2012 Treasury Symposium

1. Internal Banking all Grown Up
Susan Fitzgerald (Prager & Co.)
James Matteo (University of Virginia)
Chris Malins (University of Washington)
January 2012

2. INTERNAL BANKS
Akin to academic medical centers:
“You see one internal bank, you’ve seen one internal bank”
Agenda:
• Definition/History
• Components/Issues
• Survey of internal banks
• Lessons learned
• Case Study: University of Virginia
• Case Study: University of Washington
2

3. WHAT IS THE INTERNAL BANK?
Definition – The adoption of one or more banking practices such as cash management, investment
management, and debt management to (1) facilitate the flow of resources from external sources to
internal uses and/or (2) create unrestricted resources.
General objectives for the Internal Bank:
 Centrally manage financial resources
 Loans
 Investments
 Cash balances
 Create predictability in capital costs (and working capital returns) for budgeting and planning
 Generate funds that can be used for a variety of purposes
 Optimize capital financing sources to ensure attractive long-term risk adjusted cost of capital to
overall enterprise
 Provide a vehicle for working capital/liquidity management
Numerous institution-specific considerations involved in establishing and managing the Internal
Bank.
 Objectives for the Internal Bank must be determined by the Treasury or the Board
 Policy and procedures for management of the Bank must be established
3

4. EVOLUTION OF THE CENTRAL BANK
Merging of
Project Debt and
Specific Liquidity
Borrowing Management
Central Bank Increasingly
for Debt Sophisticated
Management Management
and Oversight
4

5. KEY DECISION POINTS
• Objectives for funds
• Recycling to limit external debt
• Redeployment for strategic initiatives
• Equity in campus facilities
• Components:
• Debt
• Working Capital
• Other Investments
• Operations:
• Funding the bank
• Establishing and adjusting the blended rate
• Establishing and adjusting the payout rate
• Rules for internal loans
• Investment of funds
• Ongoing monitoring and management
• Reporting:
• Internal
• Financial statements
• Governance: Board involvement?
5

6. CASH MANAGEMENT/INVESTMENTS
Discussion Questions
• What are the investment considerations
for Internal Bank funds?
Project Funds/Internal Loans
• Duration
• Liquidity
Capital Sources
Debt Service
• How will the Internal Bank reserves be
Internal Bank viewed by member institutions?
• Will operating working capital and
internal bank cash be co-mingled?
Endowment Working Capital Internal Bank Cash
Cash Management / Investing
6

7. PROJECT FUNDS/INTERNAL LOANS
Discussion Questions
• What is the process/procedures for
internal loan origination? What approvals
Project Funds/Internal Loans
are necessary?
Project 1 Project 2 Project 3
• What is the structure of internal loans? Is
there a uniform methodology?
• Principal and interest frequency?
Capital Sources
Debt Service
• How are items like capitalized interest and
Internal Bank
costs structured?
• What is the rate charged to internal loans?
• Pass-thru rate? If equity funded, what is
cost of capital assumption?
Cash Management / Investing
• Single/blended rate? If so, what is the
setting methodology/calculation? How
often is rate analyzed? How/when was rate
adopted? How often has rate been reset?
Are there loans included in the bank but
excluded from blended rate?
7

8. REPORTING AND MANAGING
Simple Excel spreadsheet can monitor and model
• Outflows: Debt Service and other Expenses
• Inflows: Payments under internal loans
• Reinvestment earnings
• Ending balance
• Sensitivity to changes in blended rate charged to internal loan or changes in
assumptions of reinvestment earnings
Outflows Inflows
Beginning Reinvestment Ending
Fiscal Year Balance External DS Expenses Internal DS Earnings Balance PV @ 3.85%
2011 - (910,329) (80,731) 1,631,097 7,620 647,657 636,686
2012 647,657 (3,565,081) (161,462) 5,633,586 63,287 2,617,986 2,476,592
2013 2,617,986 (7,941,029) (161,462) 11,889,465 204,614 6,609,573 6,016,818
2014 6,609,573 (9,360,467) (161,462) 13,958,203 382,815 11,428,662 10,011,411
2015 11,428,662 (9,498,026) (161,462) 14,105,469 573,632 16,448,275 13,865,218
2016 16,448,275 (9,498,026) (161,462) 14,105,469 770,334 21,664,589 17,573,701
2017 21,664,589 (9,498,026) (161,462) 14,105,469 974,744 27,085,314 21,142,341
2018 27,085,314 (9,498,026) (161,462) 14,105,469 1,187,164 32,718,459 24,576,411
2019 32,718,459 (9,498,026) (161,462) 14,105,469 1,407,909 38,572,348 27,880,986
2020 38,572,348 (9,498,026) (161,462) 14,105,469 1,637,303 44,655,632 31,060,949
2021 44,655,632 (9,498,026) (161,462) 14,105,469 1,875,687 50,977,299 34,120,998
2022 50,977,299 (9,498,026) (161,462) 14,105,469 2,123,412 57,546,691 37,065,656
2023 57,546,691 (9,498,026) (161,462) 14,105,469 2,380,845 64,373,517 39,899,274
2024 64,373,517 (9,498,026) (161,462) 14,105,469 2,648,365 71,467,862 42,626,040
2025 71,467,862 (9,498,026) (161,462) 14,105,469 2,926,369 78,840,212 45,249,981
2026 78,840,212 (9,498,026) (161,462) 14,105,469 3,215,267 86,501,460 47,774,977
2027 86,501,460 (9,498,026) (161,462) 14,105,469 3,515,486 94,462,926 50,204,757
2028 94,462,926 (9,498,026) (161,462) 14,105,469 3,827,469 102,736,376 52,542,913
2029 102,736,376 (9,498,026) (161,462) 14,105,469 4,151,679 111,334,035 54,792,899
2030 111,334,035 (9,498,026) (161,462) 14,105,469 4,488,592 120,268,608 56,958,041
8

9. REPORTING AND MANAGING:
FINANCIAL STATEMENTS
Blended Rate Component:
 A blended, or single rate, is established to be charged to all internal loans. Operating Statement
Revenues
Internal Loan Interest 26,000 25,000
 Generally, the initial blended rate is established based on external cost of capital Investment Income 2,000 4,000
plus certain administrative and interest rate buffers. Total Revenues 28,000 29,000
Expenses
 The rate is reviewed annually based on the actual and projected performance of External Interest 26,000 26,000
Other 1,000 1,000
Internal Bank revenues and resources.
Increase in Bank Equity 1,000 2,000
Internal Loan Component:
Balance Sheet
 Procedures developed for application, approval, and tracking of loans. Assets
Cash and Investments 46,000 50,000
 Loan structures are independent of funding sources. Internal Loans Receivable 398,000 395,000
Total Assets 444,000 445,000
 Internal loan program is presented to schools and divisions. Liabilities
Long-Term Debt 321,000 320,000
Commercial Paper 100,000 100,000
Total Liabilities 421,000 420,000
External Debt Component: Equity 23,000 25,000
 Model to track actual and expected debt service and costs taking into account
timing and risk in debt portfolio.
9

10. SURVEY OF INTERNAL BANKS IN HIGHER ED:
PURPOSE
External/Internal Debt
Fund Common Benefits
Op. Portf. Investment
Take Deposits
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Source: Treasury Leadership Group Survey, 2010
10

11. SURVEY OF INTERNAL BANKS IN HIGHER ED:
COMMON BENEFITS
Strategic initiatives
Capital project funding
President/Provost
Central administration
0% 5% 10% 15% 20% 25% 30% 35% 40% 45%
Source: Treasury Leadership Group Survey, 2010
11

12. SURVEY OF INTERNAL BANKS IN HIGHER
EDUCATION: INVESTMENT STRATEGIES
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1 2 3 4 5 6 7 8 9 10
Cash/MM Fixed Income Endowment Other
Source: Treasury Leadership Group Survey, 2010
12

13. LESSONS LEARNED
 Constant evolution
 Written objectives, policies, procedures
 Ongoing communication
―Administrative
―Departmental
―Governing body
 Consistency of application
 How often to change blended rate/payout rate
 Alterations to investment profiles/risk tolerance of
the bank
 How to treat certain borrowings and “one offs”:
taxable debt? Refinancing savings?
 Discipline
13

14. Case Study: University of Virginia
Presenter: Jim Matteo

15. UVA INTERNAL BANK - OBJECTIVES
 Centrally manage financial resources and risks
 Provide settlement function for cash flows with
endowment
 Generate unrestricted resources
 Providing units with a full range of services:
 Loans
 Investments
 Cash Balance Tracking
15

16. UVA INTERNAL BANK - OPERATING
PROCEDURES
 Bank Activities include debt management,
investment management, and cash management.
 Internal Bank serves as a settlement agent
 Executive management involvement is increasing. No
board involvement at this time
 Distribution of unrestricted resources the biggest
item to be considered
16

17. UVA INTERNAL BANK - COMPONENTS
17

18. UVA INTERNAL BANK - FINANCIAL STATEMENTS
Balance Sheet
as of June 30, 2011
Assets
Cash
Investments - Short Term Internal Bank
Investments - Short Term CRP
Investments - Long Term Internal Bank
Investments - Long Term CRP
Investments - Restricted Debt Proceeds
Internal Loans Receivable
Internal Loans Receivable - Working Capital
Direct Loans Receivable (VCBA & State Issued)
Total Assets
Liabilities
Commercial Paper
Long Term Debt
Bond Premium or Discount
Build America Bonds rebate
Internal Investment Program Deposits
Due to Construction Projects
Due to Departments
Total Liabilities
Equity
Retained Earnings - CRP
Retained Earnings - Internal Bank
Distributions - Internal Bank
Net Assets
Total Net Assets and Liabilities
18

19. UVA INTERNAL BANK - FINANCIAL STATEMENTS
Income Statement
for the twelve months ended June 30, 2010
Revenues
Income on Bank Deposits
Escrowed Income
Income on ST Investments - IB
Restricted Income on Invested Bond Proceeds
Unrealized Gain/(Loss) on Investments
Unrealized Gain/(Loss) on Investments Restricted - CRP
Internal Loan Income Restricted - CRP
Internal Loan Income - Working Capital
BABS Subsidy
Total Revenues
Expenses
Bank Fees
UVIMCO Management Fee
UVIMCO Incentive Fee
PFM Management Fee
Debt Issuance Fees
Debt Maintenance Fees
Amortizations of Bond Premium
Interest Expense - External Debt
Interest Expense - Internal Investment Program
Operational Expenses
Total Expenses
Net Income
19

20. UVA INTERNAL BANK - FINANCIAL STATEMENTS
Statement of Cash Flows
for the twelve months ended June 30, 2010
Cash Flows from Operating Activities
Net Income
Unrealized Gain on Investments
Net Cash Flows Provided/(Used) by Operating Activities
Cash Flows from Financing Activities
Increase in Bond Premium/Discount
Decrease in Amounts Due to Departments
Decrease in Due to Construction Projects
Increase in Long-term Debt
Increase in Short-term debt
Decrease in Build America Bond rebate
Decrease in Internal Investment Program Deposits
Net Cash Flows Provided/(Used) in Financing Activities
Cash Flows from Investing Activities
Increase in Internal Loans Receivable
Decrease in Direct Loans Receivable
Decrease in ST Investments
Increase in LT Investments
Increase in Restricted Investments - CRP
Increase in Restricted Investments - Debt Proceeds
Net Cash Flows Provided/(Used) by Investing Activities
Decrease in Cash and Cash Equivalents
Cash and equivalents, July 1
Cash and equivalents, December 31
20

21. UVA INTERNAL BANK - MODELING
21

22. UVA INTERNAL BANK - MODELING
Treasury Operations Modeling - Consolidated
Assumption Standard
CRP IB Return Deviation Present Value of Wealth Created
Target Endowment Weight 100.00% 75.00% Cash/Short Term Investments 0.00% 0.0% 9%
Long Term Investments 7.50% 10.0% 8%
Minimum Initial Payout $10,000,000 $10,000,000 Internal Loans Receivable 4.74% 0.0%
7%
Capital Reserve Ratio 25.00% 10.00% Commercial Paper 0.12% 0.0%
6%
Payout Over X Years 10 10 Long Term Debt 4.17% 0.0% y
t
i
l
i 5%
Payout Deferred for X Years 1 1 Internal Investment Program Deposits 0.00% 0.0% b
a
Payout Increase Limit Amount 20.00% 10.00% Due to Departments 0.00% 0.0% b
o4%
r
P
3%
Discretionary Payout Yes Yes
2%
Discretionary Payout Over X Years 10 -
1%
Discretionary Payout Threshold - $10,000,000
0%
$250 $467 $684 $900 $1,117 $1,333 $1,550 $1,767
Stochastic Returns Yes Yes
$MM Present Value
Discount Rate for PV Calculations 7.50% 7.50%
Annual Distribution Amount Probability of Negative Equity Value
$450 5.0%
$400 4.5%
4.0%
$350
3.5%
M $300 99%
M
$ y 3.0%
t 95% t
i
u$250 l
i
o
y b2.5%
a 75% a
P$200 b
l o
r
a 50% P2.0%
u
n
n$150 25%
A 1.5%
5%
$100 1.0%
1%
$50 0.5%
$0 0.0%
2010 2015 2020 2025 2030 2035 2040 2010 2015 2020 2025 2030 2035
Year Year
22

23. UVA INTERNAL BANK - MODELING
Annual Payout Assets
$160,000,000 Cash/Short Term Investments Long Term Investments
Investments - Restricted Debt Proceeds Internal Loans Receivable
$140,000,000 Discretionary Internal Loans Receivable - Working Capital Direct Loans Receivable (VCBA & State I
Payout
$120,000,000 $4,000,000,000
$3,500,000,000
$100,000,000
Annual Payout
$3,000,000,000
$80,000,000
$2,500,000,000
$60,000,000
$2,000,000,000
Assets
$40,000,000
$1,500,000,000
$20,000,000 $1,000,000,000
$0 $500,000,000
2010 2015 2020 2025 2030 2035 2040
-$20,000,000 $0
Year 2010 2015 2020 2025 2030 2035
-$500,000,000
Year
Equity Liabilities
$2,000,000,000 Due to Departments Due to Construction Projects
Internal Investment Program Deposits Build America Bonds Rebate
$1,800,000,000
Equity Bond Premium or Discount Long Term Debt
$1,600,000,000 Commercial Paper
$2,500,000,000
$1,400,000,000
$1,200,000,000 $2,000,000,000
Equity
$1,000,000,000
$1,500,000,000
Liabilities
$800,000,000
$600,000,000 $1,000,000,000
$400,000,000
$500,000,000
$200,000,000
$0 $0
2010 2015 2020 2025 2030 2035 2040 2010 2015 2020 2025 2030 2035
Year Year
23

24. UVA INTERNAL BANK - GOVERNANCE
 Treasury Management responsible for operation of
the bank
 Executive Management is getting involved in
operation and distribution guidelines
 Financial Statements are produced for CFO
 Statements are used for internal management only
24

25. Case Study: University of Washington
Presenter: Chris Malins

26. OVERVIEW
 Central bank began operations on 7/1/2008
 Cost of funds at 5.5%
 General Revenue credit used for all university
borrowing
 Statutory authority to issue debt for all purposes
granted in 2007
 Annual audited financial statements
 $10m in rate stabilization at 6/30/2011
26

27. OBJECTIVES & DECISION MAKING
Program Goals
• Achieve lowest risk-adjusted cost of capital for the institution
• Provide stable and predictable rate for internal borrowers
Decision Making
Debt Advisory Committee meets quarterly
• Reviews credit markets, debt strategy and structure for upcoming bond issues
• Membership includes Washington Deputy State Treasurer, UW’s financial advisors,
UW Investments team members, and underwriter representatives
27

28. OPERATING STRUCTURE
Internal Lending Program
Capital
External Debt
Portfolio
Internal Debt
Debt Service
Portfolio
Capital External
Debt Internal Internal Rate
Service Debt Loan Stabilization
Service Funding
Account /
Program Costs
External Debt
Market
UW Internal
Borrower
28

29. INITIAL CHALLENGES AND OPPORTUNITIES
 Creating the basic structure of the bank
 Institutional buy-in
 Strong policy
 Up-leveling key decisions
 Accounting and reporting
29

30. CURRENT CHALLENGES AND OPPORTUNITIES
 State reporting
 Managing expectations and communicating the
message to borrowing units in a low interest rate
environment
 The role of the Treasury Office in decision-making
 Projects that wouldn't otherwise be financeable
can now be approved
 Need for additional resources
 Staffing
 Modeling
30

31. CURRENT CHALLENGES AND OPPORTUNITIES
(CONTINUED)
 Diversifying the debt portfolio through variable rate
debt
 Making the case to senior management and
regents
 Policy amendment
 Decisions made when starting a bank can make huge
differences down the line
 Cash flow neutral to refundings generated
“windfall” revenues to the bank which are
especially needed as the capital plan is funded.
 Higher initial rate
31

32. FUTURE CHALLENGES AND OPPORTUNITIES
 The “debt deluge” and its impacts on the future
 Institutional challenges and market forces could
increase UW’s cost of capital
 Federal funds reliance
 Widening credit spreads and overall rate
increases
 Stewardship of rate stabilization account
 Policy for excess funds
 Use to fund future projects (equity and/or loan)
 Lower the rate to reduce reserve over time
 Rebate to departments
 The asset side
32

33. FUTURE CHALLENGES AND OPPORTUNITIES
(CONTINUED)
 Higher assurance bank sufficiency measures
 Off the shelf model
 Homegrown model
 Ongoing disclosure and credit review “early warning”
system
 Project early warning vs. institutional risk
management
 Reporting that drives decision-making
 Board level
 Senior leadership
33

34. Appendix

35. INTERNAL BANKS IN HIGHER EDUCATION
 School 1
― Two banks effective July 1, 2010:
― The University Bank manages all non-endowed cash and investments
― The Capital Bank is somewhat of a 'debt pool' and manages amortization schedules, capital plans, swap issues, debt
structure, and market risk and defines the appropriate rate to charge divisions and schools for allocated outstanding
debt
― Capital Bank started with minimal assets on July 1, 2010
― ‘Assets' of the Capital Bank are claims on cash managed in the University Bank (i.e., the Capital Bank will not have real
cash and investments)
 School 2
― Bank was funded by GO debt and school cash balances and is used to make internal loans to schools and centers
― The bank’s assets are these internal loans, investment in intermediate treasuries, the endowment and cash.
― Now implementing statements on the bank
 School 3
― Bank includes debt, investment, and cash management
― Bank is designed to be self-sustaining
― Funding is derived from fees and positive spreads between the cost/return on funds and the interest received/paid from
or to units
 School 4
― Internal Bank is primarily funded with externally issued debt
― Secondary funding sources include: spread between blended rate and actual portfolio rate; dedicated institutional
allocation of a portion of overhead receipts; and a portion of operating assets (liability)
35

36. INTERNAL BANKS IN HIGHER EDUCATION
 School 5
― The bank operates between four offices – CFO (approvals), Financial Services(Investment and Debt Management,
Controller (Accounting) and Resource Planning (Analysis)
― The bank is self-sustaining through spread management
 School 6
― “Internal Bank” has enhanced and expanded long-term structures for managing internal/external debt and cash
operations/projections
― The “Bank” provides policies and tools for aggregating data for analyses, decision-making and managerial refinements
 School 7
― Operating Bank: self-sustaining with approved depts/schools/units receiving interest on avg. cash balances based on 3m
T-bills
― Capital Bank: Beginning deposit of quasi endowment. Self-sustaining with monitoring of minimum balance ($100mm).
Internal borrowers pay level amortization. External debt managed on a portfolio basis. Bank receives some annual
unrestricted spending from endowment. Long term invested with endowment and short term needs invested in the
operating bank. All debt part of bank
 School 8
― School has a debt bank, and separately working capital fund balances are managed by the management company and
cross invested into the merged pool
― President has the discretion to determine % of working capital fund balances are invested in Merged Pool (between 70
and 90%)
― Fund holders receive a guaranteed money market return, excess returns are deposited 1st into a buffer = 35% of fund
balances, then into funds functioning as endowment controlled by the President
― These funds are typically used to co-invest or provide seed funding for new strategic initiatives
36

37. DISCLAIMERS
1. This presentation is for your internal use alone, for the limited purpose of assisting an evaluation of your potential
interest in the strategies described, and is confidential as to third parties (with the exception that there is no limit on any
disclosure of the US tax treatment or tax structure of any transaction). This material may not be given to third parties
without our prior written consent. Information regarding values should not be relied on for maintaining books and records.
2. This presentation is not contractual, not a research report nor an offer to buy or sell or a solicitation of an offer to buy or
sell any security or interest. Contractual obligations will be created only by formal written agreement. Information regarding
pricing, interest rates, and transaction costs is preliminary and indicative only. We invite inquiry into the assumptions
underlying future projections and other forward looking statements in the presentation.
3. Except as compelled by applicable law we make no warranty, express or implied of any nature as to any information or
technique herein and do not guarantee satisfactory results. In no event may we be liable for any special or consequential
damages that may be incurred in using the data provided. Before entering into any transaction, you must independently
determine the economic risks, and your institution’s ability to assume the risks. Senior management should be involved in
or informed as to this process.
4. Risk assessment of derivative products is complex. One must also consider the implications of accounting and financial
disclosure rules such as the FASB requirements for mark-to-market procedures or the extensive GASB reporting
requirements.
5. We are not lawyers, accountants or tax specialists; you should seek and rely on independent advice as to such matters
from properly qualified firms or individuals.

38. INTERNAL LOAN TERM SHEET EXAMPLE
38