2) the Statement of Revenues, Expenses, and Changes in Net Position; and (3) the Statement of Cash Flows. The information contained in the financial statements of UH is part of and included in the State of Texas's Comprehensive Annual Financial Report.

The financial statements of UH are presented for the fiscal year ended August 31, 2017. The format of the Texas statewide financial statements presents a comprehensive perspective of the state's financial activities. The state's activities are divided into three types for presentation in the primary financial statements. They are Governmental Activities, Business-type Activities, and Component Units. The financial operations of UH are considered a business-type activity because UH charges a fee, in the form of tuition, to customers in order to pay for a

Internal Audit 03/08/18 15 of 62 9 UNIVERSITY of HOUSTON Management's Discussion and Analysis For the year ended August 31, 2017 significant percentage of the cost of the services provided. Under this classification, UH financial statements conform to the guidelines and presentation formats prescribed for proprietary funds; revenues are recognized when earned and expenses are recognized when a liability is incurred, regardless of when cash is exchanged.

Statement of Net Position

The first schedule presented is the Statement of Net Position. The statement reflects UH's financial position as of the conclusion of the fiscal year. This is a point in time financial presentation and presents a snapshot view of the financial status as of August 31, 2017. Assets and liabilities are presented as either current or non-current to provide an indication of their anticipated liquid ation. Net position is equal to total assets plus deferred outflows of resources less total liabilities plus deferred inflows of resources. Net position is divided into three major categories. The first, net investment in capital assets, provides UH's equity in property, plant, and equipment owned by UH. The restricted net position category is subdivided into nonexpendable and expendable classifications. Restricted nonexpendable net position consists solely of UH's permanent endowment funds and is only available for investment purposes. Restricted expendable net position is available for expenditure by UH , but must be spent for purposes as determined by donors and/or external entities that have placed time or purpose restrictions on the use of th e assets. The fina l major category, unrestricted net position, is available to UH for any lawful purpose, but may have significant constraints on resources, which are imposed by management or implied by statutes or regulations, but can be removed or modified. Additional net position balances are reserved for specific purposes by nature of their origin.

The Statement of Net Position presents information on all of UH's assets, liabi lities, and deferred outflows/inflows of resources, with the difference reported as net position. Over time, increases or decreases in net position may serve as a useful indicator of whether the financial position of UH is improving or deteriorating. other nonfinancial factors, such as UH's enrollment and the condition of UH's infrastructure, need to be considered in order to assess the overa ll health of UH.

Statement of Revenues. Expenses. and Changes in Net Position

The next statement comprising the primary financial statements is the Statement of Revenues, Expenses, and Changes in Net Position. This schedule identifies operating and nonoperating revenues received by UH . Additionally, both the operating and nonoperating expenses incurred by UH during the fiscal year are displayed. Finally, any other gains and losses or other forms of revenue and expenses are reported. The Statement of Revenues, Expenses, and Changes in Net Position presents information showing how UH's net position changed during the most recent year. All changes in net position are reported as soon as the underlying event giving rise to the change occurs, regardless of the timing of related cash flows

During the 2017 fiscal year, UH recognized operating revenues of $671 million and operating expenses of $991 million. After recognizing nonoperating activities and other gains and losses, UH realized a net increase in net position of $108 million.

Revenues and expenses are classified as either operating or nonoperating in the financial statements. Operating revenues are received and recognized as a result of providing services. Tuition and fee revenues are reported net of any scholarship discounts and allowances. A scholarship allowance is the difference between the stated charge for services provided by UH and the amount that is paid by the student or third parties making payments on behalf of the student. Funds received to satisfy student tuition and fee charges are reported as revenue only once. Institutional resources provided to students as financial aid are reported as scholarship allowances in amounts up to and equal to amounts owed by the students to UH .

Operating expenses are the costs necessary to provide services to customers and to fu lfill the mission of UH. Operating expenses are displayed in the statement using th e natural method of presentation which displays the operating expenses in a manner that categorizes the objects of expenditure within various cost centers. Nonoperating revenues are those received for which no services are directly provided. State appropriations are classified as nonoperating revenue because they are provided by the Legislature to UH without the Legislature directly receiving goods or services for those revenues. Additionall y, certa in federal resources for student financial

Internal Audit 03/08/18 16 of 62 10 UNIVERSITY of HOUSTON Management's Discussion and Analysis For the year ended August 31, 2017 aid, as well as most gift revenue, are classified as nonoperating revenue. Significant portions of UH's recurring resources are classified as nonoperating.

Statement of Cash Flows

The third primary statement included in the financial statements is the Statement of Cash Flows. This schedule explains th e change during the fiscal year in cash and cash equivalents, regardless of whether there are restrictions on their use. The Statement of Cash Flows should be used in conjunction with related disclosures and information in the other financial statements. The statement can provide relevant information about an entity, such as th e ability to generate future net cash flows, the ability to meet obligations when due, or reasons for differences between operating income and associated cash receipts and payments. The statement is comprised of five sections. The first section recognizes the cash flows from operating activities as well as the net cash used by operating activities. The second section identifies th e cash flows from noncapital financing activities. The third section reflects th e cash flows from capital and related financing activities. The next section details the cash flows from investing activities. The final section reconciles net cash used to the operating loss or income reflected on the Statement of Revenues, Expenses, and Changes in Net Position.

The cash and cash equivalents balance at the conclusion of the 2017 fiscal year totaled $277 million, which reflected a net increase in cash balances of $30 million .

Notes to Financial Statements

The notes to the fina ncial statements provide add itional inform ation that is essential to a full understanding of the data provided in th e financial statements. The notes are the last section of the basic financial statements.

Required Supplementary Information

In addition to basic financial statements, MD&A, and accompanying notes, this report also presents certain Required Supplementary Information (RSI). The RSI includes schedule of changes in net pension liability and related ratios for the Teacher Retirement System (TRS) and schedule of contri butions for TRS. RSI can be found after the notes to the basic financial statements.

FINANCIAL ANALYSIS

As noted earlier, net position may serve over time as a useful indicator of UH's financial position. Assets and deferred outflows of resources exceed liabilities and deferred inflows of resources by $1.280 billion as of August 31, 2017 in the primary government. The largest portion of UH's net position reflects its investments in capital assets (e.g., land, building, equipment, improvements, construction in progress, and infrastructure), less any debt used to acquire those assets that is sti ll outstanding. UH uses these capital assets to provide services; consequentl y, these assets are not available for future spending. Although UH's investment in its capital assets is reported net of related debt, it should be noted that the resources needed to repay this debt must be provided from other sources, since the assets themselves cannot be used to liquidate these liabilities.

Internal Audit 03/08/18 17 of 62 11 UNIVERSITY of HOUSTON Management's Discussion and Analysis For the year ended August 31, 2017

Statement of Net Position:

The following table reflects the condensed Statement of Net Position:

Condensed Statements of Net Position Increase/ 2017 2016 (Decrease) Assets Current Assets $ 785,743,602 $ 728,315,179 $ 57,428,423 Noncurrent Assets Capital Assets, Net 1,205,185,282 1,146,815,043 58,370,239 Other Assets 618,073,703 579,774,291 38,299,412 Total Assets 2,609,002,587 2,454,904,513 154,098,074

Deferred Outflows of Resources Loss on Bond Refunding 2,160,743 2,208,809 {48,066) Pensions 28,825,083 28,084,062 741,021 Total Deferred Outflows of Resources 30,985,826 30,292,871 692,955

Total Assets and Deferred Outflows of Resources $ 2,639,988,413 $ 2,485,197,384 $ 154,791,029

Liabiliti es Current Liabilities $ 360,649,835 $ 334,112,443 $ 26,537,392 Noncurrent Liabilities 982,122,492 953,549,065 28,573,427 Total Liabilitles 1,342,772,327 1,287,661,508 55,110,819

Deferred Inflows of Resources Pensions 16,603,755 20,196,099 Total Liabilities and Deferred Inflows of Resources $ 1,359,376,082 $ 1,307,857,607 $ 55,110,819

Net Position Net Investment in Capital Assets $ 406,500,839 $ 388,401,810 $ 18,099,029 Restricted, Non-Expendable 379,536,208 337,964,380 41,571,828 Restricted, Expendable 233,865,612 263,582,636 {29,717,024) Unrestricted 260,709,672 187,390,951 73,318,721 Total Net Position $ 1,280,612,331 $ 1,177,339,777 $ 103,272,554

Internal Audit 03/08/18 18 of 62 12 Internal Audit 03/08/18 19 of 62 UNIVERSITY of HOUSTON Management's Discussion and Analysis For the year ended August 31, 2017

During the 2017 fiscal year, Standard & Poor's Ratings Services (S&P) affirmed its rating of AA for the UH System long-term debt; additionally, Moody's affirmed its ratings of Aa2. Both rating agencies have affirmed th e outlook as stable. This rating also affirms Moody's positive view of the UH System's strategic positioning as the largest four-year higher education provider in the economically vibrant Houston metropolitan region , supported by robust operating and capital support from the Aaa-rated State of Texas, with good operating cash flow bolstered by rising gift support. S&P views the UH System as a very strong institution characterized by healthy governance and management, continual growth in enrollment, and good selectivity and retention. S&P assessed UH System's financial profile as very strong - characterized by solid financial performance, with recurri ng surpluses, and conservative budgeting processes.

ECONOMIC OUTLOOK

As the global economy becomes increasingly driven by the creation of new knowledge and technological innovation, success for the Texas Gulf Coast region depends increasingly on the existence of a highly-skilled, professional workforce and cutting-edge research and development. As the region's largest provider of comprehensive (baccalaureate to doctorate) higher education services, UH plays a leading role in meeting these needs. In doing so, UH must also succeed in providing access to a regional population that is growing increasingly diverse. The student population at UH closely mirrors this diversity and is succeeding in providing access to a diverse student population.

With UH improving performance on most of its key progress and goals measures this year, UH is poised for continued success in the coming years. To harness this potential, UH is actively expanding its reach in terms of both new degree programs that meet state and regional workforce needs and campus infrastructure that support the growing student populations and faculty. Aligned to major industries and university strengths, including energy, health care, and education, these recently added programs will support our economy, enhance our academic reputation, and produce new revenue streams for the universities. In addition, several major construction projects are currently underway, among them new student residence halls, research facilities, and an enhanced basketball arena - all of which will elevate the profile of UH and allow UH to better serve its students, faculty, staff, and the community.

During the past several years, much progress has also been made in expanding the reach and accessibility of UH academic programs throughout the Houston region. By the year 2020, enrollment at these centers is expected to be over 9,000 students - an increase of over 80%. UH is also taking a much more coordinated approach to undergraduate admissions. The applications of students not accepted to UH are now immediately directed to UHD and UHV, and undergraduates at all four universities now have the ability to seamlessly take up to six hours at one of the other UH System institutions. These new services facilitate enrollment at UH System universities and make it easier for students to complete a degree.

In recent years, competition for federal research funding has become much more intense. In addition, increased federal scrutiny of higher education makes advocacy on relevant policy issues all the more important. In the upcoming fiscal years, new resources will be used to expand outreach to the federal government. New resources will also be allocated to support community relations.

Student enrollment has grown steadily over the last decade, increasing by an average of 3. 1 % each year. In 2017, over 45,300 students were enrolled at UH, with 95% of all freshmen being full-time students. The student body at UH has also become increasingly diverse. Fall 2017 enrollment was composed of 30.6% Hispanic students, 25.6% White students, 20.6% Asian Americans, 9.7% African Americans, and the remaining 13.5% of the student body were International, Multiracial, Native American, Pacific Islanders or Unknown. U.S. News & World Report has named UH the second most diverse public university in the nation.

The Texas Legislature has been heading toward a higher education funding model based on performance. The emphasis is shifting to graduating students, not just enrolling them. UH has embraced that approach with a strategic enrollment focus. More than ever before, UH is concentrating on student success and degrees

Internal Audit 03/08/18 20 of 62 14 UNIVERSITY of HOUSTON Management's Discussion and Analysis For the year ended August 31, 2017 produced, rather than simple head count. Students graduating in 4, 5, or 6 years is rising, with the most recent statistics showing more graduating in 5 years than in 6 years.

BUDGETARY INITIATIVES

Several budgetary initiatives and priorities on which UH will continue to focus during the 2018 fiscal year are: (1) Student access and success: Increasing the enrollment, retention, and graduation of a diverse student body with exceptional academic qualifications is paramount. These goals will be achieved by increasing scholarships, expanding course offerings, enhancing student support staff, improving the curriculum, and implementing more rigorous admissions standards. (2) National competitiveness I academic and research excellence: In fiscal year 2018, UH will continue to increase external research funding and enhance its academic programs, including the availability and delivery of courses. (3) University infrastructure and administration: UH physical plant includes considerable land acreage, many buildings, and several million gross square feet of space. Sustaining this infrastructure year around requires a significant investment in utilities, maintenance, repairs, renovations, and improvements. Making these investments is also essential to supporting UH's goals of student success and national competitiveness. Another measure of administrative effectiveness is the extent to which UH can expand its resources through the cultivation of private gifts. Staff excellence is designed to deliver greater efficiency and better performance, but also commits UH to providing staff with competitive salaries, professional development opportunities, and a campus culture that recognizes excellence even as it expects accountability. (4) Community advancement: Many of UH 's academic initiatives are directed toward community need and interest. Emphasis will also be placed on university initiatives that are both partnership-oriented and community-minded. These endeavors are implemented in part via UH's various centers and institutes.

The state of economic issues facing Texas and the United States cannot be predicted; however, UH administration believes that its financial management continues to demonstrate strength and a capacity to respond and adjust to ongoing economic uncertainties. Although it is not possible to predict ultimate results, management believes UH will continue to maintain a sound financial position, and will be administratively structured and governed in a manner that will equip UH to withstand the current national and international financial situations. UH continues to stand committed to the principles of prudent and sound stewardship. UH will not compromise on its long-term goals. Its commitment to student success, research development, and responsibility to the community will remain at the forefront of the financial decision-making process.

CONTACTING UH'S FINANCIAL MANAGEMENT

This financial report is designed to provide a general overview of UH's finances. Questions concerning this report or requests for additional financial information should be directed to Kevin Draper; Executive Director, Financial Reporting; University of Houston; 5000 Gulf Frwy, Bldg 1, Rm 232; Houston, TX 77204-0901 ; Phone: 713-743- 8726. General Information about UH may be found on the website: www.UH.edu.

Internal Audit 03/08/18 21 of 62 15 Internal Audit 03/08/18 (This page intentionally left blank.) 22 of 62 16 BASIC FINANCIAL STATEMENTS

Internal Audit 03/08/18 23 of 62 17 UNIVERSITY of HOUSTON Statement of Net Position August 31, 2017

Total 2017 Assets Current Assets Cash and Cash Equivalents Cash on Hand $ 37,675.00 Equity (deficit) in Consolidated Cash (338,626,348.79) Cash in State Treasury 60,392,348.36 Cash Equivalents 215,894,634.32 Short-Term Investments 6,922,545.44 Restricted: Equity in Consolidated Cash 339,339,275.91 Legislative Appropriation 132,380,324.65 Receivables: Federal Receivables 6,404,206.71 Accounts Receivable 23,532,732.60 Gifts 53,853,645.47 Other 2,171,593.21 UHS lntercampus Receivables 221,135,446.74 Due From Other Agencies 14,746,873.90 Consumable Inventories 338,714.05 Merchandise Inventories 1,340,714.10 Prepaid Costs 35,269,176.43 Loans and Contracts 10,610,043.65

Total Current Assets 785,743,601.75

Non-Current Assets Restricted: Receivables 58,833,287.30 UHS lntercampus Receivables 484,146,715.88 Loans and Contracts 3,719,667.96 Investments 1,185,200.71 UHS lntercampus Receivables 70,188,831.65 Capital Assets Non-Depreciable or Non-Amortizable 209,981,222.20 Depreciable or Amortizable, Net 995,204,060.26

Total Non-Current Assets 1,823,258,985.96

Total Assets 2,609,002,587.7 1

Deferred Outflows of Resources Loss on Bond Refunding 2,160,742.70 Pensions 28,825,082.77

Total Deferred Outflows of Resources 30,985,825.47

Total Assets and Deferred Outflows of Resources $ 2,639,988,413.18

Internal Audit 03/08/18 18 24 of 62 UNIVERSITY of HOUSTON Statement of Net Position August 31, 2017

Total 2017 Liabilities Current Liabilities: Payables: Accounts Payable 14,373,539.69 Federal Payable 9,190.04 Payroll Payable 40,966,447.73 Other Payable 2,155,363.65 UHS lntercampus Payable 32,648,345.56 Due to Other Agencies 209,635.70 Unearned Revenues 183,972,871.48 Revenue Bonds Payable 51,460,787.84 Claims and Judgments Payable 72,520.35 Employees' Compensable Leave 9,591,980.11 Funds Held for Others 25,189,152.36

Total Current Liabilities 360,649,834.51

Non-Current Liabilities Employees' Compensable Leave 9,626,573.49 Revenue Bonds Payable 832,895,810.47 Net Pension Liability 139,600,108.07

Total Non-Current Liabilities 982,122,492.03

Total Liabilities 1,342,772,326.54

Deferred Inflows of Resources Pensions 16,603,755.34

Total Deferred Inflows of Resources 16,603,755.34

Total Liabilities and Deferred Inflows of Resources $ 1,359,376,081.88

Net Position Invested in Capital Assets, Net of Related Debt 406,500,838.77 Restricted for: Debt Retirement 501.05 Capital Projects 2,989,515.90 Edowments Non-Expendable True Endowments 379,536,208.11 Expendable Term Endowments 1,311 ,713.99 Funds Functioning as Endowments 32,734,214.66 Other Restricted 196,829,667.12 Unrestricted 260,709,671.70

Total Net Position $ 1,280,612,331 .30

See notes to financial statements.

Internal Audit 03/08/18 19 25 of 62 UNIVERSITY of HOUSTON Statement of Revenues, Expenses, and Changes in Net Position For the year ended August 31, 2017

Total 2017 Operating Revenues Sales of Goods and Services Tuition and Fees-Pledged $ 491,069,338.04 Discounts and Allowances (103,055,881.20) Auxiliary Enterprise-Pledged 106,732,631.96 Discounts and Allowances (8,861,615.70) Other Sales of Goods and Services-Pledged 57,885,350.00 Federal Revenue-Operating 62,036,886.91 Federal Pass-Through Revenue 3,663,227.80 State Grant Revenue 3,262,817.79 State Grant Pass-Through Revenue 35,578,213.27 Other Grants and Contracts-Operating 21,422,639.99 Other Operating Revenues 941,518.96

Total Operating Revenues 670,675,127.82

Operating Expenses Cost of Goods Sold 2,233,664.72 Salaries and Wages 473,391,580.76 Payroll Related Costs 120,308,410.22 Professional Fees and Services 93,527,011.30 Federal Pass-Through Expenses 1,559,078.39 State Pass-Through Expenses 45,083.99 Travel 14,902,497.63 Materials and Supplies 30,010,942.13 Communication and Utilities 41,220,990.78 Repairs and Maintenance 13,162,294.48 Rentals and Leases 20,694,721.86 Printing and Reproduction 2,943,567.96 Depreciation and Amortization 78,651 ,155.07 Interest 60,221.45 Scholarships 56,648,566.80 Claims and Judgments 626,887.62 Other Operating Expenses 41,334,746.45

Total Operating Expenses 991 ,321,421.61

Operating Income (Loss) (320,646,293.79)

Internal Audit 03/08/18 20 26 of 62 UNIVERSITY of HOUSTON Statement of Revenues, Expenses, and Changes in Net Position For the year ended August 31, 2017

Total 2017 Non-Operating Revenues (Expenses) Legislative Revenue 155,655,428.00 Additional Appropriations 37,188,516.47 Federal Revenue Non-Operating 60,878,312.89 Gifts 81,676,554.50 Investment Income 17,761,742.03 Interest Expense and Fiscal Charges (38,463,824.84) Net Increase in Fair Value of Investments 32,083,561.95 Other Non-operating Revenues 10,419,346.94 Other Non-operating Expenses (25,633,828.55)

Total Non-operating Revenues (Expenses) 331,565,809.39

Income (Loss) before Other Revenues, Expenses, Gains, Losses and Transfers 10,919,515.60

Other Revenues, Expenses, Gains, Losses and Transfers Capital Appropriation (HEAF) 52,770,054.00 Additions to Permanent and Term Endowments 17,711 ,790.68 UHS lntercampus Transfers In 19,574,510.33 UHS lntercampus Transfers Out (11,871 ,530.26) lnteragency Transfer Capital Assets 259,348.51 Transfers In 24,343,956.21 Transfers Out (14,442,216.43) Legislative Transfer In 9,673,869.00

Total Other Revenues, Expenses, Gains, Losses and Transfers 98,019,782.04

Changes in Net Position 108,939,297.64

Net Position Beginning 1,172,838,162.81 Restatements (1,165,129.15)

Net Position, Beginning, as Restated 1,171,673,033.66

Net Position, Ending $ 1,280,612,331.30

See notes to financial statements.

Internal Audit 03/08/18 21 27 of 62 UNIVERSITY of HOUSTON Statement of Cash Flows For the year ended August 31, 2017

Total 2017

Cash Flows From Operating Activities Receipts from Customers $ 58,176,824.41 Proceeds from Tuition and Fees 412,119,750.07 Proceeds from Research Grants and Contracts 122,548,054.82 Proceeds from Loan Programs 125,190,557.46 Proceeds from Auxiliaries 97,290,928.91 Proceeds from Other Revenues 941,518.96 Payments to Suppliers for Goods and Services (222,543,600.91) Payments to Employees for Salaries (467,088,151.09) Payments to Employees for Benefits (117,804,287.66) Payments for Loans Provided (120,710,915.62) Payments for Other Expenses (100,726,710.35)

Net Cash Provided (Used) by Operating Activities (212,606,031.00)

Cash Flows from Noncapital Financing Activities Proceeds from State Appropriations 177,518,625.53 Proceeds from Gifts 69,121,187.71 Proceeds from Endowments 17,711,790.68 Proceeds of Transfers from Other Funds 54,337,813.48 Proceeds from Grants 60,878,312.89 Payments for Transfers to Other Funds (30,238,702.53)

Net Cash Provided (Used) by Noncapital Financing Activities 349,329,027.76

Cash Flows from Capital and Related Financing Activities Proceeds from Debt Issuance 147,750,000.00 Proceeds from Other Financing Activities 22,660,202.39 Proceeds from Capital Contributions 52,770,054.00 Payments for Additions to Capital Assets (138,524,099.32) Payments of Principal on Debt Issuance (140,640,991.47) Payments of Interest on Debt Issuance (38,415,758.61) Payments of Other Costs on Debt Issuance (12,832,990.63)

Net Cash Provided (Used) by Capital and Related Financing Activities (107,233,583.64)

Cash Flows From Investing Activities Proceeds from Sales of Investments 959,101.36 Proceeds from Investment Income 17,761,742.03 Payments to Acquire Investments (18,058,368.32)

Net Cash Provided (Used) by Investing Activities 662,475.07

Net Increase (Decrease) in Cash and Cash Equivalents 30,151,888.19

Cash and Cash Equivalents, Beginning 246,885,696.61

Cash and Cash Equivalents, Ending $ 277,037,584.80

Internal Audit 03/08/18 22 28 of 62 UNIVERSITY of HOUSTON Statement of Cash Flows For the year ended August 31, 2017

Total 2017

Reconciliation of Operating Income (Loss) to Net Cash Provided (Used) by Operating Activities

Operating Income (Loss) $ (320,646,293.79)

Adjustments to Reconcile Operating Income (Loss) to Net Cash Provided (Used) by Operating Activities

Pension Expense 14,918,986.52 Depreciation and Amortization Expense 78,651 ,155.07 Operating Income (Loss) and Cash Flow Categories: Classification Differences 4,479,641.84 Changes in Assets and Liabilities: (Increase) Decrease In Receivables 826,008.75 (Increase) Decrease in Inventories 99,422.78 (Increase) Decrease in Prepaid Expenses (1,786,503.51) (Increase) Decrease in Other Assets 3,356,452.44 Increase (Decrease) in Payables (7,741,760.99) Increase (Decrease) in Deferred Income 22,362,803.89 Increase (Decrease) in Compensated Absences 66,603.59 Increase (Decrease) in Benefits Payable (6,178,037.88) Increase (Decrease) in Other Liabilities (1,014,509.71)

Total Adjustments 108,040,262.79

Net Cash Provided (Used) by Operating Activities $ {212,606,031.00)

Non-Cash Transactions Net Change in Fair Value of Investments $ 32,083,561.95

Non-Cash Transactions $ 32,083,561 .95

See notes to financial statements.

Internal Audit 03/08/18 23 29 of 62 (This page intentionally left blank.) Internal Audit 03/08/18 24 30 of 62 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31, 2017

NOTE 1: Summary of Significant Accounting Policies

Reporting Entity

The University of Houston System (the UH System) is an agency of the State of Texas (the State) and is reported as one of six university systems and five independent universities that in total are presented as a major enterprise fund in the State's Comprehensive Annual Financial Report.

The UH System is comprised of four academic institutions, which includes the University of Houston (UH), UH­ Clear Lake, UH-Downtown, and UH-Victoria. The academic units operate teaching facilities in Katy, Northwest Houston, Pearland, and Sugar Land. Also at UH is Houston Public Media, home to KUHT-TV8, Houston's PBS station; KUHF-88.7, Houston's National Public Radio station; and KUHF 88.7 HD-2, Houston's digital classical music stream. The stations and academic entities are under the direction, management, and control of the UH System Board of Regents (the Board). which acts separately and independently on all matters. The Board consists of ten members, nine of whom are appointed by the governor of the State and a student regent elected by the student body. In some instances, shared services and management are provide for the entities by the UH System Administration (UHSA).

These financial statements are for UH , which is sometimes referred to as the "main campus". UH has been identified by the Comptroller's office as agency/entity number 730. These financial statements do not include the activities of the three remaining academic units, UH System, UHSA, or other activities under the oversight of the Board. The UH Foundation (UH F) is a separate legal entity registered with the IRS as a 501 (c) organization and its efforts benefit th e UH System, it's academic units and its students. UHF is separately governed and operates autonomously from the Board, and its related activities are not included in the UH System's or UH 's financials statements.

UH serves the State as the primary provider of educational and cultural opportunities, skilled employers and leaders, technica l knowledge, and innovative research to the Houston metropolitan area and the Gulf Coast region. Houston and the upper Gulf Coast region represent approximately one fourth of the State's population and economy.

The accounting policies followed by UH in maintaining accounts and in the preparation of the financial statements are in accordance with the Texas Comptroller of Public Accounts' Reporting Requirement for the Fiscal 2017 Annual Financial Reports of State Agencies and Universities (Comptroller's AFR requirements) and with generally accepted accounting principles in th e United States of America (GAAP). The Governmental Accounting Standards Board (GASB) is responsible for establishing GAAP for state and local governments. The Comptroller's AFR Requirements are designed to assist the Texas Comptroller of Public Accounts in compiling and preparing a CAFR for the State and, accordingly, have some untrad itional elements, such as the prohibition of rounding, unique ordering and specific numbering of footnotes, and the inclusion of footnote titles when the subject matter does not apply.

No entities have been identified meeting GASB's definition of component units, which are legally separate entities and, accordingly, none are included within the reporting entity. As previously noted, UH is considered by the State as one of the academic entities that consist of the UH System, however, each entity is considered an agency of the State.

Basis of Accounting

For financial reporting purposes, institutions of higher education are considered proprietary funds, which are used to account for business-type activities. Business-type activities are defined as those that are financed in whole or in part by fees charged to external parties for goods and services. The basis of accounting determines when revenues and expenditures or expenses are recognized in the accounts reported in the financia l statements. The accounting and financial reporting treatment applied to a fund is determined by its measurement focus. Proprietary funds use the flow of economic resources measurement focus (whether or not the entity is economicall y better off as a result of the events and transactions that occurred during the fiscal period reported)

Internal Audit 03/08/18 25 31 of 62 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31, 2017 and the full accrual basis of accounting, meaning revenues are recognized when earned and expenses are recorded when an obligation has occurred.

Budget and Budgetary Accounting

The state budget is prepared biennially and represents appropriations authorized by the Legislature and approved by the Governor (the General Appropriations Act). Additionally, the UH prepares an annual budget which represents anticipated sources of revenues and authorized uses. This budget is approved by UH's Board. Unencumbered appropriations are generally subject to lapse 60 days after the end of the fiscal year for which they were appropriated.

Assets, Liabilities, and Fund Balances/Net Position

ASSETS Current and Non-Current Assets Current assets are those that are readily available to meet current operational requirements. Non­ current assets are those that are not readily available to meet current operational requirements and, instead, are intended to support long-term institutional needs.

Cash and Cash Equivalents Short-term highly liquid investments with an original maturity of three months or less are considered cash equivalents.

Restricted Assets Restricted assets include monies or other resources restricted by legal or contractual requirements. These assets include proceeds of enterprise fund general obligation and revenue bonds and revenues set aside for statutory or contractual requirements. Assets held in reserve for guaranteed student loan defaults are also included.

Investments Investments are generally stated at fair value with certain exceptions in accordance with GASB Statement No. 72, Fair Value Measurement and Application. Fair value, which is determined based on quoted market prices, is the amount at which an investment could be exchanged in a current transaction between parties other than in a forced or liquidation sale. Changes in unrealized gain (loss) on the carrying value of investments are reported as a component of investment income in the accompanying Comparative Statement of Revenues, Expenses, and Changes in Net Position.

Legislative Appropriations This item represents the balance of general revenue funds at year end as calculated in the Texas State Comptroller's General Revenue Reconciliation.

Inventories and Prepaid Items Inventories include both merchandise inventories on hand for sale and consumable inventories. Inventories are valued at cost, generally utilizing the last-in, first-out method. The consumption method of accounting is used to account for inventories and prepaid items that appear in the governmental and proprietary fund types. The cost of these items is expensed when the items are consumed.

Capital Assets Assets such as furniture, equipment, and vehicles with an aggregate cost of more than $5,000 and an estimated useful life in excess of one year are capitalized. Capitalization thresholds are also utilized for buildings and building improvements ($100,000), infrastructure ($500,000), and facilities and other improvements ($100,000). Capital assets are recorded at cost or estimated historical cost if actual historical cost is not available. Donated capital assets are reported at acquisition value. For fabricated assets financed by debt, construction period interest is

Internal Audit 03/08/18 26 32 of 62 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31, 2017

capitalized as part of the capital asset cost. The capitalized interest is combined with the other costs associated with constructing the asset and depreciated over the appropriate useful life beginning when the asset is placed into service.

Capital assets are depreciated over the estimated useful life of the asset using the straight-line method based on allocation methods and estimated lives prescribed by the Statewide Property Accounting (SPA) system. Depreciation is recorded as a periodic expense and accumulated as an offset to the asset book values. Depreciation expense is not allocated to functional categories for this Annual Financial Report.

Intangible capital assets are defined as assets that lack physical substance, are nonfinancial in nature, and have an initial useful life extending beyond a single reporting period. These assets are required to be reported if they are identifiable. Land use rights are capitalized if the cost meets or exceeds $100,000. Purchased computer software is capitalized if the aggregate cost of the purchase meets or exceeds $100,000. Internally generated computer software has a capitalization threshold of $1,000,000, and other intangible capital assets must be capitalized if the cost meets or exceeds $100,000. Intangible assets are amortized based on the estimated useful life of the asset using the straight-line method.

Current Receivables - Other Other receivables include year-end revenue accruals. This account can appear in governmental and proprietary fund types.

Non-Current Receivables - Other Receivable balances not expected to be collected within one year of fiscal year end are included in this account.

Deferred Outflows of Resources Deferred outflows of resources refer to the net consumption of assets that is applicable to a future fiscal year. These deferred outflows arose due to the new reporting requirements for pensions as discussed in the net pension liability section. Deferred outflows are discussed in detail in Notes 9 and 28.

LIABILITIES Accounts Payable Accounts payable represent the liability for the value of assets or services received at the balance sheet date for which payment is pending.

Current Payables - Other Payables are the accrual at year-end of expenditure transactions. Payables may be included in either the governmental or proprietary fund types.

Unearned Revenues Unearned revenues include amounts for tuition and fees, certain auxiliary activities, and amounts from grant and contract sponsors received prior to the end of the fiscal year, but related to the subsequent accounting period.

Funds Held for Others Current balances in funds held for others result from UH acting as an agent or fiduciary for other organizations.

Non-Current Payables - Other Payable balances not expected to be paid within one year of fiscal year-end are included in this account.

Internal Audit 03/08/18 27 33 of 62 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31, 2017

Employees' Compensable Leave Balances Employees' compensable leave balances represent the liability that becomes due upon the occurrence of relevant events such as resignations, retirements, and uses of leave balances by covered employees. Liabilities are reported separately as either current or non-current in the Statement of Net Position.

Capital Lease Obligations Capital lease obligations represent the liability for future lease payments under capital lease contracts contingent upon the appropriation of funding by the Legislature. Liabilities are reported separately as either current or non-current in the Statement of Net Position.

Bonds Payable - General Obligation Bonds The unmatured principal of general obligations bonds is accounted for in the long-term liabilities column. Payables are reported separately as either current or non-current in the Statement of Net Position.

Bonds payable are recorded at par. The bond proceeds are accounted for as an other financing source in the governmental funds when received, and expenditures for payment of principal and interest are recorded in debt service funds when paid. These amounts are adjusted in the Long­ Term Liabilities column.

Bonds Payable - Revenue Bonds Revenue bonds are generally accounted for in th e proprietary funds. The bonds payable are reported at par, less unamortized discount or plus unamortized premium. Interest expense is reported on the accrual basis with amortization of discount or premium. Payables are reported separately as either current or non-current in the Statement of Net Position.

Net Pension Liability Due to the implementation of GASB Statement No. 68, Accounting and Financial Reporting for Pensions, UH must now recognize its proportionate share of net pension liability and operating statement activity related to changes in the collective pension liability for participation in Teacher Retirement System {TRS) pension plan. The net pension liability is UH's proportionate share of the total TRS pension plan liability less the plan's net assets as reported by the TRS pension plan for fiscal year 2016. UH's proportionate share is based on its contributions to the pension pla n relative to the contribution of other employers participating in the plan. The net pension liability and related changes to the collective pension liability are included in this Annual Financial Report and represent the total net pension liability for UH. Pensions are discussed in greater detail in Note 9.

Deferred Inflows of Resources Deferred inflows of resources are defined as the net acquisition of assets that is applicable to a future fiscal year. These deferred inflows arose due to th e new reporting requirements for pensions as discussed above. Deferred inflows are discussed further in Notes 9 and 28.

NET POSITION Net position is the difference between assets plus deferred outflows of resources and liabilities plus deferred inflows of resources. Net position is divided into three categories as described below.

Invested In Capital Assets, Net of Related Debt Invested in capital assets, net of related debt consists of capital assets, net of accumulated depreciation, and reduced by outstanding balances for bonds, notes, and other debt that are attributed to the acquisition, construction, or improvement of those assets.

Internal Audit 03/08/18 34 of 62 28 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31, 2017

Restricted Net Position Restricted net position results when constraints placed on net positon use are either externally imposed by creditors, granters, contributors, and the like, or imposed by law through constitutional provisions or enabling legislation. When both restricted and unrestricted assets are available for use, restricted resource are used first, then unrestricted resources are used as needed.

Expendable - net position use by UH is subject to externally imposed stipulations that can be fulfilled by actions of UH pursuant to those stipulations, or that expire by the passage of time.

Non-expendable - net position subject to externally imposed stipulations that they be maintained permanently by UH. Such assets include the principal of UH's permanent endowment funds.

Unrestricted Net Position Unrestricted net position consists of net resources, which do not meet the definition of the two preceding categories. Unrestricted net position often has constraints on resources, which are imposed by management, but can be removed or modified.

Operating and non-operating revenues and expenses Operating revenues and expenses- include activities such as student tuition and fees; net sales and services of auxiliary enterprises; exchange basis federal, state and local grants and contracts and related expenses including depreciation; scholarships and fellowships, impairment losses, insurance recovery in the year of the loss, and incurred but not reported liabilities.

Non-operating revenues and expenses - included actives such as gifts and contributions, insurance recoveries received in years subsequent to the loss, State appropriations, investment income, nonexchange basis federal and state grants and contracts, and other nonoperating items defined by GASB.

Internal Audit 03/08/18 29 35 of 62 Internal Audit 03/08/18 36 of 62 Internal Audit 03/08/18 37 of 62 Internal Audit 03/08/18 38 of 62 Internal Audit 03/08/18 39 of 62 UNIVERSITY of HOUSTON Notes to Financial Statements For th e year ended August 31, 2017

Information regarding individual bond series outstanding is as follows:

Revenue Bonds • Consolidated Revenue Variable Rate Demand Bonds, Series 2004 - To finance the acquisition, purchase, construction, improvement, renovation, enlargement, and equipping of any property, buildings, structures, facilities, roads, or related infrastructure for the UH System, including the individual campuses of the System. - Proceeds were used to repair damage from Tropical Storm Allison (UH). - $25,000,000: all bonds authorized have been issued (UH - $25,000,000). - Issued 06-16-2004. - Source of revenue for debt service - Tuition and various other fees, and revenues and balances that may be legally available for payment of debt obligations. (Funding for fiscal year 2017 fully from Legislative Appropriation-Tuition Revenue Bonds.) - The bonds bear interest at a variable rate , which is determined on a weekly basis on each Wednesday, and the rate is effective for a seven-day period commencing on the immediately following Thursday. The variable rate in effect on August 31 , 2015 was 0.02%. - Bondholders have the option to tender their bonds for purchase at a price equal to the principal amount thereof, plus accrued interest, at the times and subject to the conditions described in the bond resolution. Tendered bonds may be remarketed and remain outstanding. Bonds tendered for purchase will be paid first from the proceeds of remarketing, if any, and then from legally available money advanced by the Board of Regents. In order to provide for the payment of the purchase price of tendered bonds, the Board has agreed to provide self-liquidity. The Board has not entered into an agreement with an outside entity to provide liquid ity in the event that the remarketing agent is unable to remarket the bonds on an optional tender date. Liquidity support for the bonds will be provided by the System's funds and is expected to be provided first from funds invested in the System's non-endowed investment pool and money market accounts. - Outstanding bonds maturing subsequent to 02-15-2017, totaling $155,000 were extinguished early by using existing assets.

General Obligation Bonds At August 31, 2017, UH had no bonds payable classified as General Obligation Bonds.

Refunding Bonds • Consolidated Revenue and Refunding Bonds, Series 2008 - To (a) refund and defease certain outstanding commercial paper notes of the System and (b) finance the acquisition, purchase, improvement, enlargement and equipping of property, buildings, structures, activities, services, operations and other facilities, roads, or related infrastructure for or on the behalf of the System, including individual campuses of the System. - In addition to the defeasement of the commercial paper noted above, the proceeds were used to finance the construction of the Calhoun Lofts, East Parking Garage Part 1, and MacGregor Land purchase (UH), the Allied Health Facility, The Regional Center for Economic Development, and Building 2, Sugarland (UHV). - $175,030,000: all bonds have been issued (UH - $143,615,000 and UHV- $31,415,000). - Issued 07-01-2008. - Source of revenue for debt service - Tuition and various other fees and revenues and balances that may be legally available for payment of debt obligations. (Funding for fiscal year 2017 partially from Legislative Appropriations-Tuition Revenue Bonds.) - Sufficient funds from proceeds of advance refunding bonds were deposited in FY16 with an escrow agent to provide for full payment of certain outstanding obligations related to the 2008 series bonds that mature subsequent to 02-15-2019 totaling $67,525,000, after they are called for early redemption on 02-15-2018. - Sufficient funds from proceeds of advance refunding bonds were deposited in FY17, with an escrow agent to provide for full payment of certain outstanding obligations related to the 2008 series bonds that mature subsequent to 02-15-2022 totaling $38,400,000, after they are called for early redemption on 02-15-2018.

Internal Audit 03/08/18 40 of 62 34 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31, 2017

• Consolidated Revenue and Refunding Bonds, Series 2009 - To (a) defease certain outstanding commercial paper notes of the System and (b) finance the acquisition, purchase, construction, improvement, enlargement, and equipping of property, buildings, structures, activities, services, operation and other facilities, roads, or related infrastructure for or on behalf of the System, including individual campuses of the System. - In addition to the defeasement of the commercial paper noted above, the proceeds were used to finance the Science Lab renovations, the purchase of Bayou Oaks, the construction of the Stadium Parking Garage Part 1 and East Garage Part 2 (UH) and the renovation of the Arbor Building (UHCL). - Issued 02-04-2009. - $108,395,000; all bonds authorized have been issued (UH - $98,230,000 and UHCL - $10,165,000). - Source of revenue for debt service - Tuition and various other fees, revenues and balances that may be legally available for payment of debt obligations. (Funding for fiscal year 2017 partially from Legislative Appropriation-Tuition Revenue Bonds.) - Sufficient funds from proceeds of advance refunding bonds were deposited in FY17, with an escrow agent to provide for full payment of certain outstanding obligations related to the 2009 series bonds that mature subsequent to 02-15-2021 totaling $50,325,000, after they are called for early redemption on 02-15-2019.

• Consolidated Revenue and Refunding Bonds, Series 2009-A - To (a) refund and defease $20,515,000 of outstanding Consolidated Revenue Bonds, Series 1999 and (b) finance the acquisition, purchase, construction, improvement, enlargement, and equipping of property, buildings, structures, activities, services, operation and other facilities, roads, or related infrastructure for or on behalf of the System, including individual campuses of the System. - In addition to the defeasement of the bonds noted above, the proceeds were used to finance the construction of Cougar Village Part 1 (UH). - Issued 07-02-2009. - $71,175,000; all bonds authorized have been issued ($52,200,000 revenue bonds: UH; and $18,975,000 refunding bonds: UH - $6,829,102.50, UHD - $4,267,477.50, and UHV - $7,878,420.00). - Source of revenue for debt service - Tu ition and various other fees, revenues and balances that may be legally ava ilable for payment of debt obligations. (Funding for fiscal year 2017 partially from Legislative Appropriation-Tuition Revenue Bonds.) - Average interest rate of bonds refunded - 4.885%. - Net proceeds from refunding series - $20,892,799.63, after receipt of bond premium of $1,719,638.50 and additional available funds of $377,640.50 and payment of $179,479.37 in underwriting fees, insurance, and other issuance costs. - Sufficient funds were deposited with an escrow agent to provide for full payment of all outstanding obligations related to the 1999 series bonds, after they were called for early redemption. - The 1999 seri es bonds maturing subsequent to 02-15-2009 are considered fully defeased, and the obligation for those bonds has been removed from the reported liabilities of the System. - Refunding of the 1999 series bonds reduced the System's debt service payments over th e life of the bond issues by approximately $2,023,239.08. - Economic gain - $1,742,552.43; the difference between the net present value of the old and new debt service payments. - Sufficient funds from proceeds of advance refunding bonds were deposited in FY17, with an escrow agent to provide for full payment of certain outstanding obligations related to the 2009A series bonds that mature subsequent to 02-15-2024 totaling $12,840,000, after they are called for early redemption on 02-15-2019.

• Consolidated Revenue and Refunding Bonds, Series 2010-A -To (a) defease certain outstanding commercial paper notes of the System and (b) finance the acquisition, purchase, construction, improvement, enlargement, and equipping of property, buildings, structures, activities, services, operations and other facilities, roads, or related infrastructure for or on behalf of the System, including individual campuses of the System. - In addition to the defeasement of the commercial paper noted above, the proceeds were used to fina nce construction costs related to the renovation of UH Moody Towers Dining Hal l and the purchase of UH Energy Research Park. - Issued 04-15-2010 - $23,305,000; all bonds authorized have been issued (UH - $23,305,000). - Source of revenue for debt service - Designated tuition and various other fees, revenues and balances that may be legally available for payment of debt obligations.

Internal Audit 03/08/18 41 of 62 35 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31 , 2017

• Consolidated Revenue and Refunding Bonds, Series 2010-B - To (a) defease certain outstanding commercial paper notes of the System and (b) finance the acquisition, purchase, construction , improvement, enlargement, and equipping of property, buildings, structures, activities, services, operations and other facilities, roads, or related infrastructure for or on behalf of the System, including individual campuses of the System. - In addition to the defeasement of the commercial paper noted above, the proceeds were used to finance costs related to the construction of a classroom/business building and the Health and Biomedical Sciences building (UH), the renovation of certain facilities at the UH Energy Research Park (UH) and construction costs related to Jaguar Residence Hall (UHV). - This bond issue is a qualified Build America Bond (BAB) as defined within Sections 54AA and 6431 of the Internal Revenue Code of 1986, as amended. - Issued 04-15-2010. - $79,975,000; all bonds authorized have been issued (UH -$74,595,000 and UHV- $5,380,000). - Source of revenue for debt service - Designated tuition and various other fees, reven ues and balances that may be legall y available for payment of debt obligations. The System will receive interest subsidy payments from the U.S. Treasury equal to 35 percent of the interest payable on related qualified Build America Bonds contemporaneously with the interest payment dates of the qualified Build America Bonds.

• Consolidated Revenue and Refunding Bonds, Series 2010-C - To (a) defease certain outstanding commercial paper notes of the System and (b) finance the acquisition, purchase, construction, improvement, enlargement, and equipping of property, buildings, structures, activities, services, operations and other facilities, roads, or related infrastructure for or on behalf of the System, including individual campuses of the System. - In addition to the defeasement of the commercial paper noted above, the proceeds were used to finance construction costs for Stadium Parking Garage Part 2, and renovation of certain facilities at the UH Energy Research Park (UH) and at construction costs related to Jaguar Residence Hall (UHV). - Issued 04-15-2010. - $18,255,000; all bonds authorized have been issued (UH - $16,620,000 and UHV - $1,635,000). - Source of revenue for debt service - Designated tuition and various other fees, revenues and balances that may be legally available for payment of debt obligations.

• Consolidated Revenue and Refunding Bonds, Series 2011-A - To (a) refund and defease $78,195,000 of outstanding Consolidated Revenue Bonds, Series 2002-A and $9,255,000 of Consolidated Revenue Refunding Bonds, Series 2002-B and (b) finance the acquisition, purchase, construction, improvement, enlargement, and equipping of property, buildings, structures, activities, services, operation and other facilities, roads, or related infrastructure for or on behalf of the System, including individual campuses of the System. -In addition to the defeasement of the bonds noted above, the proceeds were used to fi nance the acquisition, construction, or renovation of the University Center, Quadrangle, Moody Towers, Cougar Place, Cougar Village 2, Radio Station, Parking Garage 1A, and various bui ldings at UH Energy Research Park (UH) and Residential Housing (UHV). - Issued 12-29-2011. - $265,500,000; all bonds authorized have been issued ($75,640,000 refunding bonds: UH - $35,921 ,187.96, UHCL - $18,691,900.89, UHD - $9,487,588.77, and UHV - $11 ,539,322.38; and $189,860,000 revenue bonds: UH - $179,785,000 and UHV - $10,075,000). - Source of revenue for debt service - Tuition and various other fees, revenues and balances that may be legally available for payment of debt obligations. (Funding for fiscal year 2017 partiall y from Legislative Appropriation-Tu ition Revenue Bonds.) - Average interest rate of bonds refunded - 4.464013%. - Net proceeds from refunding series - $89,366,528.00, after receipt of bond premium of $12,525,317.05 and additional available funds of $1,427,621.11 and payment of $226,410.16 in underwriting fees, insurance, and other issuance costs. - Sufficient funds were deposited with an escrow agent to provide for full payment of all outstanding obligations related to the 2002-A and 2002-B series bonds, after they were called for early redemption on 02-15-2012.

Internal Audit 03/08/18 42 of 62 36 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31, 2017

- The 2002-A and 2002-B series bonds maturing subsequent to 02-15-2012 are considered ful ly defeased and the obligation for those bonds has been removed from th e reported liabilities of the System. - Refunding of the 2002-A and 2002-B series bonds reduced the System's debt service payments over the life of the bond issues by approximately $12 ,683,166.71. - Economic gain - $11,417,870.29; the difference between the net present value of the old and new debt service payments. - Outstanding bonds maturing subsequent to 02-15-2016, totaling $7,360,000 were extinguished early by using existing assets. - Outstanding bonds maturing subsequent to 02-15-2033, totaling $750,000 were extinguished early by using existing assets.

• Consolidated Revenue and Refunding Bonds, Series 2011-B - To (a) defease certain outstanding commercial paper notes of the System and (b) finance the acquisition, purchase, construction, improvement, enlargement, and equipping of property, buildings, structures, activities, services, operations and other facilities, roads, or related infrastructure for or on behalf of the System, including individual campuses of the System. - In addition to the defeasement of the commercial paper noted above, the proceeds were used to finance construction costs for West Dining Hall and renovation of the University Center (UH). - Issued 12-29-2011. - $21,310,000; all bonds authorized have been issued (UH - $21,310,000). - Source of revenue for debt service - Designated tuition and various other fees, revenues and balances that may be legally available for payment of debt obligations.

• Consolidated Revenue and Refunding Bonds, Series 2013-A - To (a) refund and defease $5,175,000 of Consolidated Revenue Refunding Bonds, Series 2003; $16,355,000 of Consolidated Revenue Bonds, Series 2005; and $10,415,000 of Consolidated Revenue and Refunding Bonds, Series 2006, and (b) finance the acquisition, purchase, construction, improvement, enlargement, and equipping of property, buildings, structures, activities, services, operation and other facilities, roads, or related infrastructure for or on behalf of the System, including individual campuses of the System. - In addition to the defeasement of the bonds noted above, the proceeds were used to finance the acquisition, construction, or renovation of the Girard Street Parking Garage (UHD), Jaguar Court Residence Facility (U HV), and UH Energy Research Park renovations and improvements (UH), and {b) to defease certain outstanding commercial paper notes of the System. - Issued 9-17-2013. - $50,155,000; all bonds authorized have been issued ($30,1 10,000 refunding bonds: UH - $20,335,000, UHD - $9,605,000, and UHV - $170,000; and $20,045,000 revenue bonds: UH - $10,045,000, UHD - $6,035,000, and UHV - $3,965,000). - Source of revenue for debt service - Tuition and various other fees, revenues and balances that may be legally available for payment of debt obligations. (Funding for fiscal year 2017 partially from Legislative Appropriation-Tuition Revenue Bonds.) - Average interest rate of bonds refunded - 4.74%. - Net proceeds from refunding series - $33,077,545.71, after receipt of bond premium of $3,186,375.65 and payment of $218,829.94 in underwriting fees, insurance, and other issuance costs. - Sufficient funds were deposited with an escrow agent to provide for full payment of all outstanding obligations related to the 2003, 2005, and 2006 series bonds, after they were called for early redemption on 02-15-2015. - The advance refunded 2003, 2005, and 2006 series bonds maturing subsequent to 02-15-2015 are considered fully defeased and the obligation for those bonds has been removed from the reported liabilities of the System. - Refunding of the 2003, 2005, and 2006 seri es bonds reduced the System's debt service payments over the life of the bond issues by approximately $3,11 6,482.36. - Economic gain - $2,640,370.82; the difference between the net present value of the old and new debt service payments. - Accounting loss {deferred outflows of resources) - $515,099.28; the accounting loss (the difference between the reacquisition price and the net carrying value of the refunded bond s) resulted from the advance refunding.

Internal Audit 03/08/18 43 of 62 37 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31, 2017

• Consolidated Revenue and Refunding Bonds, Series 2013-B - To (a) defease certain outstanding commercial paper notes of the System and (b) finance the acquisition, purchase, construction, improvement, enlargement, and equipping of property, buildings, structures, activities, services, operations and other facilities, roads, or related infrastructure for or on behalf of the System, including individual campuses of the System. - In addition to the defeasement of the commercial paper noted above, the proceeds were used to finance the construction of a Football Stadium (UH), a Multidisciplinary Research and Engineering Building (UH), UH Energy Research Park renovations and improvements (UH), and Jaguar Court Residence Facility (UHV). - Issued 9-17-2013. - $102,420,000; all bonds authorized have been issued (UH - $101,200,000 and UHV - $1,220,000) . - Source of revenue for debt service - Designated tuition and various other fees, revenues and balances that may be legally available for payment of debt obligations.

• Consolidated Revenue Refunding Bonds, Series 2014 - To refund $18,385,000 of Consolidated Revenue Bonds, Series 2006; and $32,715,000 of Consolidated Revenue and Refunding Bonds, Series 2006. - Issued 11-18-2014. - $47,915,000; all bonds authorized have been issued (UH - $29,525,000, UHD - $17,765,000, and UHV - $625,000). - Source of revenue for debt service - Tuition and various other fees, revenues and balances that may be legally available for payment of debt obligations. (Funding for fiscal year 2017 partially from Legislative Appropriation-Tuition Revenue Bonds.) - Average interest rate of bonds refunded - 4.67%. - Net proceeds from refunding series - $52,309,205.77, after receipt of bond premium of $5,037,241.05 and payment of $643,035.28 in underwriting fees, insurance, and oth er issuance costs. - Sufficient funds were deposited with an escrow agent to provide for full payment of all outstanding obligations related to the 2006 series bonds, after they were called for early redemption on 02-15-2015. - The advance refunded 2006 series bonds maturing subsequent to 02-15-2015 are considered fully defeased and the obligation for those bonds has been removed from the reported liabilities of the System. - Refunding of the 2006 series bonds reduced the System's debt service payments over the life of the bond issues by approximately $9,051,334.58. - Economic gain - $7,400,593.85; the difference between the net present value of the old and new debt service payments. - Accounting gain (deferred inflows of resources) - $445,456.16; the accounting gain (the difference between the reacquisition price and the net carrying value of the refunded bonds) resulted from the advance refunding.

• Consolidated Revenue and Refunding Bonds, Series 2016-A - To (a) refund and defease $67,525,000 of Consolidated Revenue and Refunding Bonds, Series 2008, and (b) finance the acquisition, purchase, construction, improvement, enlargement, and equipping of property, buildings, structures, activities, services, operations and other facilities, roads, or related infrastructure for or on behalf of the System, including individual campuses of the System. - In addition to the defeasement of the bonds noted above, the proceeds were used to finance the acquisition, construction, or renovation of Sophomore housing facilities - 3200 N. Ben W ilson Residence Facility (UHV), and (b) to defease certain outstanding commercial paper notes of the System. - Issued 2-16-2016. - $100,650,000; all bonds authorized have been issued ($63,605,000 refunding bonds: UHSA - $10,260,000, UH - $49,480,000, and UHV - $3,865,000; and $37,045,000 revenue bonds: UH - $21 ,290,000, UHSA - $6,910,000, and UHV - $8,845,000). - Source of revenue for debt service - Designated tuition and various other fees, reven ues and balances that may be legally available for payment of debt obligations. - Average interest rate of bonds refunded - 5.106634%. - Net proceeds from refunding series - $73,326,358.81, after receipt of bond premium of $10,146,107.80 and payment of $424,748.99 in underwriting fees, insurance, and other issuance costs.

Internal Audit 03/08/18 38 44 of 62 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31, 2017

- Sufficient funds were deposited with an escrow agent to provide for full payment of all outstanding obligations related to the 2008 series bonds maturing subsequent to 02-15-2019, after they are called for early redemption on 02-15-2018. - The advance refunded 2008 series bonds maturing subsequent to 02-15-2019 are considered fully defeased and th e obligation for those bonds has been removed from the reported liabilities of the System. - Refunding of the 2008 series bonds reduced the System's debt service payments over the life of the bond issues by approximately $11,368,241.94. - Economic gain - $9,431,071.76; the difference between the net present value of the old and new debt service payments. - Accounting loss (deferred outflows of resources) - $3,725,515.23; the accounting loss (the difference between the reacquisition price and the net carrying value of the refunded bonds) resulted from the advance refunding.

• Consolidated Revenue and Refunding Bonds, Series 2016-B - To (a) defease certain outstanding commercial paper notes of the System and (b) finance the acquisition, purchase, construction, improvement, enlargement, and equipping of property, buildings, structures, activities, services, operations and other facilities , roads, or related infrastructure for or on behalf of the System, including individual campuses of the System. - In addition to the defeasement of the commercial paper noted above, the proceeds were used to finance a portion of the Multidisciplinary Research and Engineering Building (UH ), Science, Technology, Engineering, and Mathematics Building (UHCL), and the Health and Biomedical Building 2 (UH). - Issued 2-1 6-2016. - $184,350,000; all bonds authorized have been issued (UH -$120,300,000 and UHCL- $64,050,000). - Source of revenue for debt service -Designated tuition and various other fees, revenues and balances that may be legally available for payment of debt obligations. (Funding for fiscal year 2017 partially from Legislative Appropriations-Tuition Revenue Bonds.)

• Consolidated Revenue and Refunding Bonds, Series 2017-A - To (a) advance refund and defease $37,650,000 of Consolidated Revenue Refunding Bonds, Series 2008; $50,325,000 of Consolidated Revenue and Refunding Bonds, Series 2009; and $12,840,000 of Consolidated Revenue and Refunding Bonds, Series 2009A, (b) finance the acquisition, purchase, construction, improvement, enlargement, and equipping of property, buildings, structures, activities, services, operation and other facilities, roads, or related infrastructure for or on behalf of the System, including individual campuses of the System and (c) to defease certain outstanding commercial paper notes of the System. - In addition to the defeasement of the notes and bonds noted above, the proceeds were used to finance the acquisition, construction, or renovation of various properties, buildings, and facilities at the UH - System Administration, UH , UH - Clear Lake, UH - Downtown, and UH - Victoria. - Issued 2-16-2017. - $379,450,000; all bonds authorized have been issued; (a) $93,460,000 refunding bonds: Series 2008: UHSA- $265,000, UH - $35,300,000, and UHV - $95,000; Series 2009: UH - $41,990,000, and UHCL - $4, 165,000; and Series 2009A: UH - $1 1,645,000; and (b) $285,990,000 new money revenue bonds: UHSA - $40,920,000, UH - $47,180,000, UH CL - $53,830,000, UHD - $84,750,000 and UHV - $59,310,000. - Source of revenue for debt service - Tuition and various other fees, revenues and balances that may be legally available for payment of debt obligations. (Funding for fiscal year 2017 partially from Leg islative Appropri ation-Tuition Revenue Bonds.) - Average interest rate of bonds refunded - 4.971035%. - Net proceeds from refunding series - $108,438,040.58, after receipt of $93,460,000 par va lue, plus receipt of the bond premium of $15,956,653, and payment of $978,612.42 in underwriting fees, insurance, and other issuance costs. - Refunding of the 2008, 2009, and 2009A series bonds reduced the System's debt service payments over the life of the bond issues by approximately $1 4,322,761.90. - Economic gain - $10,020,739.63; the difference between the net present value of the old and new debt service payments.

Internal Audit 03/08/18 39 45 of 62 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31, 2017

- Accounting loss (deferred outflows of resources) - $2,300,255.73; the accounting loss (the difference between the reacquisition price and the net carrying value of the refunded bonds) resulted from the advance refunding.

• Consolidated Revenue and Refunding Bonds, Series 2017-B - To (a) defease certain outstanding commercial paper notes of the System and (b) finance the acquisition, purchase, construction, improvement, enlargement, and equipping of property, buildings, structures, activities, services, operations and other facilities, roads, or related infrastructure for or on behalf of the System, including individual campuses of the System. - In addition to the defeasement of the commercial paper noted above, the proceeds were used to finance the Basketball Arena (UH) and Football Stadium (UH). - Issued 2-16-2017. - $11,635,000; all bonds authorized have been issued (UH - $11,635,000). - Source of revenue for debt service - Designated tuition and various other fees, revenues and balances that may be legally available for payment of debt obligations.

Pledged Future Revenues The following table provides the pledged future revenue information for UH 's revenue bonds:

Pledged revenue required for future principal and interest on existing revenue bonds $ 1,208,040,523.00 Term of commitment year ending 08/31 2043 Percentage of revenue pledged 100% Current year pledged revenue $ 669,537,245.26 Current year principal and interest paid $ 88,384,372.33

Pledged revenue sources include operating income from tuition and fees and sales and service revenue from auxiliary and non-auxiliary activities including intercollegiate athletics, residential life, parking, rental of facilities, continuing education, royalties, publications, clinics, bookstores, and vending commissions.

Build America Bonds Build America Bonds (BABs) were created as part of the federal American Recovery and Reinvestment Act of 2009 (ARRA). Taxable bonds were issued by governmental entities, including state agencies and state universities, as Tax Credit BABs or as Direct Payment BABs. Tax Credit BABs provide a federal tax credit to investors equal to 35 percent of the interest received from the bond issuer. Direct Payment BABs provide a direct federal reimbursement to state and local governmental issuers equal to 35 percent of the interest paid on the bonds. Authority to issue BABs expired on December 31, 2010.

During the 2010 fiscal year, UH issued $74,595,000 of Consolidated Revenue and Refunding Bonds, Series 2010-B, taxable revenue bonds under the Direct Payment BABs program. A balance of $70,920,000 remained outstanding at August 31, 2017. No Tax Credit BABs were issued.

Pursuant to the requirements of the Balanced Budget Emergency Deficit Control Act of 1985, as amended, certain automatic reductions occurred as of March 1, 2013, until further amended. These reductions apply to certain qualified bonds, including BABs. The sequestration reduction applicable to the Series 2010-B bonds was $96,323.88. The full amount of interest due to bond holders was paid by UH System.

NOTE 7: Derivative Instruments

Derivatives are financial instruments the value of which is derived, in whole or part, from the value of any one or more underlying assets or index of asset values. Derivatives include swap contracts, futures contracts, options, options on futures contracts, and forward contracts.

Hedging derivative contracts are entered into for the purpose of reducing the overall cost of borrowing long-term capital and to protect the agency against the ri sk of rising interest rates. The hedging derivatives primarily consist

Internal Audit 03/08/18 40 46 of 62 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31 , 2017 of interest rate swap agreements entered into, in connection with long-term bonds. The derivative contracts enable the agency to issue bonds at a cost less than what the agency would have paid to issue conventional fixed-rate debt.

Investment derivatives are entered into with the intention of managing transaction or currency exchange risk in purchasing, selling, or holding investments. Ineffective hedges are also reported as investment derivatives.

As of August 31, 2017, UH had no investments in derivative instruments.

NOTE 8: Leases

Operating Leases Included in the expenditures reported in the financia l statements are rent paid or due under operating lease obligations of $9,128,042.73.

Future minimum lease rental payments under non-cancelable operating leases having an initial term in excess of one year are as follows:

Year Ending August 31, Amount 2018 $ 7,302,434.18 2019 5,476,825.64 2020 3,651 ,217.09 2021 1,825,608.55 2022 912,804.27 2023-2027 2,282,010.68 2028-2032 1,140,319.80 Total Minimum Future Lease Rental Payments $ 22,591,220.21

Capital Leases As of August 31 , 2017, UH had no capital leases.

NOTE 9: Pension Plans and Optional Retirement Program

The State has joint contributory retirement plans for substantially all its employees. UH participates in the plans administered by the Teachers Retirement System of Texas (the Retirement System). Future pension costs are the liabil iti es of the Retirement System. The Retirement System does not account for each State agency separately. Annual financial reports prepared by the Retirement System include audited financial statements and actuari al assumptions and conclusions.

The State has also established an Optional Retirement Program for institutions of higher education. Participation in the Optional Retirement Program is available to certain eligible employees and is in lieu of participation in the Retirement System.

The contri butions made by plan members and employers for the fiscal year ended August 31, 2017 are:

TRS ORP Total Particieants Particieants Contributions Member Contributions $ 19,101,346.76 $ 10,324,446.00 $ 29,425,792.76 Employer Contributions 16,965,260.92 11,22 1,579.00 28, 186,839.92 Total $ 36,066,607.68 $ 21,546,025.00 $ 57,612,632.68

Internal Audit 03/08/18 41 47 of 62 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31 , 2017

The State has three retirement systems in its financial reporting entity - Employees Retirement System (ERS), Teacher Retirement System (TRS), and Texas Emergency Services Retirement System (TESRS). These three retirement systems administer the following six defined benefit pension plans: • ERS - the Employees Retirement System of Texas Plan (ERS), the Law Enforcement and Custodial Officer Supplemental Retirement Plan (LECOS), the Judicial Retirement System of Texas Plan One (JRS1) and Judicial Retirement System of Texas Plan Two (JRS2). • TRS - the Teacher Retirement System of Texas (TRS) plan. • TESRS - the Texas Emergency Services Retirement System (TESRS) plan.

ERS , LECOS, JRS2, TRS, and TESRS plans are administered through trust; JRS1 plan is on a pay-as-you-go basis.

TRS Plan The Retirement System is the administrator of the TRS Plan, a cost-sharing, multiple-employer defined benefit pension plan with a special funding situation.

The employers of the TRS Plan include the State, TRS, the State's public schools, education service centers, charter schools, and community and junior colleges. All employees of public, state-supported education institutions in Texas who are employed for one-half or more of the standard work load and not exempted from membership under Texas Government Code, Title 8, Section 822.002 are covered by the TRS Plan. Employees of TRS and State colleges, universities, and medical schools are members of the TRS Plan.

The TRS Plan provides retirement, disability annuities, and death and survivor benefits. The benefit and contribution provisions of the TRS Plan are authorized by State law and may be amended by the Legislature. The pension benefit formulas are based on members' average annual compensation and years of service cred it. The standard annuity is 2.3 percent of the average of the five highest annual salaries multiplied by years of service credit. For grandfathered members who were hired on or before August 31, 2005 and meet certain criteria, the standard annuity is based on the average of the three highest annual salaries. The TRS Plan does not provide automatic cost of living adjustments.

The audited Comprehensive Annual Financial Report for the Retirement System may be obtained from: Teacher Retirement System of Texas 1000 Red River Street Austin, Texas 78701-2698

During the measurement period of 2016 for fiscal 2017 reporting, the amount of UH's contributions recognized by the TRS plan was $9,590,588. The contribution rates for the State and the members in the measurement period are presented in the table below:

Required Contribution Rates TRS Plan Contribution Rates Employer 6.8% Employees 7.2%

The total pension liability is determined by an annual actuarial valuation. The table below presents the actuarial methods and assumptions used to measure the total pension liability as of the August 31 , 2016 measurement date:

Internal Audit 03/08/18 42 48 of 62 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31 , 2017

Actuarial Methods and Assumptions TRS Plan

Actuarial Valuation Date August31 , 2016 Actuarial Cost Method Individual Entry Age Normal Amortization Method Level Percentage of Payroll, Floating Actuarial Assumptions: Discount Rate 8.0% Investment Rate of Return 8.0% Inflation 2.50% Salary Increase 3.50% to 9.50% including inflation Mortality: Active 90% of the RP 2014 Employee Mortality Tables for males and females Post-Retirement 2015 TRS Healthy Pensioner Mortality Tables Ad Hoc Post-Employment Benefit Changes None

The actuarial assumptions used in the valuation were primarily based on the result of an actuarial experience study for the four-year period ending August 31 , 2014 and adopted on September 2015. The mortality rates were based on 90% of the RP 2014 employee Mortality Tables for the active members. The post-retirement mortality rates were based on 2015 TRS Healthy Pensioner Mortality Tables.

There have been no changes to the benefit provisions of the TRS Plan since the prior measurement date.

The discount rate of 8% was applied to measure the total pension liability. There has been no change in the discount rate since the prior measurement period. The projected cash flows into and out of the TRS Plan assumed that members, employers, and the non-employer contributing entity make their contributions at the statutorily required rates. Under this assumption, the TRS Plan's fiduciary net position is projected to be sufficient to make all future pension benefit payments of current TRS Plan members. Therefore, the 8% long-term expected rate of return on TRS Plan investments was used as the discount rate without incorporating the municipal bond rate.

The long-term expected rate of return on TRS Plan investments was developed using a building-block method with assumptions including asset class of investment portfolio, target allocation, real rate of return on investments, and inflation factor. Under this method, best estimate ranges of expected future real rates of return (net of investment expense and inflation) are developed for each major asset class. These ranges are combined to produce the long-term expected rate of return by weighing the expected future real rates of return by the target asset allocation percentage and by adding expected inflation.

Internal Audit 03/08/18 49 of 62 43 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31 , 2017

The target allocation and best estimates of geometric real rates of return for each major asset class for the TRS Plan's investment portfolio are presented below: Long-Term Expected Target Geometric Real Asset Class Allocation Rate of Return Global Equity U.S. 18% 4.6% Non-U.S. Developed 13% 5.1% Emerging Markets 9% 5.9% Directional Hedge Funds 4% 3.2% Private Equity 13% 7.0% Stable Value U.S. Treasury 11 % 0.7% Absolute Return 0% 1.8% Stable Value Hedge Funds 4% 3.0% Cash 1% -0.2% Real Return Global Inflation Linked Bonds 3% 0.9% Real Assets 16% 5.1% Energy and Natural Resources 3% 6.6% Commodities 0% 1.2% Risk Parity Risk Parity 5% 6.7% Total 100%

A sensitivity analysis was performed on the impact of changes in the discount rate on the proportionate share of e UH's net pension liability. The result of the analysis is presented in the table below:

Sensitivity of the UH's Proportionate Share of the Net Pension Liability to Changes in the Discount Rate

1% Decrease Current Discount Rate 1% Increase (7%) (8%) (9%)

$213,336,913.00 $ 139,600,108.07 $73,811,746.71

The TRS Plan's fiduciary net position is determined using the economic resources measurement focus and accrual basis of accounting, which is the same basis used by the Retirement System. Benefits and refunds of contributions are recognized when due and payable in accordance with the terms of the TRS Plan. Investments are reported at fair value. Fair value is a market-based measurement, not an entity-specific measurement. The Retirement System utilizes one or more of the following valuation techniques in order to measure fa ir value: the market approach, the cost approach, and the income approach. More detailed information on the TRS Plan's investment policy, assets, and fiduciary net position may be obtained from TRS' fiscal 2016 Comprehensive Annual Financial Report.

At August 31, 2017, UH reported a liability of $139,600,108.07 for its proportionate share of the collective net pension liability. The collective net pension liability was measured as of August 31, 2016, and the total pension liability used to calculate th e net pension liability was determined by an actuarial valuation as of that date. UH's proportion at August 31, 2016 was 0.3647789 percent which was an increase from the 0.3634349 percent measured at the prior measurement date. UH's proportion of the collective net pension liabi lity was based on its

Internal Audit 03/08/18 50 of 62 44 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31 , 2017 contributions to the TRS Plan relative to the contributions of all the employers and non-employer contributing entity to the TRS Plan for the period September 1, 2016 through August 31 , 2017.

For the year ending August 31, 2017, UH recognized pension expense of $14,918,986.52. At August 31, 2017, UH reported deferred outflows of resources and deferred inflows of resources related to pensions from the following sources:

Deferred Deferred Outflows of Inflows of Resources Resources Difference between expected and actual experience $ 2,161 ,376 $ 4,115,958 Changes of assumptions 4,201,254 3,820,867 Net difference between projected and actual investment return 11,672,391 Change in proportion and contribution difference 315,351 8,666,930 Contributions subsequent to the measurement date 10,474,711 Total $ 28,825,083 $ 16,603,755

The $10,474,711 reported as deferred outflows of resources resulting from contributions subsequent to the measurement date will be recognized as a reduction in the net pension liability for the year ending August 31 , 2018.

Amounts reported as deferred outflows and inflows of resources related to pensions will be recognized in pension expense in the following years:

Year Ending August 31 , Amount 2018 $ (631,496) 2019 (631,496) 2020 6,813,724 2021 (1,203,432) 2022 (2,798,335) Thereafter 197,652

NOTE 10: Deferred Compensation (Administering Agencies Only)

State employees may elect to defer a portion of their earnings for income tax and investment purposes pursuant to authority granted in the Texas Government Code Annotated, Section 609.001. Two deferred compensation plans are available, which are administered by the Employees Retirement System. The assets of the plans do not belong to UH or the State. UH or the State has no liability related to this plan.

NOTE 11: Postemployment Health Care and Life Insurance Benefits

Provisions of this requirement apply only to University of Texas, Texas A&M University, Teacher Retirement System, and Employee Retirement System.

Internal Audit 03/08/18 45 51 of 62 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31, 2017

NOTE 12: lnterfund Activity and Transactions

UH experienced routine transfers with other state agencies that were consistent with the activities of the fund making the transfer. UH has no interfund activity to report.

NOTE 13: Continuance Subject to Review

The UH is not subject to the provisions of the Texas Sunset Act (the Act) (Chapter 325, Texas Government Code Annotated). The Act provides for the regular assessment of the continuing need for State agencies to exist. Certain agencies, such as institutions of higher education and courts, are not subject to the Act.

NOTE 14: Adjustments to Net Position

During fiscal year 2017, certain accounting changes or adjustments were made that required the restatement of fund balances or net position. The restatements are presented below:

Table 14.1 - Restatement of Net Position for FY2017 Net Position, 09/01/16 $ 1,297,779,424.48 Current Year Restatements (1,165,129.15) Net Position, 09/01 /16 Restated $ 1,296,614,295.33

Table 14.2 - Changes in Net Position for FY2016 Change in Net Position, 08/31/16 $ 56,438,192.57 Current Year Restatements (1,165,129.15) Change in Net Position, 08/31/16 Restated $ 55,273,063.42

A restatement of $(1, 165,129.15) is due to corrections related to asset valuation in the prior period.

NOTE 15: Contingencies and Commitments

Unpaid Claims and Lawsuits As mentioned in Note 5, various lawsuits and claims involving UH were pending. While the ultimate liability, if any, remains uncertain, management does not expect any possible adverse ruling to have a material effect on UH's financial position.

Federal Assistance UH has received several federal grants for specific purposes that are subject to review and audit by the grantor agencies. Such audits could lead to a request for reimbursements to grantor agencies for expenditures disallowed under the terms of the grant. Based on prior experience, management believes such disallowances, if any, will be immaterial.

Arbitrage Rebatable arbitrage is defined by Internal Revenue Code, Section 148, as earnings on investments purchased with the gross proceeds of a bond issue in excess of the amount that would have been earned if the investment were invested at a yield equal to the yield on the bond issue. The rebatable arbitrage must be paid to the federal government.

UH monitors its investments to restrict earnings to a yield less than the bond issue and, therefore, limit any arbitrage liability. UH estimates that rebatable arbitrage liability, if any, will be immaterial to its overall financial condition.

Privatized Student Housing Facilities Several student housing facility projects have been constructed by private external entities in order to enhance the residential life experience of students at various UH System campuses. The participating entities have

Internal Audit 03/08/18 52 of 62 46 Internal Audit 03/08/18 53 of 62 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31, 2017

NOTE 18: Management's Discussion and Analysis

See Management's Discussion and Analysis Section.

NOTE 19: The Financial Reporting Entity

See Financial Reporting Entity in Note 1.

NOTE 20: Stewardship, Compliance, and Accountability

These statements are prepared in compliance with the guidelines provided by the Texas Comptroller of Public Accounts. There were no material violations of fina nce related legal or contractual provisions, no deficit net position, no changes in accounting principles, and no changes in reporting of loans

NOTE 21: N/A

Note 21 is not applicable to the annual financial report reporting requirements process.

NOTE 22: Donor Restricted Endowments

-Expenditure of endowed funds is not permitted without the express consent of the donor. The majority of UH's endowments are held in perpetuity. In many cases, endowment earnings are expendable for student financia l assistance or other purposes as specified by the donor. In other cases, endowment earnings are reinvested.

The Board has established an endowment policy which attempts to balance the long-term objective of maintaining the purchasing power of the endowment with the goal of providing a reasonable, predictable, stable, and sustainable level of income to support current needs. Payout is derived from interest, dividends, and realized gains, net of portfolio management fees. The historical rate of payout has been 4 to 5 percent, with any change to this range to be approved by the Board.

The net appreciation (cumulative and unexpended) on donor-restricted endowments, presented below in Table 22.1, is available for authorization and expenditure by the UH .

Table 22.1 - Net Appreciation of Endowments

Amount of Net Donor-Restricted Appreciation/ Endowments {Depreciation) Reported in Net Positions True Endowments $ 95,118,541.62 Restricted Expendable Term Endowments 301,781.26 Restricted Expendable Total $ 95,420,322.88

(A fair market value increase of $21,754,411.15 was recognized for endowments at or above historical cost, and a fair market value increase of $5,604,562.27 was recognized for endowments below historical cost.)

Internal Audit 03/08/18 54 of 62 48 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31 , 2017

Variances from prior year-end for expendable and nonexpendable balances are shown in Table 22.2:

Table 22.2 - Changes from Prior Year Balances:

Endowment Funds I ncrease/(Decrease) Reason for Change

Expendable Balances True Endowments $29,806,939.46 Fair value increase in portfolio True Endowments $(14, 176,079.00) Spending distribution from Endowment Term Endowments $144,656.04 Fair value increase in portfolio Term Endowments $(70,201.00) Spending distribution from Endowment

Non-Expendable Balances True Endowments Term Endowments

NOTE 23: Extraordinary and Special Items

No items have been identified meeting the criteria of extraordinary or special items.

NOTE 24: Disaggregation of Receivable and Payable Balances

Balances of receivables and payables reported on the Statement of Net Position may be aggregations of different components. GASB Statement 38, Certain Financial Statement Note Disclosures, requires that the UH provide details in the notes to the financial statements when significant components have been obscured by aggregation. The Statement of Net Position is presented in the classified format and, therefore, the current and non-current portions of receivables and payables are separately disclosed.

Significant balances in various classifications of receivables and payables are disclosed below:

Gross Allowance Net Federal $ 6,404,206.71 $ $ 6,404,206.71 Accounts 24,439,181.18 906,448.58 23,532,732.60 Gifts 54,397,621.69 543,976.22 53,853,645.47 Other 2,171,593.21 2,171,593.21 $ 87,412,602.79 $ 1,450,424.80 $ 85,962,177.99

NOTE 25: Termination Benefits

UH has no material termination benefits at year-end.

NOTE 26: Segment Information

UH has no segment activity that requires separate disclosure in the notes to the financial statements.

NOTE 27: Service Concession Arrangements

As of August 31 , 2017, UH has no agreements that are qualified as service concession agreements.

Internal Audit 03/08/18 49 55 of 62 UNIVERSITY of HOUSTON Notes to Financial Statements For the year ended August 31, 2017

NOTE 28: Deferred Outflows of Resources and Deferred Inflows of Resources

In fiscal 2017, UH reported deferred outflows of resources and deferred inflows of resources in connection with the following activities:

Deferred Deferred As of Outflows of Inflows of August31,2017 Resources Resources

Loss/Gain on Bond Refunding $ 2,160,742.70 $ Pension Plans (Note 9) 28,825,082.77 16,603,755.34

Total $ 30,985,8252.47 $ 16,603,755.34

NOTE 29: Troubled Debt Restructuring

As of August 31, 2017, no debts have been identified that fall under the troubled debt restructuring GASB guidelines.

NOTE 30: Non-Exchange Financial Guarantees

As of August 31, 2017, UH has no non-exchange financial guarantees; therefore, there are no balances to be reported.

NOTE 31: Tax Abatements

As of August 31, 2017, UH has no tax abatement agreements entered into to reduce the reporting revenues nor agreements with other governments that reduce the tax revenues.

NOTE 32: Fund Balances

As of August 31, 2017, UH does not have any fund balance reporting of obligations or requirements as established by GASB, because the UH's fund balances are reported as proprietary funds and not governmental funds.

Internal Audit 03/08/18 50 56 of 62 REQUIRED SUPPLMENTARY INFORMATION

Internal Audit 03/08/18 57 of 62 51 (This page intentionally left blank.) Internal Audit 03/08/18 52 58 of 62 UNIVERSITY of HOUSTON Schedule of UH's Proportionate Share of the Net Pension Liability Teacher Retirement System of Texas Plan For the year ended August 31, 2017

2017 2016 2015

UH's Proportion of the Net Pension Liability (Asset) 0.3647789% 0.3607261% 0.4096612%

UH's Proportionate Share of the Net Pension Liability (Asset) $ 139,600,108.00 $ 127,511,844.00 $ 109,448,520.00

UH's Covered Payroll $ 148,621,253.00 $ 138,692,386.00 $ 150,1 58,436.87

UH's Proportionate Share of the Net Pension Liability (Asset) as a Percentage of its Covered Employee Payroll 92.75% 91.94% 72.89%

UH's Plan Fiduciary Net Position as a Percentage of the Total Pension Liability 78.00% 78.43% 83.25%

The data presented above is for UH's fiscal year which is one year after the Plan's measurement year.

This schedule is intended to present 10 years of information. Currently, only three years of information is available. Information for future years will be added when it becomes available.

Notes to Required Supplementary Information:

Changes in assumptions There were no changes in Assumptions of other inputs that affected measurement of the total net pension liability since the prior measurement period.

Changes in Benefits There were no changes in benefit terms that affected measurement of the total net pension liability since the prior measurement period.

Internal Audit 03/08/18 53 59 of 62 UNIVERSITY of HOUSTON Schedule of UH's Contributions Teacher Retirement System of Texas Plan For the year ended Au gust 31, 201 7

Contributions 2017 2016 2015 2014

Statutorily Required Contributions $ 10,474,711 .00 $ 9,590,588.00 $ 10,681,525.00 $ 10,386,052.00

Contributions in Relation to the Satutorily Required Contributions 10,474,711.00 9,590,588.00 10,681,252.00 10,386,052.00

Contribution Deficiency (Excess) $ 0.00 $ 0.00 $ 0.00 $ 0.00

UH's Covered Employee Payroll $ 136,035,208.00 $ 148,621,253.00 $ 138,692,386.00 $ 150,158,437.00

Contributions as a Percentage of Covered Employee Payroll 7.70% 7.75% 7.70% 6.92%

Internal Audit 03/08/18 54 60 of 62 Internal Audit 03/08/18 61 of 62 4800 Calhoun Rd. Houston, TX 77004

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