Presentation from 2013 NACUBO in Indianapolis with a focus on risk management. Co-presented with Thomas Richards (University of Missouri System) and Sherry Mondou (University of Puget Sound). My slides are pp3-12.
Q3 2024 Earnings Conference Call and Webcast Slides
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Active Debt Management for Two Institutions
1. Active Management of the
Debt Portfolio
Remy Hathaway, Prager & Co., LLC
Sherry Mondou, University of Puget Sound
Thomas Richards, University of Missouri System
2. Prager & Co. LLC, Financial Advisor to two Very Different
Institutions
University of Missouri University of Puget Sound
3. Policy, Strategy and Implementation
ī§ Comprehensive policy covering debt, derivatives and
liquidity
ī§ Shortâso people will read it
ī§ Establishes risk framework, then optimizes cost
ī§ Ongoing communication strategy at enterprise level
ī§ Financing strategy driven by (in order)
ī§ 1. Mission
ī§ 2. Existing portfolio and institutional risk
ī§ 3. Transactional economics
ī§ Evaluation of outcomesâincluding extreme ones
4. Strategy â Risk-First Framework
ī§ Most debt policies use phrase ârisk-adjusted cost of capitalâ or
ârisk toleranceâ but do not quantify it
ī§ Starting with riskâespecially tail eventsâallows the
institution to elect where and how much risk is acceptable
ī§ Taking into account other institutional risks (e.g. market
rate risk and tax risk)
ī§ Compensation for risk must be considered. Is it worth it,
and where else might we be better compensated for risk?
6. Risk Assessment - Categorization
ī§ Debt Service Risk: âHow much different could debt service be
from whatâs in the budget?â
ī§ Market Rate Risk
ī§ Credit Risk
ī§ Tax Risk (and Basis Risk)
ī§ Liquidity Repricing Risk
ī§ Counterparty
Performance Risk
ī§ Liquidity Risk: âHow much of the balance sheet is exposed to
the debt portfolio?
ī§ Reissuance/Remarketing Risk
ī§ Liquidity Facility Renewal/Failure Risk
ī§ Swap Collateralization Risk
ī§ Swap Termination Risk
7. One More Risk â Brain Damage Risk
ī§ How much management and staff time is dedicated to
managing the debt portfolio?
ī§ Issuance/refundings
ī§ Renegotiation of liquidity facilities
ī§ Managing puts/liquidity events
ī§ How much board/regent/trustee time is spent?
ī§ Is there an appropriate return on invested time? On future
expected demands on time?
8. Debt Service Risk â From Complex to Basic
Max
Rate Ratio Change Impact % of O.E.
Market Rate Risk
195 Tax-Exempt Variable-Rate 0.11% 2.9% 5.6
75 Taxable Variable-Rate 0.40% 4.6% 3.4
-165 LIBOR Fixed Payer Receipt 0.15% 67% 3.1% -5.1
LIBOR Fixed Receiver Payment
SIFMA Fixed Payer Receipt
SIFMA Fixed Receiver Payment
Basis Swap Payment
Basis Swap Receipt
4.0 0.6%
Tax Risk
195 Tax-Exempt Variable-Rate 1.7% 3.3
SIFMA Fixed Payer Receipt
SIFMA Fixed Receiver Payment
Basis Swap Payment
Basis Swap Receipt
BABs Subsidy
3.3 0.5%
Credit Risk
195 Tax-Exempt Variable Rate 0.11% 4.0% 7.8
75 Taxable Variable Rate 0.40% 7.0% 5.3
13.1 2.1% $ Millions % of O.E.
Liquidity Repricing Risk Maximum One-Year Risk: 15.1 2.4%
100 Liquidity Facility 2.0% 2.0 0.3% 50% of Maximum 11.2 1.8%
25% of Maximum 5.6 0.9%
Counterparty Performance Risk
-165 Swap Notional 0.0 0.0%
0%
1%
2%
3%
Market Rate
Risk
Tax Risk
Credit Risk
Liquidity
Repricing Risk
Counterparty
Performance
Risk
Max Debt Service Risk Components
(as percentage of 1 Year Operating Expenses)
9. Measuring Risk in Context
$ Millions % of O.E.
Maximum One-Year Risk: 4.6 4.6%
50% of Maximum 2.3 2.3%
25% of Maximum 1.2 1.1%
0%
1%
2%
3%
4%
Market Rate Risk
Tax Risk
Credit Risk
Liquidity
Repricing Risk
Counterparty
Performance
Risk
Max Interest Rate Risk Components
(as percentage of 1 Year Operating Expenses)
$ Millions % of E.R.
75.2 49.5%
50.1 33.0%
37.5 24.7%25% of Maximum
Maximum Three-Year Risk:
50% of Maximum
0%
10%
20%
30%
40%
Reissuance Risk
Facility Renewal
Risk
Collateralization
Risk
Swap Termination
Risk
Max Liquidity Risk Components
(as percentage of Expendable Resources)
10. Example: Collateralization/Termination Exposure
ī§ How useful are historical results?
(70%)
(60%)
(50%)
(40%)
(30%)
(20%)
(10%)
0%
10%
1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013
Backward-Looking Maximum Percentage Declines in 10-Year Treasury
From One-Year Prior
From Three Years Prior
5/30/84-8/21/86:
51% decline within
three years
4/17/85-4/16/86:
38% decline within
one year
Source: Federal Reserve
11. Projecting Short-Term Rates using Fed Funds
(Fed Funds History + Projections = Potential Outcomes)
30Y Low:4.51%
Average: 5.21%
30Y High: 7.53%
0%
5%
10%
15%
20%
1954
1959
1964
1969
1974
1979
1984
1989
1994
1999
2004
2009
Source: Federal Reserve
0%
1%
2%
3%
4%
5%
6%
7%
12/31/2012
12/31/2013
12/31/2014
12/31/2015
12/31/2016
12/31/2017
12/31/2018
12/31/2019
12/31/2020
12/31/2021
12/31/2022
12/31/2023
12/31/2024
12/31/2025
12/31/2026
12/31/2027
Fed Funds Expected Rate Range
(6/19/2013 Release)
Most hawkish governor up
to highest 30-year average
Median governor up
to 60-year average
Most dovish governor
up to lowest long-term
target rate.
12. âIt is better to be vaguely right than exactly
wrong.â
-Carveth Read
13. The Experience of Two Very Different Institutions,
one largeâĻ
ī§ University of Missouri
System
ī§ Public research university with 4
campuses + health system
ī§ Enrollment 75,000
ī§ Endowment $1 billion
ī§ $2.7 billion operating expenses
ī§ $1.3 billion debt outstanding
ī§ Aa1 / AA+
ī§ Treasurer and Interim VP
Finance
14. Policy / Governance â University of Missouri
ī§ Recently adopted comprehensive policy for debt and
derivatives management
ī§ Outlines authority, responsibilities and reporting
ī§ Board approves any issuance of debt
ī§ Board receives quarterly comprehensive reporting on portfolio
ī§ Board receives annual evaluation of debt capacity, given anticipated
debt-financed projects within a five year timeframe
ī§ Establishes framework for evaluating risks in debt
portfolio as well as any new issuance of debt
ī§ Board receives annual debt portfolio risk assessment
ī§ Policy does not define specific limits, giving maximum
flexibility to management team and Board.
15. Strategic Restructuring â University of Missouri
ī§ Recently launched $350 million commercial paper program
capable of issuing either taxable or tax exempt paper.
ī§ CP provides particular flexibility during construction phase of
capital projects, allowing for low cost âjust-in-timeâ financing
with ability to convert to permanent financing at any time.
ī§ CP program was structured in a manner that minimizes our
need to provide daily self-liquidity by establishing a $100
million cap on CP maturing within any seven day time period.
ī§ Even with $350 million in CP outstanding, daily liquidity
requirement remains $100 million due to the cap.
16. Strategic Restructuring â University of Missouri
ī§ Prior to CP Program
ī§ $100 million weekly reset VRDBs
ī§ $120 million daily reset VRDBs
ī§ $220 million daily self-liquidity requirement
ī§ Post CP Program Launch
ī§ $100 million weekly reset VRDBs remain outstanding
ī§ $120 million daily reset VRDBs converted to CP
ī§ $60 million new CP issued
ī§ $200 million daily self-liquidity requirement
ī§ Total variable rate debt increased from $220 million to $280
million, yet daily self-liquidity requirement decreased from
$220 million to $200 million
17. Strategic Restructuring â University of Missouri
ī§ By reducing our daily self-liquidity requirement and
essentially capping it at $200 million, we can better optimize
the investment of our working capital to generate additional
return.
ī§ Opportunity cost of holding daily self-liquidity could easily be
100-300bps when compared to other alternatives.
ī§ Our General Pool (essentially working capital) averages $1.7
billion throughout the year. Optimization of risk-adjusted
returns is a top priority as investment income helps fund
operations.
18. The Experience of Two Very Different Institutions,
one smallâĻ
ī§ University of Puget
Sound, Tacoma, WA
ī§ National residential liberal
arts college
ī§ Enrollment 2650
ī§ Operating budget $120
million
ī§ Endowment $275 million
ī§ $75 million debt outstanding
ī§ A1/A+ rating
ī§ VP Finance & Administration
with broad portfolio
19. Policy / Governance â University of Puget Sound
ī§ First adopted debt policy in 2005; now refined annually
ī§ Provides general framework
ī§ Based in mission and strategic goals, with the long term in mind
ī§ Debt is a valuable and scarce resource
ī§ Consider affordability, risks, financial structure
ī§ Monitor capital markets, refunding and other opportunities
ī§ No specific limits, allows flexibility
ī§ Clarifies responsibilities
ī§ Board approves issuance of debt, committee approves terms
ī§ Management, with expert counsel, monitors market and risk, makes
recommendations, negotiates terms, interfaces with external parties
ī§ Board receives annual review of debt portfolio risk
20. Goals of 2012 Transaction â University of Puget Sound
ī§ Improve student success
through strong residential
programming
ī§ Policy change, programs,
bed capacity
ī§ Manage debt portfolio risks
ī§ Within context of broad
institutional risks
ī§ Decrease debt portfolio
risk
ī§ Retain debt capacity at
A1/A+ rating
21. Risk Assessment and Strategic Restructuring â
University of Puget Sound
ī§ Comprehensive assessment of risk profile
ī§ A year in advance of anticipated debt financing
ī§ Changing market conditions
ī§ Changes in boardâs risk tolerance or risk allocation?
ī§ Strategic residential objective, upcoming debt financing
ī§ Prager & Co. as financial advisor served as an extension of
university staff
ī§ Assessment of financial condition, risks, credit and debt capacity, peer
analysis, structures, etc
ī§ Quantitative analysis of options
22. Risk Assessment and Strategic Restructuring â
University of Puget Sound
ī§ The portfolio before the transaction:
ī§ $60 million VRDNs, all synthetically fixed, structured in
different rate environment, still low cost of capital,
performed well to date
ī§ $10 mil, 3.6% all-in, self-liquidity, Soc-Gen long-term swap
ī§ $50 mil ($20 + $30), 4.3% all-in, bank LOC, BoNY long-term swap
ī§ Board not as comfortable with debt risks as they once
were
ī§ Swap counterparty performance
ī§ Mismatch between 67% LIBOR and SIFMA
ī§ Failed remarketing, deterioration of LOC provider credit
ī§ Liquidity (LOC) renewal/repricing risk in 2012
23. Risk Assessment and Strategic Restructuring â
University of Puget Sound
ī§ Should we issue traditional fixed rate on new money for
residence hall?
ī§ Should we convert all or some of VRDNs to fixed rate?
ī§ How would we handle outstanding swaps?
ī§ What would be the budget impact?
ī§ Should we consider a direct bank purchase vs. new LOC
provider for all or some of our variable rate debt?
25. Risk Assessment and Strategic Restructuring â
University of Puget Sound
The Transaction
ī§ Issued new debt at fixed rate for residence hall
ī§ Refunded 30% of VRDNs and converted to fixed rate, retained
orphan swap with intent to terminate when conditions are
favorable
ī§ Refunded 50% of VRDNs through a 7-year direct purchase
transaction, retained swap
ī§ Retained 20% of VRDNs with self-liquidity, retained swap,
may terminate swap in future
26. Risk Assessment and Strategic Restructuring â
University of Puget Sound
ī§ End result
ī§ 47% traditional fixed
ī§ 40% variable rate direct bank purchase, synthetically fixed
ī§ 13% VRDN with self liquidity, synthetically fixed
ī§ Reduced interest rate risk and liquidity risk
ī§ Expected WACC of 4.79% and within Boardâs risk comfort
ī§ Level debt service affordable in budget, with new money
structured to accommodate temporary orphaned swap
27. Ongoing Monitoring and Reporting
ī§ Puget Sound assesses debt portfolio review annually,
including risk trend
28. Additional Considerations (at Issuance and Beyond)
ī§ Taxable vs Tax-Exempt
ī§ Cost differential
ī§ Reporting requirements
ī§ Value/cost of par call for tax-exempt debt
ī§ Term
ī§ Direct purchase: renewal risk at put date
ī§ Matched to project life
ī§ Longer to allow recycling/internal bank structures
ī§ Issuance Timing
ī§ Interest rate outlook
ī§ Negative arbitrage in refundings
ī§ Hedging efficacy/outcomes
29. Conclusions
ī§ Clear policy should drive debt portfolio decisions
ī§ Portfolio risks and outcomes must be monitored on an
ongoing basis
ī§ Quantitative frameworks should be established for budget
and balance sheet outcomes
ī§ Current and pro forma debt portfolio
30. Resources
ī§ University of Missouri System Debt Policy
ī§ http://www.umsystem.edu/ums/fa/treasurer/debt_policy
ī§ University of Missouri System Quarterly Debt Report
ī§ http://www.umsystem.edu/ums/fa/treasurer/debt_snapshot_reports
ī§ Federal Reserve Historical Data
ī§ http://www.federalreserve.gov/releases/h15/data.htm
ī§ Federal Reserve Interest Rate Projections
ī§ http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm
(Click on âPDFâ under Projections Materials)
31. Appendix â Why Fed Funds?
ī§ Quarterly average SIFMA rates (and LIBOR rates) correlate
very well with Fed Funds, but with more history.
y = 63.23%x + 0.37%
R² = 94.82%
0%
1%
2%
3%
4%
5%
6%
7%
8%
0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
SIFMA
Fed Funds (Effective, 3-Day Lag)
Least Squares Regression (Quarterly Average, n=88)
Source: Federal Reserve, SIFMA
32. Appendix â Why the 10-Year Treasury?
ī§ Good correlation with LIBOR Swap RatesâĻnot so much MMD,
but even MMD is generally reasonable, and thereâs more
history.
y = 1.0505x + 0.0073
R² = 0.9632
y = 0.4935x + 0.0254
R² = 0.6619
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0%
10-Year Treasury Rate
Interest Rate Correlations with 10-Year Treasury (1998-Present)
100% of 30 Yr LIBOR Swap Curve
30 Yr Tax-Exempt Fixed Rate
Linear (100% of 30 Yr LIBOR Swap Curve)
Linear (30 Yr Tax-Exempt Fixed Rate)
Source: Federal Reserve, Thompson, Bloomberg