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Business Officer Magazine

Debt Rules

What’s a smart way to manage debt? Develop a policy that’s in sync with your institution’s strategic plan.

By Judy Van Gorden

Managing the Resource

Strategic management of debt is a proactive, year-round process that should be part of your college or university’s strategic financial plan. Your staff support requirements are determined by the debt financing plan, the size of the portfolio, and the complexity of the outstanding debt. The governing board needs to adopt a debt utilization policy that establishes the framework and guidelines for borrowing institutional debt under the guidance of qualified and prudent financial officers within the context of the institutional strategic plan. The policy should not resemble a strait jacket; it should be tailored to your college or university.

Decisions regarding access to debt for capital projects are made at the executive and governing board level in coordination with the strategic plan. Are there exceptions to this general rule? Yes. For instance, at a large institution, decisions about internal debt below certain dollar limits and for certain types of projects (such as lab equipment or renovation projects costing less than $1 million) may be delegated to streamline the process. At smaller institutions, this amount would be at a level aligned with delegated budgetary authority.

Most debt decisions are strategic because they represent the permanent allocation of substantial financial resources to repay the debt in the future. Because debt is a limited resource, the use of debt for one project may impede its availability for another, higher priority project. For these reasons, you can use debt most effectively when you budget and plan for it on a multiyear time frame in coordination with the strategic and capital plans. 

Another decision that occurs at the executive and governing board level relates to access to debt for working capital. Decision makers must review whether the debt is a permanent or short-term need, the source of funds for paying the cost of borrowing, and a plan for the length of time this support is needed.

Key Questions to Address

A strategic debt utilization policy sets principles and broad parameters to guide decision makers. Operational procedures for issuing and monitoring debt may be appended to the policy or may be stand-alone documents. The policy should answer the following questions:

For what purposes can chancellors, deans, and department heads use debt and in what amounts? From an institutional perspective, there are two sources of debt—internal and external. However, making this difference transparent to institutional borrowers both simplifies and elevates the management of the resource. The institutional commitment is to provide the lowest cost of financing available for the particular purpose. Projects and needs may be financed from internal resources as an alternative investment of the endowment or operating fund investments, or funds may be identified specifically for this purpose as part of the budgeting process.

Your policy should address how much is available for loan, how much interest is charged to the borrower, and what types of projects are financed with this source. In determining the amount of capital available for loan, consider how the decision will affect both the lending source and the borrower. Apply standard diversification principles for investment pools and the risk characteristics of the loans. Access to internal sources of debt is particularly desirable for working capital loans, for projects that don’t meet statutory requirements for external financing, and for projects that have private-use characteristics. The interest rate on internal loans may be set at the alternative investment rate if those dollars were otherwise invested or may be set at a lower rate if there are subsidies by a central budgetary unit.

External debt, available from both public and private markets for a full range of capital facilities and for working capital, is limited by state statutory constraints that apply to your institution. The amount of debt available is related to your institution’s evaluation of its debt capacity. Tax-exempt debt is available for qualified capital projects that are not considered private use.

What is your institution’s debt capacity at a particular rating level, how much debt is outstanding, and what mix of debt types and maturities is desired and permitted? The debt capacity is the amount of outstanding debt that your college or university wants to support as an institutional policy. When determining capacity, consider the rating level of outstanding debt and the desired rating level for future debt because the amount of debt could influence your bond rating levels.

Although the external capital markets will finance a wide range of needs, your institution should determine, as a policy matter, the types of projects for which it will use external debt. Will your institution borrow for equipment; land acquisition; and auxiliary, educational, and research facilities? Will it borrow for repair, replacement, and expansion or only for new facilities? Will it limit its borrowing to projects that provide an incremental revenue stream upon completion?

Will your institution access external debt for working capital? A working capital loan, or a bank line of credit, is desirable in two circumstances: when your institution needs assistance paying expenses on time because operating balances are low, thus avoiding high vendor late fees, or when your institution keeps cash invested at higher returns for longer periods and uses a line of credit to meet day-to-day obligations.

How much of a project cost may be financed, and what is the allowable repayment period? To reinforce the fact that debt is a limited resource, you may want to require partial funding of projects with cash resources at some established level. Some policies are inflexible on this point; others delegate authority to waive this requirement under certain identified circumstances.

What are the requirements for coverage of repayment sources for the borrowed funds and for matching to gift commitments and research revenues and recoveries? Gifts restricted to the same use as tax-exempt financing, upon receipt, must be used to reduce outstanding debt within the time frames defined by IRS regulations. Consult with your bond counsel to ensure that you’re meeting the requirements. Failure to comply may result in tax-exempt bonds becoming taxable.

Will research revenues and recoveries related to capital facilities be directed toward debt repayment? Decide how much, if any, of these resources will be used to repay debt obligations.

What level of coverage of debt from income is sufficient for your institution? Through financial feasibility studies, you can determine whether 100 percent coverage of debt from income is sufficient or whether you need to establish a higher hurdle (e.g., 125 percent) to provide a buffer as insurance for the payment.

The Multiple Steps of Borrowing

The process of borrowing debt from the capital markets takes three to six months to complete. As the responsible financial officer, you begin the planning process for debt issuance by providing a picture of the institution’s debt utilization profile after the issuance, the amount of the financing, the projects to be financed, and a general outline of the expected timetable. You can use this time to reinforce the debt management policy previously approved by the governing board.

To implement an effective debt issuance process, assemble the financing team, which might include you (as the responsible institutional financial officer), a financial adviser, bond counsel, university counsel, underwriters (if negotiated sales), and other appropriate persons. Ideally, the financing team will already be in place based on the results of an RFP or other authorized selection processes.

Beyond the financing team, you must ensure that people whose work will be influenced by the financing plans are aware of the plans. For instance, if the budget office needs to secure approvals from a state budget department, make sure the budget office knows your plans; if the controller’s office is responsible for the accounting of the transaction, make sure staff members know the timing for the transaction and have the information that they need to record and report it.

It helps to develop a calendar and schedule for the financing, including planning steps, all internal and external reviews and approval processes, and the rating process through closing date and investment of proceeds. As you develop the schedule, be realistic about how much time it will take for the various steps, realizing that some steps may occur simultaneously. 

Review the financial feasibility for each project and check that the appropriate officers have approved of each project’s priority and plan. If the project’s feasibility study is a stretch, develop a backup plan for paying debt service if revenue streams are delayed or do not materialize as predicted.

If using tax-exempt financing, review projects to ensure that they are qualified projects and to identify any private use issues. Review and resolve these issues with departments and bond counsel. IRS guidelines limit the proportion of a tax-exempt debt financing that may be used to finance private use facilities. If this proportion is exceeded, taxable instruments may be used for a portion of the project.

Other steps in the borrowing process include:

  • Bundling the projects to estimate total size of the debt financing.
  • Structuring the bond issue by making decisions regarding the technical aspects of the financing, such as fixed versus variable debt, use of swaps, debt maturities, reserve funds, repayment schedules, projected investment earnings, projected cost of issuance, and whether projects will be net or gross funded. 
  • Estimating the specific project repayment schedules. If debt is pooled, run scenarios to project the impact of the new financing on the pool and the pool’s interest rate. If debt is not pooled, then the individual project repayment schedules need to be coordinated with the pro-formas for the bond issue.
  • Preparing the preliminary official statement for the investment community.  
  • Preparing all legal documents associated with the financing, ensuring that they are reviewed for both legal and business points. Be alert to opportunities to streamline the debt issuance and debt monitoring processes.
  • Tracking issues raised and planned changes and requiring that they be addressed prior to the sale of the bonds. Agreements made as part of the transaction will last for the life of the debt—potentially 20 to 30 years or longer. Carefully consider all of the agreements in this context.
  • Preparing presentations for bond rating agencies. Ideally, you will already have established relationships with the representatives of the agencies, and they will be knowledgeable about your institution. They are an excellent resource for information about the capital markets and financing options, as well as the strategies and economics of higher education.
  • Developing plans for investing proceeds prior to drawdowns for project and program expenses.
  • Securing executive and governing board approvals for bond issuance. Explain the covenants that the institution is adopting by approving the resolution and the ramifications of violating these covenants.
  • Making presentations to bond rating agencies and requesting ratings.
  • Receiving bond ratings from rating agencies.
  • Marketing the bonds and considering the purchase of bond insurance. For a negotiated sale, discuss with your underwriter how the bonds will be allocated among the underwriters and plans to sell to institutional buyers versus retail buyers. For a public sale, the financial adviser presents the plans for the upcoming sale to underwriters who may bid on the bonds. The decision on bond insurance can be incorporated into the bidding process.
  • Selling the bonds.
  • Closing the deal, signing documents, making deposits, and investing the proceeds, as appropriate.
  • Reviewing covenants, monitoring requirements for new debt, and integrating them into the overall monitoring process.

What actions will you take if a project fails to meet its financial feasibility plan? A backup plan for making debt service payments is a good idea for risky or tight financial feasibility plans.  

Does your institution use a commercial paper program to provide interim financing for project expenses? A commercial paper program provides low-cost, tax-exempt or taxable, renewable, interim financing for project expenses; reduces negative arbitrage because the borrowing is at the lower cost end of the yield curve; keeps working capital invested; and delays the finalization of permanent financing. After your institution reaches the established limit of the program, commercial paper funding can be taken out or replaced with cash or with permanent financing. After this occurs, the commercial paper program limit is again available to support interim project expenses.

Under what conditions may outstanding debt be refinanced, for what may savings be used, and when may the savings be taken? Some colleges and universities establish a target savings rate that must be achieved to pursue a refinancing. This can be limiting because they may some day want to refinance for reasons other than savings, such as to modify the debt or repayment structures. If there are financial savings, you may take the savings upfront, spread over the life of the financing, or at the end of the repayment period to reduce the average life of the financing. If you want to ration capital, using savings to reduce the average life of the financing will accelerate the availability of capital for other high-priority projects. 

What costs will a project be charged when it uses debt resources? For example, is a project apportioned a share of the issuance and interest costs of the specific bond issue that financed the project, or is institutional debt pooled and all projects charged an average rate representative of all bond issues? The latter approach protects departments from volatile swings in interest rates and extends the benefits and risks of lower-cost, variable-rate debt to the entire debt portfolio.

Will your institution use financial derivative products, such as swaps, in its debt financing strategies? If so, you will need a policy that provides guidelines for the use of financial derivative products to achieve debt-financing goals. It’s important to understand the terms, conditions, and implications of these products under various economic scenarios before you purchase them.

Does your institution have any preferences or requirements for selection of negotiated deals or public sale deals, for selection of a financing team, for funding a debt service reserve, and for investment of proceeds? Colleges and universities have several choices when they go to market for capital. They may negotiate deals with a selected underwriter or group of underwriters, with or without an independent financial adviser. Institutions with higher credit ratings may sell bonds at public auction with the assistance of an independent financial adviser; in this situation, the underwriter is the successful bidder on the bonds.

Bond counsel services may be provided internally or externally. If you use external counsel, initiate a request for proposal or another process that meets your procurement rules. Consider the bond counsel a year-round resource as well as an active member of the financing team.

A debt service reserve, if desired, may be funded either with cash or debt or replaced with a surety bond. Replacing the reserve with a surety bond preserves debt capacity for project uses. The average life of the proceeds is one to one and a half years, depending on the project-spending schedule. Consider different investment vehicles to maximize the return on this investment at the permissible risk level. Investment vehicles such as guaranteed investment contracts can be tailored to the project draw schedule, improving investment earnings and increasing the certainty of the amount of investment earnings for planning purposes.

What are the monitoring requirements? Charge an officer with responsibility for meeting the specific covenants and reporting requirements of bond resolutions. 

Plan Debt Financing

An adjunct to the multiyear capital and budget plans, the debt financing plan identifies the programs and projects that will be financed with capital (either internal or external), when the funds will be needed, and the source and term of repayment for the borrowed capital plus interest. For instance, capital projects or programs that are implemented in advance of receipt of donor gifts and financed with borrowed capital are included in the plan. In these cases, it’s particularly important to match up the repayment of the borrowed capital with sources of funds, since the timing of the receipt of the donor’s gift may be uncertain and the gift may not be available to be used for interest payments.

The result of a debt financing plan is a cash-flow projection that identifies the projects and programs to be financed, the timing of the borrowed capital needs to support project and program expenses, the cost of the interest for the financing, and the timing of the repayment plans. This projection allows your institution to make debt allocation decisions strategically rather than one project at a time. It also lets you plan the timing of debt issuances in advance, giving you the opportunity to bundle debt issuances instead of borrowing funds for individual projects one at a time.

Monitoring Outstanding Debt

To monitor outstanding debt, adopt a systematic process to ensure that the covenants in various bond issues are reviewed periodically and reports are made as required. Institutions with effective monitoring processes incorporate a review in the annual budgeting process to ensure that departments are budgeting to fully meet their annual debt service obligations. Making these payments with automatic transfers from the departments puts these plans into effect.

You will also want to develop and implement a process for reviewing changes in uses of facilities that change private use. Too much private use of a tax-exempt financed facility violates bond covenants and can result in bonds becoming taxable. Consult with bond counsel on these issues.

Review periodically any revenue pledges provided from operations of specific facilities or the pledge of property to ensure that these resources are intact and uncompromised. Advise constituents of the process for releasing pledged revenue streams and properties. To identify opportunities to refinance at lower costs, monitor borrowing rates and call dates for debt.

Reports identified by the bond covenants and the Securities and Exchange Commission’s Rule 15c2-12 must be made in accordance with agreed-upon timetables and in specified formats to the required parties.

Educate Constituent Groups

Your institution’s constituents are familiar with personal debt from their home mortgages, student loans, and car loans. Unfortunately, many may want to avoid institutional debt, fearing that it will drain resource allocations from other priorities, such as faculty salaries and benefit increases.

  • Strategic Financial Analysis for Higher Education, Sixth Edition (NACUBO, 2005), available at
  • NACUBO’s debt financing and management Web page:

You face the task of educating your governing board and executive staff about institutional debt. Explain the bond rating process, share the rating agency reports, and provide a context for the information. Remind them that they approved the strategic debt utilization policy, review key components such as debt capacity, and update them on plans to issue debt in the future.

Provide many opportunities for faculty and staff to learn about the debt portfolio and the institutional priority of maintaining debt at a manageable level and paying the debt back. To strengthen your message, make sure that your budget officer, auditor, controller, and their staffs understand how debt can be an effective resource to help achieve strategic goals.

Upon completion of a bond issue, report the results to your institutional constituents. Use this as an opportunity to reinforce the existing policies that govern the use of debt. Provide periodic reports on debt capacity utilization and the debt portfolio and the important projects that have been financed with this resource.

Debt’s Many Returns

Debt can help institutions achieve their strategic plans. Debt provides financial resources for investment to improve or expand capital facilities that retain and attract revenue sources, allows your institution to pay for a new or improved facility over its life rather than upfront, and has a low cost of capital relative to quasi-endowment.  Its use can preserve and protect return-generating liquid and illiquid assets and generate new fund balances. With careful analysis, you can determine when debt is the right answer for your institution. 

JUDY VAN GORDEN, treasurer and chief investment officer emerita, Regents and System of the University of Colorado, Boulder, provides financial consulting services to higher education institutions.