Managing Risk Around Capital Structure, Liquidity, and Mission

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2011 Treasury Symposium

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Managing Risk Around Capital Structure, Liquidity, and Mission

  1. 1. Managing Risk Around Capital Structure, Liquidity and Mission Martha Bradley, Washington University in St. Louis Jim Matteo, University of Virginia Charlie Giffin, J.P. Morgan
  2. 2. Today’s panel www.treasuryinstitute.org www.treasuryinstitute.org Charlie Giffin Executive Director Head of Public Finance Debt Capital Markets J.P. Morgan Jim Matteo Assistant Vice President for Treasury Operations and Fiscal Planning University of Virginia Martha Bradley Assistant Treasurer Washington University in St. Louis
  3. 3. Agenda <ul><li>Developing a Comprehensive Risk Framework </li></ul><ul><li>Overview of Risk Approach for WashU and UVA </li></ul><ul><li>Today’s Big Issues: Liquidity and Debt Structure </li></ul><ul><li>Recent Risk Management Actions & Data Analysis </li></ul><ul><li>Summary Observations </li></ul><ul><li>Appendix: Industry risk study results </li></ul>www.treasuryinstitute.org
  4. 4. Managing risk in the new environment <ul><li>Many institutions learned some tough lessons from the financial crisis </li></ul><ul><li>Several key risk factors came to light: </li></ul><ul><ul><li>Institutional exposure to fall in asset prices </li></ul></ul><ul><ul><li>Reliance on endowment for operating costs </li></ul></ul><ul><ul><li>Liquidity exposures in capital structure and investment activity </li></ul></ul><ul><ul><li>Swap MTM exposure in falling rate environment </li></ul></ul><ul><ul><li>Relationship of financial risks to implementation of the strategic plan </li></ul></ul>www.treasuryinstitute.org
  5. 5. The risk management process is fairly established <ul><li>Identify key risk areas </li></ul><ul><ul><li>Seek input across the institution </li></ul></ul><ul><li>Quantify risks where possible </li></ul><ul><ul><li>Identify which risks could be considered “normal” vs. risks that are non-normal (“event risks”) </li></ul></ul><ul><ul><li>Do appropriate stress testing </li></ul></ul><ul><li>Determine appropriate risk tolerance </li></ul><ul><ul><li>Seek input across the institution </li></ul></ul><ul><li>Build the concept of Financial Enterprise Risk Management </li></ul>www.treasuryinstitute.org
  6. 6. Building an enterprise-wide framework (flows) www.treasuryinstitute.org Endowment Treasury Operations Capital / Commitments Other Support <ul><li>Maximize long-term return </li></ul><ul><li>Make annual distributions </li></ul><ul><li>State revenues </li></ul><ul><li>Federal grants, other </li></ul><ul><li>Net tuition & fees </li></ul><ul><li>Auxiliary net revenues </li></ul><ul><li>Building, acquisition </li></ul><ul><li>Institutional commitments </li></ul>Debt <ul><ul><li>Expected periodic fund flows </li></ul></ul><ul><li>Funding </li></ul><ul><li>Debt service </li></ul>
  7. 7. Building an enterprise-wide framework (risks) www.treasuryinstitute.org Endowment Treasury Operations Capital / Commitments Other Support <ul><li>Potential payment holiday </li></ul><ul><li>Potential cuts </li></ul><ul><li>Shift in demand statistics </li></ul><ul><li>Unforeseen expenditures </li></ul><ul><li>Reduction in expenditures </li></ul>Debt <ul><ul><li>Potential Disruptions / Recourses </li></ul></ul><ul><li>Access to capital risk </li></ul><ul><li>Taxable borrowing capacity </li></ul><ul><li>Bank risk </li></ul>
  8. 8. Determining exposure to certain risk factors <ul><li>Investments </li></ul><ul><ul><li>Domestic equities, international equities, domestic fixed income, international fixed income, treasuries, short-term rates </li></ul></ul><ul><li>Debt </li></ul><ul><ul><li>Short-term interest rates, long-term interest rates, bank support </li></ul></ul><ul><li>Operating environment </li></ul><ul><ul><li>Student demand, net tuition & fees </li></ul></ul><ul><li>Other </li></ul><ul><ul><li>Inflation, construction costs, bank credit support, state/federal support, student loans, annual giving </li></ul></ul>www.treasuryinstitute.org Endowment Treasury Operations Capital / Commitments Other Support Debt
  9. 9. Summary of key overall risk topics <ul><li>Investment performance continues to drive overall risk exposures </li></ul><ul><ul><li>Which is more important: risk in net assets or risk in the annual budget? </li></ul></ul><ul><li>Risk is highly inter-related across the institution between investments, funding and operations, requiring an integrated management approach </li></ul><ul><li>Liquidity is the key metric of risk between these different exposures and should be actively managed </li></ul><ul><li>Rigorous stress testing must become a more routine part of risk management – assumptions will always be wrong in some way </li></ul>www.treasuryinstitute.org
  10. 10. Integrated risks require integrated management <ul><li>Risks across the institution are increasingly inter-related, though management is sometimes de-centralized </li></ul><ul><ul><li>Endowment, Investments, Treasury, Debt, Strategy, Advancement, Admissions </li></ul></ul><ul><li>Many schools have bridged these divides through new management structures </li></ul><ul><ul><li>Coordination of investment, financing, strategy at the board/committee level </li></ul></ul><ul><ul><li>Elevation of risk officers and Enterprise Risk Management professionals </li></ul></ul><ul><ul><li>Management committees across multiple disciplines </li></ul></ul>www.treasuryinstitute.org
  11. 11. Agenda <ul><li>Developing a Comprehensive Risk Framework </li></ul><ul><li>Overview of Risk Approach for WashU and UVA </li></ul><ul><li>Today’s Big Issues: Liquidity and Debt Structure </li></ul><ul><li>Recent Risk Management Actions & Data Analysis </li></ul><ul><li>Summary Observations </li></ul><ul><li>Appendix: Industry risk study results </li></ul>www.treasuryinstitute.org
  12. 12. WashU overview <ul><li>Key stats (as of June 30,2010) </li></ul>www.treasuryinstitute.org www.treasuryinstitute.org Number of Students Approx. 12,300 Investments $ 5.525 billion Debt Outstanding $1.254 billion Debt Structure 22% Variable / 78% Fixed Swaps $90.5 million SIFMA variable to fixed $9.98 million LIBOR variable to fixed Endowment distribution % of operations: 11% Liquidity 35% - 40%, one-month Credit Rating Moody’s – Aaa , S&P – AAA Academic Ranking (US News 2011 Rankings) Undergraduate 13 th School of Medicine 4 th
  13. 13. WashU overview <ul><li>Risk governance structure – Board of Trustees Committees </li></ul><ul><li>University Finance Committee </li></ul><ul><ul><ul><li>Reviews and approves the broadest range of financial matters including budgets, debt, liquidity, insurance, and tuition rates </li></ul></ul></ul><ul><li>Asset Management Committee </li></ul><ul><ul><ul><li>Reviews endowment return estimates and approves payout projections </li></ul></ul></ul><ul><ul><ul><li>Reviews investments of operating funds </li></ul></ul></ul><ul><li>Audit Committee </li></ul><ul><ul><ul><li>Reviews broad range of compliance matters in addition to financial audit; Chief compliance officer reports to this committee </li></ul></ul></ul><ul><li>WU Investments Management Committee – Separate from BOT </li></ul><ul><ul><ul><li>Oversees all matters related to endowment performance </li></ul></ul></ul><ul><li>Executive Committee </li></ul><ul><ul><ul><li>Final approval on financial matters </li></ul></ul></ul><ul><li>Chief Financial Officer responsible for financial risk oversight through these Committees </li></ul>www.treasuryinstitute.org www.treasuryinstitute.org
  14. 14. UVa overview <ul><li>Key stats (as of June 30,2010) </li></ul>www.treasuryinstitute.org www.treasuryinstitute.org Number of Students Approx. 21,000 Investments (excl. foundations) Approx. $3.6 billion Debt Outstanding $992 million Debt Structure 14% Variable / 86% Fixed Swaps $100 million SIFMA fixed payer Endowment distribution % of operations: 6% Liquidity 212.8 annual days cash on hand (FYE 2009) Credit Rating Moody’s – Aaa , S&P – AAA, Fitch - AAA Academic Ranking (US News 2011 Rankings) Undergraduate - Overall 25th (tied) Undergraduate – Publics 2 nd
  15. 15. UVa overview <ul><li>Risk governance structure </li></ul><ul><li>University Finance Committee </li></ul><ul><ul><ul><li>responsible in all matters relating to the University's financial affairs and business operations </li></ul></ul></ul><ul><li>Audit & Compliance Committee </li></ul><ul><ul><ul><li>responsible for all matters relating to financial accounting and reporting and has direct access to internal and external auditors to assess their performance, the scope of audit activities and the adequacy of the system of internal accounting controls </li></ul></ul></ul><ul><li>UVIMCO Board of Directors </li></ul><ul><ul><ul><li>Oversees all matters related to endowment performance </li></ul></ul></ul><ul><li>ERM Initiative </li></ul><ul><ul><ul><li>Lead by CFO </li></ul></ul></ul><ul><ul><ul><li>Currently being reviewed with new President for assignment of Strategic, Operational, and Compliance risks. </li></ul></ul></ul>www.treasuryinstitute.org www.treasuryinstitute.org
  16. 16. Agenda <ul><li>Developing a Comprehensive Risk Framework </li></ul><ul><li>Overview of Risk Approach for WashU and UVA </li></ul><ul><li>Today’s Big Issues: Liquidity and Debt Structure </li></ul><ul><li>Recent Risk Management Actions & Data Analysis </li></ul><ul><li>Summary Observations </li></ul><ul><li>Appendix: Industry risk study results </li></ul>www.treasuryinstitute.org
  17. 17. Big issue #1: Sizing liquidity <ul><li>What is the “optimal level of liquidity” </li></ul><ul><ul><li>Difficult to answer because of the number of different factors involved </li></ul></ul><ul><ul><li>What are the different potential uses of liquidity? </li></ul></ul><ul><ul><li>What are the potential sources of liquidity and how likely is it that the institution will have access to different sources of liquidity? </li></ul></ul><ul><li>Developing a liquidity framework </li></ul><ul><ul><li>Distinguish between committed sources of liquidity (cash) and uncommitted sources of liquidity (CP draws, bank lines) </li></ul></ul><ul><ul><li>Establish liquidity needs in “normal” environments and in a variety of stressed environments </li></ul></ul>www.treasuryinstitute.org “ Liquidity is like the air in this room, you don’t really notice it until its gone”
  18. 18. Segmenting optimal cash balances The above chart is shown for illustrative purposes only. Considerations Segment optimal cash balance by liquidity needs Operating Cash (Horizon-Daily) Strategic Cash (Horizon—Longer-term) Reserve Cash (Horizon—Daily / Monthly) 70 40 60 90 0 10 20 30 50 80 Operating <ul><li>Forecasted excess balances for a particular near-term or cyclical purpose </li></ul>Reserve Strategic Restricted Cash (Horizon—Longer-term) Restricted 4 S   T   R   A   T   E   G   I   C     L   I   Q   U   I   D   I   T   Y     M   A   N   A   G   E   M   E   N   T <ul><li>Funds daily operating needs which may be subject to unforeseen volatility </li></ul><ul><li>Held in restricted account or as collateral for certain credit agreements </li></ul><ul><li>No short-term forecasted use; investment horizon usually one year or longer </li></ul>
  19. 19. WashU - Developing a Liquidity Framework <ul><li>Committed sources </li></ul><ul><ul><ul><li>Cash (same day availability), </li></ul></ul></ul><ul><ul><ul><li>Short term investments (2 day-2 week availability) </li></ul></ul></ul><ul><ul><ul><li>Committed lines of credit </li></ul></ul></ul><ul><li>  </li></ul><ul><li>Established liquidity needs in a “normal” environment </li></ul><ul><ul><ul><li>Operating swings: $100 million drawn or excess in any given day over course of 1 month </li></ul></ul></ul><ul><ul><ul><li>Policy to keep no less than $50 million immediately available cash </li></ul></ul></ul><ul><li>Stressed liquidity with potential worst case scenarios </li></ul>www.treasuryinstitute.org www.treasuryinstitute.org
  20. 20. UVa - Developing a Liquidity Framework <ul><li>Current Approach </li></ul><ul><ul><li>Determine liquidity needs by: </li></ul></ul><ul><ul><ul><li>Identifying cash flow cycle troughs </li></ul></ul></ul><ul><ul><ul><li>Identifying max consecutive day needs </li></ul></ul></ul><ul><ul><ul><li>Rating agency reviews </li></ul></ul></ul><ul><ul><ul><li>Holding enough buffer to be comfortable </li></ul></ul></ul><ul><li>Developing Approach </li></ul><ul><ul><li>Identifying risk profile (sources, uses, drivers) </li></ul></ul><ul><ul><li>Identifying risk tolerance </li></ul></ul><ul><ul><li>Consolidate Modeling efforts </li></ul></ul><ul><ul><li>Stress test scenarios </li></ul></ul><ul><ul><li>Determine a cost of liquidity </li></ul></ul>www.treasuryinstitute.org www.treasuryinstitute.org
  21. 21. Big issue #1: Sizing liquidity www.treasuryinstitute.org Sources Uses ($MM) Normal Stress Environment 1 Week 6 Months 12 Months 1 Week 6 Months 12 Months Liquidity Sources Tier 1 Cash 200 200 200 200 200 198 Tier 2 Cash 100 100 100 100 99 98 Treasury Investments 200 200 200 190 188 184 Total Committed Liquidity 500 500 500 490 487 480 Uncommitted Sources Endowment Distribution/Loan 250 250 250 - - - Bank SBPA 300 300 300 300 300 300 Bank Operating Lines 500 500 500 475 375 200 Debt Capacity (CP or Bonds) 250 250 250 - 200 150 Total Liquidity Sources 1,800 1,800 1,800 1,265 1,362 1,130 Liquidity Uses Uncommitted Funding (VRDBs, etc.) 300 300 300 300 300 300 Endowment Payout Holiday - - - - 350 350 Operational Contingency 50 300 500 100 500 500 University Commitments 50 200 250 50 200 250 Total Liquidity Uses 400 800 1,050 450 1,350 1,400 Committed Liquidity Ratio 1.25 0.63 0.48 1.09 0.36 0.34 Uncommitted Liquidity Ratio 4.50 2.25 1.71 2.81 1.01 0.81
  22. 22. Big issue #2: Debt structure <ul><li>Understand the relationship between capital structure and liquidity </li></ul><ul><ul><li>Short-term funding and rolling debt has an effect on liquidity </li></ul></ul><ul><ul><li>Liquidity related to investment activity should relate to the choice of debt structure (fixed vs. floating, committed vs. uncommitted) </li></ul></ul><ul><li>The “right” amount of uncommitted funding relates to excess liquidity </li></ul><ul><ul><li>Choices of interest rate mix are a second order decision that can be managed with certain derivative solutions where warranted </li></ul></ul>www.treasuryinstitute.org
  23. 23. Agenda <ul><li>Developing a Comprehensive Risk Framework </li></ul><ul><li>Overview of Risk Approach for WashU and UVA </li></ul><ul><li>Today’s Big Issues: Liquidity and Debt Structure </li></ul><ul><li>Recent Risk Management Actions & Data Analysis </li></ul><ul><li>Summary Observations </li></ul><ul><li>Appendix: Industry risk study results </li></ul>www.treasuryinstitute.org
  24. 24. WashU key management risk factors & recent actions <ul><li>Management Risk Factors </li></ul><ul><ul><ul><li>Debt policy is conservative – no changes required after financial crisis </li></ul></ul></ul><ul><ul><ul><li>Endowment asset allocation – little change </li></ul></ul></ul><ul><li>Recent Actions </li></ul><ul><ul><ul><li>Bi-weekly meetings with endowment director of risk management </li></ul></ul></ul><ul><ul><ul><li>More frequent monitoring on financial health of banks, insurers and other counterparties </li></ul></ul></ul><ul><ul><ul><li>Increased committed operating lines of credit </li></ul></ul></ul><ul><ul><ul><li>Reviewed overall asset allocation of operating funds </li></ul></ul></ul><ul><ul><ul><li>Diversified SBPA providers; moved from 364-day to multi-year facilities </li></ul></ul></ul><ul><li>Other Actions </li></ul><ul><ul><ul><li>Developed crisis management team </li></ul></ul></ul><ul><ul><ul><li>Committee formed to review how the University handles Enterprise Risk Management </li></ul></ul></ul>www.treasuryinstitute.org www.treasuryinstitute.org
  25. 25. WashU risk dashboard www.treasuryinstitute.org * Private institutions, definitions summarized in the appendix. Source: Moody’s Municipal Financial Ratio Analysis & J.P. Morgan, additional information available upon request. $5,039 $4,953 Total Cash and Investments Metric WashU Peer Avg* Ratings Aaa/AAA Aaa-A3 Net Assets ($mm) $5,680 $5,221 Total Volatility ($mm) $427 $474 Total Volatility (%) 7.52% 8.14% 95% Worst Net Assets ($mm) $4,843 $4,292 Operating Margin Volatility (%) 0.57% 2.03% Investment Portfolio Volatility (%) 8.50% 8.38% Operating Revenue from Investments (%) 15.0% 20.3% Balance Sheet Leverage 1.33 1.58 Annual Liquidity to Total Volatility 5.12 4.89 Annual Liquidity to Operating Risk 6.76 6.12 Annual Liquidity to Puttable Debt 6.28 4.50
  26. 26. UVa key management risk factors & recent actions <ul><li>Risk Factors </li></ul><ul><ul><li>Risks assessed in a vacuum </li></ul></ul><ul><ul><ul><li>Cash flow, liquidity, debt capacity, debt ratios, ERM scenarios </li></ul></ul></ul><ul><ul><ul><li>Inputs are unique to each analysis </li></ul></ul></ul><ul><li>Recent Actions </li></ul><ul><ul><li>Exploring a financial model to create a data warehouse. </li></ul></ul><ul><ul><li>Model would be used to change variables and financial statement impact </li></ul></ul><ul><ul><li>Data could be used for risk analysis and measurement </li></ul></ul>www.treasuryinstitute.org
  27. 27. UVa risk dashboard www.treasuryinstitute.org * Public institutions, definitions summarized in the appendix. Source: Moody’s Municipal Financial Ratio Analysis & J.P. Morgan, additional information available upon request. $3,569 $3,569 Total Cash and Investments Metric UVA Peer Avg* Ratings Aaa/AAA Aaa-Aa3 Net Assets ($mm) $4,803 $5,535 Total Volatility ($mm) $396 $442 Total Volatility (%) 8.24% 5.98% 95% Worst Net Assets ($mm) $4,027 $4,668 Operating Margin Volatility (%) 0.52% 1.53% Investment Portfolio Volatility (%) 7.78% 6.38% Operating Revenue from Investments (%) 9.20% 5.33% Balance Sheet Leverage 1.31 1.66 Annual Liquidity to Total Volatility 2.91 7.67 Annual Liquidity to Operating Risk 5.27 6.76 Annual Liquidity to Puttable Debt 7.20 5.63
  28. 28. UVa Central Bank risk profile www.treasuryinstitute.org Summary Pro Forma Risk Exposure Map 1
  29. 29. Agenda <ul><li>Developing a Comprehensive Risk Framework </li></ul><ul><li>Overview of Risk Approach for WashU and UVA </li></ul><ul><li>Today’s Big Issues: Liquidity and Debt Structure </li></ul><ul><li>Recent Risk Management Actions & Data Analysis </li></ul><ul><li>Summary Observations </li></ul><ul><li>Appendix: Industry risk study results </li></ul>www.treasuryinstitute.org
  30. 30. WashU beyond the numbers <ul><li>What keeps you up at night? </li></ul><ul><ul><ul><li>What have we failed to recognize as a risk? </li></ul></ul></ul><ul><ul><ul><li>Concern that we are too conservative </li></ul></ul></ul><ul><li>What makes you sleep well? </li></ul><ul><ul><ul><li>Knowing that we are conservative </li></ul></ul></ul>www.treasuryinstitute.org www.treasuryinstitute.org
  31. 31. UVa beyond the numbers <ul><li>What keeps you up at night? </li></ul><ul><ul><li>Collateral risks </li></ul></ul><ul><ul><li>The lack of good risk management data tools </li></ul></ul><ul><ul><li>Missed opportunities </li></ul></ul><ul><li>What makes you sleep well? </li></ul><ul><ul><li>Conservative nature of University </li></ul></ul><ul><ul><li>Internal and external vetting of position </li></ul></ul>www.treasuryinstitute.org
  32. 32. We welcome your questions www.treasuryinstitute.org www.treasuryinstitute.org
  33. 33. Agenda <ul><li>Developing a Comprehensive Risk Framework </li></ul><ul><li>Overview of Risk Approach for WashU and UVA </li></ul><ul><li>Today’s Big Issues: Liquidity and Debt Structure </li></ul><ul><li>Recent Risk Management Actions & Data Analysis </li></ul><ul><li>Summary Observations </li></ul><ul><li>Appendix: Industry risk study results </li></ul>www.treasuryinstitute.org
  34. 34. Study Results www.treasuryinstitute.org Source: Moody’s Municipal Financial Ratio Analysis & J.P. Morgan, additional information available upon request.
  35. 35. Study Institutions www.treasuryinstitute.org Quinnipiac University Rensselaer Polytechnic Institute Rice University Smith College Stanford University Tufts University University of Chicago University of Pennsylvania University of Richmond Vanderbilt University Vassar College Wake Forest University Washington University Williams College Yale University Private Institutions: American University Amherst College Boston University Brandeis University Brown University College of the Holy Cross Columbia University Cornell University Dartmouth College Duke University Emory University George Washington University Georgetown University Harvard University Johns Hopkins University Lehigh University Massachusetts Institute of Technology New York University Princeton University Public Institutions: California State University Indiana University Michigan State University The Ohio State University Pennsylvania State University Purdue University Rutgers Texas A&M System University of Arizona University of California University of Michigan University of Minnesota University of Missouri System University of North Carolina at Chapel Hill University of Pittsburgh University of Texas System University of Virginia University of Washington West Virginia University
  36. 36. Key Definitions <ul><li>Volatility is a key measure of annual risk that is approximated with a standard deviation </li></ul><ul><li>Net Asset Total Volatility (%) = Annual Enterprise Dollar Volatility ($) / Net Assets ($) </li></ul><ul><li>Operating Margin Volatility (%) = Calculated volatility over past 5 years from Moody’s </li></ul><ul><li>Balance Sheet Leverage = Total Assets / Net Assets </li></ul><ul><li>“ Total” Leverage = (Total Assets + Pension Assets + Swap Notional) / Net Assets </li></ul><ul><li>Annual Liquidity to Total Volatility = Moody’s Annual Liquidity / Calculated total Enterprise Volatility </li></ul><ul><li>Annual Liquidity to Operating Risk = Moody’s Annual Liquidity / (Operating Margin Volatility ($) + Operating Revenue from Investments ($)) </li></ul><ul><li>Annual Liquidity to Puttable Debt = Moody’s Annual Liquidity / Puttable Debt </li></ul><ul><ul><li>Puttable debt: Debt subject to short-term refinancing risk, including VRDBs, CP, etc. </li></ul></ul><ul><li>Expendable Resources to Operations = Moody’s Expendable Resources / Total Operations </li></ul><ul><li>Expendable Resources to Debt = Moody’s Expendable Resources / Total Debt </li></ul><ul><li>Debt Service to Operations = Peak Debt Service / Total Operations </li></ul>www.treasuryinstitute.org

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