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All Debt on Deck

The lingering recession and an ebb-and-flow market continue to influence college and university debt policies—including shifting to future users the burden of paying for capital facilities. An industry expert and several chief business officers explain the benefits of an overall capital plan to keep finances afloat.

By Apryl Motley

*Board limits curb the use of funds held in reserves. Donors often restrict their contributions for specified purposes. And sometimes there simply isn't enough money up front to begin a project.

These are some of the most common reasons higher education leaders are looking for a little leverage to help them meet strategic goals and objectives, without totally disrupting their balance sheets.

"It's analogous to buying a home," says Lorrie A. DuPont, managing director at RBC Capital Markets' higher education finance group. "Issuing debt becomes a mechanism for borrowing money and paying it back over time. Institutions may not have immediate access to the entire amount needed for the project."

The financial crisis in 2008 drove some of the major borrowing trends in higher education, notes DuPont. Since that time, she says, "issuers have become more conservative in what they do. Previously people were willing to take more risk in the market."

Generally accepted ranges for investment grade-rated institutions are 3 to 5 percent for large public universities and 5 to 7 percent for smaller private institutions.

"Debt has always been part of the equation," says Bob Shea, NACUBO's senior fellow, finance and campus management, "but some institutions have reached their debt capacity."

So how much debt is too much? In DuPont's experience, rating agencies consider institutions highly leveraged when 10 percent or more of their operating budgets is going toward debt service. Generally accepted ranges for investment grade-rated institutions are 3 to 5 percent for large public universities and 5 to 7 percent for smaller private institutions.

Consequently, a key component of debt management policies and institutional capital plans is determining what percentage of an institution's operating budget will be allocated to debt service. "The majority of institutions have some sort of capital plan or debt policy," DuPont says. "Larger institutions tend to have more detailed policies based on having various constituencies. For smaller institutions, there may not be a need for policies that are as comprehensive."

However, regardless of an institution's size, DuPont says when it comes to developing debt management plans, "it all starts with the chief business officer."

Raising Revenue for Renovations

"We only borrow to renovate or build," says Jeff Amburgey, vice president for finance at Berea College, Berea, Kentucky. During Amburgey's 20-year tenure at the small private college, the focus has been on doing more of the former than the latter. "Many of our buildings on campus have been renovated," he says. "Our first new major building in 20 years-a green, energy-efficient residence hall-opened at the end of August."

To help finance the renovations, Berea has borrowed funds, with a total of $58.7 million in debt (all at fixed rates) issued as of June 2013. The college has some public debt, but recently has opted for private placements through banks, which Amburgey says "has provided very competitive rates and has kept the issuance costs low, since the amounts of the bond issues have been relatively small."

Given the college's revenue model, which is composed of endowment spendable returns, annual fund gifts, and government grants-but no tuition dollars-debt management has been an integral part of its overall fiscal strategy. "We serve only academically promising students from low-income families with average annual household incomes of approximately $26,000," says Amburgey, "and all students at Berea receive a four-year full-tuition scholarship. The spendable return from the endowment, valued at approximately $1.1 billion, funds 73 percent of the unrestricted educational and general operating budget."

As a result, the number of students enrolled at Berea is limited to 1,600. In addition, since Berea is one of seven designated federal work-study colleges, all students are required to work 10 to 15 hours per week on campus during all four years in which they are enrolled.

Amburgey acknowledges that this is a "financial model that can be drastically impacted by external factors beyond our control. When the financial markets declined in 2008 and 2009, the college actively responded by making adjustments to its operating budget."

Rainy day planning. The college was able to weather the financial storm of 2008 because of careful planning during better fiscal times. "In the 1990s, when there were significant returns in the market, we could have increased staff and other resources, but we knew a larger budget would be difficult to sustain," recalls Amburgey.

"While there are certain risks with assuming debt, we have often determined that there are also significant institutional risks in not pursuing certain projects that require borrowing."

Carl Balsam, North Park University

"Instead we limited growth in our operating budget internally by establishing two reserve funds to serve as a stabilization factor and a mechanism to help us absorb the shocks of the market," he explains. Because the college has followed a policy since 1920 of placing all unrestricted bequests in quasi-endowment, it has flexibility with the use of a significant portion of the endowment spendable return.

The two reserve funds are:

  • Capital and plant fund. These dollars are used to service debt on academic buildings, finance major renovations, or build new facilities. During the current fiscal year, $5.2 million of endowment spendable return will go into the fund. The college knows it must maintain its bricks and mortar to carry out its mission.
  • Temporary capital and emergency reserve fund (TCERF). Since the college is so heavily dependent on endowment spendable return, TCERF was established as an operating budget reserve. A portion of the annual endowment income flowing into TCERF can be reallocated back into the operating budget in periods of market decline. "It also serves as a secondary source of capital," says Amburgey. "This fiscal year, $5.4 million in endowment spendable return will go into this fund."

Conservative governance. Amburgey describes the college's board as "cautious when issuing debt." In general, board members carefully monitor the institution's debt service reserve ratio and the amount of endowment income going into the capital and plant fund that is committed to servicing debt.

While the college does have a formal debt policy, Amburgey describes it as "more of a guideline with parameters within it." The board's overarching philosophy toward use of debt is a conservative one. "The board fully understands the benefits of debt and has mechanisms in place to ensure that the college will be operating within certain parameters," Amburgey says. "Berea has an Aaa debt rating from Moody's [as of April 2013], and the board wants to make sure the college maintains that rating. Since we're so heavily dependent on financial markets, the board does not want the college to have to make reductions in budgets for people and programs in order to make debt service payments."

Sustaining With Less State Support

"As is true for many public universities, the political and economic landscape in our state has changed," says Mary Peloquin-Dodd, associate vice chancellor for finance and business and university treasurer, since May 2012, at North Carolina State University (NC State), Raleigh. "Historically, the state has paid for academic facilities, and the university has issued debt for self-liquidating projects. However, like other public universities, we face a less-certain future with respect to state funding of academic facilities."

A large public research-intensive university, NC State has traditionally relied on three major sources of revenue: state appropriations being the largest, followed by tuition and sponsored research. Today, Peloquin-Dodd describes the institution's financial model as "a three-legged stool that needs to be supported by gifts, endowments, and sales and services."

Debt offsets. To date, all debt the university has issued has been self-liquidating, supported by some identified revenue stream to satisfy the debt. "We've always identified a revenue stream that more than fulfilled the need," Peloquin-Dodd says.

For example, when a locker room on campus was renovated to provide more student recreational space, student fees supported payment of the debt service. Similarly, a student fee supported pay-
ment of debt issued to construct a new $150 million student union facility. Peloquin-Dodd believes that the almost-nonexistent student objections to varied additional fees correlate to NC State's reputation for inexpensive tuition. "Even with the increase in student fees, our total bill is still less than that of comparable peers."

Dual decisions. This approach is illustrative of the two guiding principles that Peloquin-Dodd thinks about most in her work in the university's business office:

If a project is funded by gifts, pledges are expected to be raised to support 100 percent of the cost, with 50 percent in cash in hand.

  • A revenue-funded project should cover debt service by 1.25 times.
  • As specified in the university's debt management guidelines, "a project that has a related revenue stream [self-liquidating project] will receive priority consideration."

The guidelines also place limits on the length of debt service: "The useful life of the capital project financed will be taken into consideration when determining the length of financing. No capital project will be financed for more than 120 percent of its useful life."

"We want to comfortably pay debt service and build reserves," Peloquin-Dodd explains.

She describes NC State overall as having a "moderate risk tolerance" and doesn't foresee that position changing "unless something significant happens."

"Historically, our debt load has not been high. The goal is to keep total debt service at 4 percent of operating expenses or less," she says. "However, it's the UNC Board of Governors that issues debt. We'll have to see what we receive in terms of state funding. There was a big bond issue in 2000 that paid for facilities up until 2010. Now we'll have to look even more closely at how-and whether-to proceed and on what terms. It's a challenge that public universities have been facing."

Positioning on the Perimeter

"We're benefiting tremendously from the variable-rate demand bond that we have," says Carl Balsam, executive vice president and chief financial officer for North Park University in Chicago. "Who knew that interest rates would be so low and stay low?"

Of the university's total outstanding debt, 65 percent is floating, and the remaining 35 percent is fixed. An urban, multicultural, and Christian institution, "NPU has selected a debt structure that allows it to allocate its resources in the most efficient fashion to create optimal institutional benefit," Balsam says. "This has meant borrowing at attractive rates-principally at tax-exempt variable rates-and retaining the project campaign proceeds in an investment account to support institutional strategic needs."

Funding strategy. The university's debt structure has been focused primarily on mortgage and tax-exempt borrowing. Balsam describes the latter as "the strategic acquisition of property" near the campus that's mainly used for student housing and parking. NPU's more than 900 residential students are fairly evenly divided between campus residence halls and perimeter apartments. According to Balsam, the apartments are popular with students, who are willing to pay a small annual upcharge of $500 to reside there.

NPU's tax-exempt borrowing has been to fund significant campus physical improvements, such as new buildings. "These are always supported by capital campaigns, for which our goals are to fund 100 percent of project costs, if possible," Balsam explains. "The borrowing allows us to construct the facility in a timely fashion, while we wait for the cash flow of donor pledges to be fulfilled-usually within 3 to 7 years."

Balsam describes NPU's overall debt structure as "opportunistic." The university has worked with an independent financial consultant since 1998 to make the best decisions for the university at the right times. "He will get all of the parameters and set up models, so we can do 'what-if' scenarios," Balsam says. "It is a rigorous and detailed analysis."

Policy priorities. This approach is in line with the NPU board's standing policy for debt management: Broad language essentially (1) acknowledges the role of debt in capital projects that enhance the physical assets of the campus, and (2) eschews debt as a means of managing operations or funding deficits. "The policy rationale is to rely on good judgment after careful analysis of debt needs, rather than predefining any specific debt limits or parameters," says Balsam.

Certainly, NPU's debt management policy reflects the main thrust of its strategic plan entitled "NPU@125+." The university will celebrate its 125th anniversary in FY16-17, and, among its other key components, the plan anticipates growth in traditional undergraduate enrollment from its fall 2013 level of 1,925.

Focus on increased enrollment is critical to the university's ongoing fiscal health.

Like many small colleges and universities, North Park is tuition- and student fee-dependent, a condition that seems to be growing. The percentage of student-generated revenue increased from 88 percent of total annual revenue in 2007-08 to 90 percent of total annual revenue in 2012-13. "Therefore, our business model is, of necessity, focused on increasing enrollment to sustain financial viability," Balsam says.

This reality influences Balsam's perspective on borrowing: "While there are certain risks with assuming debt, we have often determined that there are also significant institutional risks in not pursuing certain projects that require borrowing," he notes. "We might, for example, escape or avoid the debt risk but then lose students, because we cannot provide the necessary facilities to sustain quality programs. It is a delicate balance that we strive to achieve."

APRYL MOTLEY, Columbia, Maryland, covers higher education business issues for Business Officer.

Fixed-Rate Financing for Now

While colleges and universities certainly have options when it comes to issuing debt, since the financial crisis, most seem to be opting for fixed-rate financing. "Interest rates have been historically low," says Lorrie A. DuPont, managing director at RBC Capital Markets' higher education finance group, "and the trend in higher education is toward long-term, fixed-rate financing. It helps institutions to cope with any volatility they may be experiencing on the operations side."

That's not to say that institutions won't opt for flexible rates. "If you have a small private college or university that doesn't have a public rating, that institution might go to a commercial bank and get a loan with flexible rates," DuPont says. "Depending on their circumstances, institutions may tap different markets to achieve their financial objectives."

In addition, there's less interest in using derivative products than there was five years ago. "Following the financial crisis, higher education boards were more interested in having their institutions take on only fixed-rate debt, moving forward," DuPont says. "The reactions depended on the specific institution, but the overall trend is toward a more-conservative profile."

Jeff Amburgey, vice president for finance at Berea College, Berea, Kentucky, notes that while the college's debt management policy allows for issuing both variable- and fixed-rate debt, "we have all fixed-rate at this time. We had two variable-rate issues outstanding, but we swapped them to fixed-rate," he continues. "Since we can borrow more cheaply this way, these days we're almost always leaning toward fixed-rate issues."

At North Park University, Chicago, Carl Balsam, executive vice president and chief financial officer, says the university's most recent financing was in October 2012 for a $30 million fixed-rate, direct purchase bond. The capital funding was used to refinance some outstanding mortgage debt and support construction of a new science and community life facility. "A fixed-rate direct purchase bond has been added more recently, because of attractive low rates and the opportunity to diversify our debt among fixed and floating structures," Balsam says.

"As we look ahead and assess some of the factors influencing future credit enhancement agreements, we will look carefully at our structure to determine if more fixed-rate instruments are prudent," he explains. "We have, however, been well served by recent years of low floating rates."

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