Page 1

2009 NACUBO Higher Education Accounting Forum

Debt Management and Liquidity Concurrent Session

April 2009

Page 2

• History of Debt

• A Brief Recap of 2008

• Heightened Awareness

• Liquidity is Key

• Integrated Debt Management

• What Should We Do Now

• UVa Example

• Budget

• Furman Central Bank Discussion

• Conclusions

Table of Contents

Page 3

A History of Debt

• Neither a borrower nor a lender be…

• If we have to have it, pay it off as quickly as possible.

• Variable debt seems cheap.

• Swaps seem cheap.

• Debt is a perpetual component of the balance sheet.

• Debt for capital and operating purposes.

• Wait—we were supposed to be investing in bonds?

• Future – What is the “right” role of leverage.

Page 4

A Brief Recap of 2008

• Virtually all borrowers impacted

• Auction rate market implodes

• Bank liquidity dries up

• Swap collateralization and mark-to-market

• Bond insurance all but gone

• Investors look past ratings

• Lehman was A-rated—what do ratings mean?

• Spotty market access and widening spreads

• Debt office has been increasingly busy

• Difficult to focus on strategy/long-term given upheavals in the markets.

• Declining budgets, more time and responsibilities.

• Next shoe dropped…then another…how many shoes are there?

• Revisit Debt Policy

• Hope on the horizon—significant new opportunities from Washington (e.g., Build America Bonds, new “Bank Qualified” limits, and changes to Alternative Minimum Tax.

SIFMA Rates VS Auction Rates

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

5/31/06 2/8/07 10/20/07 6/30/08 3/11/09

SIFMA Auction Rate 7-Day Index

SIFMA Index

Equity Market Indices

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

5/31/2006 12/17/2006 7/5/2007 1/21/2008 8/8/2008 2/24/2009

S&P 500

Dow Jones

Page 5

Heightened Awareness

• Senior officers increasingly interested in debt portfolio

• Pro: Greater focus on debt portfolio

• Con: greater focus on debt portfolio.

• Less time, more updates.

• Governing board more involved

• Increased reporting requirements.

• Elevated sensitivity to risk.

• Broader assessment of risk.

• Perspective from other industries (e.g., Finance, Government) that may be more affected by the current crisis.

• Long-term, increased understanding and focus on risk is beneficial—in the short term, lots of work with limited options.

Page 6

Liquidity Is Key

“The market can stay irrational longer than you can stay solvent”

- John Maynard Keynes

• In the past (i.e., before 2008) growing desire to have “cashless” University (i.e., liquidity is too expensive), investment in longer-term illiquid assets.

• Liquidity – A free lunch turned into an overpriced meal.

• How do we manage this – liquidity at all costs?

• Balances with cost of capital

• When will the situation change? How do we manage?

• Impact of liquidity different for each institution, but the effect is the same:

• Most revenue sources under pressure

• Uncertainty regarding projections

• Swap collateralization requirements

• Variable rate bond support

• Increased desire for cash balances (“what if scenarios”)

• State funding

• Capital calls/endowment asset allocation

• Stresses on cash flow (gift receipts, tuition collections)

• But if effect is similar is the response the same? No.

Page 7

Liquidity (Cont.)

• Methods to Address Liquidity

• First, understand liquidity needs (different than accounting, cash basis has not been paramount)

• Tail wagging dog: liquidity driving debt decisions instead of policy

• For some, the need is not as significant. Need to educate Board and have the data

• Increase cash internally

• Identify the time period – 1 year, 5 year, 10 year (I hope not!)

• Restructure debt portfolio/reduce exposure

• Issue taxable debt

• Internal—not external (i.e., rating agency)—guidelines are best place to start

• What is the risk that a higher education institution will encounter severe stress?

• What is the impact on the rest of the market?

Page 8

Integrated Debt Management

• No side of the balance sheet is an island.

• Need to coordinate with Treasury, Endowment, Budget offices/committees.

• Need comprehensive risk, liquidity, cash assessment.

• Improved lines of communication – team solutions.

• Multidisciplinary approach of the management side.

• Leads to more creativity, solutions--improved institutional results.

Page 9

What Should We Do Now?

• Continue taking a long-term view (that has always been higher education’s strength). There will be a bright future with opportunities.

• Perform integrated modeling and determine worst-case (real worst case scenarios). Does the institution have the risk tolerance? Are risks being evaluated and priced appropriately?

• Ensure that management can articulate realistic contingency plans.

• Educate senior staff and the Board of risks in the portfolio – especially risks that were not apparent in the past.

• Minimize surprises.

• Develop a Plan B (and Plan C!) for contingencies.

• Don’t assume access to capital is guaranteed.

• Review the debt portfolio to ensure it remains appropriate given potential revision to institution risk assessment.

• Model range of budget impacts.

• Keep everyone informed, reach out to colleagues.

• Closely monitor student demand and financial aid statistics.

• Build flexibility into operating expenditures.

• Review and update (if necessary debt policy).

• Institution credit review.

Page 10

What Should We Do Know (cont.)?

• Maintain close watch on liquidity.

• Limit/diversify exposure to third parties (banks/credit providers)

• Keep everyone informed.

• Look for strategic opportunities:

• Increase in bank qualified debt limit from $10 million to $30 million.

• Repeal of alternative minimum tax for new private-activity bonds.

• Authorization for financial institutions to purchase more municipal bonds.

• Build America Bond program.• Other stimulus funds available to educational

institutions (e.g. funds for projects aimed at energy efficiency).

• Architects, contractors, subcontractors, engineers – willing to discount services substantially.

• Faculty and senior pools are particularly strong for those institutions still able to hire.

Page 11

UVa Example

• Liquidity and Debt Outlook for 2009

• Overall Plan – Proactive with regard to business risks

• Liquidity Risk Mitigation

– Pre-fund capital expenditures

– Increase amount and quality of liquid holdings

– Internal Bank providing internal liquidity

– Develop or update cash forecast

• Capital Markets Risk Mitigation

– Issuing bonds on earlier than needed timeline

– Taking advantage of ARRA through BAB’s

• Credit Risk Mitigation

– Underwriters

– Investment firms

– Commercial banking

Page 12

Budget

• Provide various debt cost assumptions, including contingencies depending on risks in the portfolio

• Outline a plan to address potential increased costs

• Especially important given other budgetary pressures

• Blended rate/ central budgeting can be helpful

• Common at large diversified research institution

• Can be useful at smaller, centralized schools

• Board involvement – focus on portfolio, not transactions• Develops a more predictable cost of funds/ reduces variance (I would have said like

endowment payout, but not anymore)• Avoids knee jerk reaction to problems – which usually results in suboptimal long-term

decisions• Furman Example

Page 13

Furman Central Bank Discussion

• Highlights of Furman's Debt Policy

• Delineates specific responsibilities of the Board of Trustees and staff.

• Specifies key ratios to be used to ensure that debt remains within acceptable levels.

• Promulgates ranges for fixed and variable rate debt and derivatives.

• Outlines the Central Bank concept.

• Central Bank at Furman

• Insulates operating budget from shifts in short term rates.

• Current blended rate is the higher of the trailing 25 years or 12 months SIFMA average.

• Investment of central bank proceeds is key.

Page 14

Conclusions

• Leverage is a tool—and it’s becoming better understood.

• Liquidity isn’t free—and when it’s expensive, it’s very expensive.

• Debt—and its risks—should be addressed institutionally.

• Blended rate and central budgeting can mitigate many of the current problems.

• Plan for expected results, but be prepared to experience stress cases.