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Debt Management and Derivatives

Debt Management and Derivatives

Status:  Adopted by Business and Financial Affairs Committee October 6, 2006, Last Revised May 11, 2012

Policy Rationale:

To fulfill its mission, the University must make capital investments, driving capital decisions that impact the University’s credit.  Appropriate financial leverage serves a useful role and should be considered a long-term component of the University’s balance sheet.  Just as investments represent an integral component of the University’s assets, debt is viewed to be a continuing component of the University’s liabilities.  Debt, especially tax-exempt debt, provides a low-cost source of capital for the University to fund its capital investments.  This policy provides the Business and Financial Affairs Committee and Administration the framework within which decisions will be made regarding the use of debt to finance capital projects.

Policy Objectives:

  • To provide a guideline for the use of debt proceeds that support the University’s capital needs while achieving the lowest overall cost of capital.
  • To provide a framework for monitoring selected financial ratios with specific targets to ensure that the University continues to operate within appropriate financial parameters while allowing the University to maintain a Moody’s Investors Service “A” category rating thereby permitting it to continue to issue debt on favorable terms.

Policy Guidelines:

Debt is defined to include all short and long term obligations, guarantees, and instruments that have the effect of committing the University to future payments, including commitments to purchase natural gas or other commodities in the future at set pricing.

The University has limited debt resources.  Administration will allocate the use of debt financing within the University with the approval of the Board of Trustees.  This will include the prioritization of debt resources among all uses, including academic projects, equipment financing, real estate investment, financial opportunities, and other capital projects.  Generally, the following guidelines will be used, although they are not intended to be all-inclusive.  Judgment by Administration and the Board of Trustees ultimately will determine the priority for the use and amount of debt.

  • Only projects that relate to the core mission of the University will be considered.
  • Projects that have a related revenue stream or create budgetary savings will receive priority consideration.  For these projects, the use of debt must be supported by an achievable financial plan that includes servicing the debt and meeting any new or increased operating costs, which could include the funding of a replacement and renovation reserve.  For projects that create budgetary savings, the budget will be reduced to fund the debt service and any additional savings will be invested into other critical capital projects.  This priority consideration is not meant to exclude other projects that are vital to the University’s mission.
  • The useful life of a project should be taken into consideration when using long-term debt for the capital investment.
  • In assessing the possible use of debt, all other revenue sources will be considered.  Philanthropy, project-generating revenues, Federal and State grants, expendable reserves, and other sources are expected to finance a portion of the cost of a project.  Fundraising for capital gifts is expected to be a major source of financing for the University’s capital investments.  A cohesive, long-range facilities plan, that addresses the strategic needs of the University clearly articulated to potential donors, is key to the success of capital fund- raising efforts.
  • A consideration in the structure of the debt portfolio is the inclusion of variable rate debt.  Fixed rate debt provides more long-term interest rate stability than variable rate debt.  However, variable rate debt is a desirable component of the debt portfolio because it is typically at lower interest rates.  Variable rate debt includes floating rate issues and commercial paper, as well as any “synthetic” variable rate debt created by fixed to floating rate “swaps.”   The use of variable rate debt exposes the debt portfolio to interest rate fluctuations.  Therefore, the University will seek to match its floating rate assets and floating rate liabilities in a manner which limits net interest rate risk.  Notwithstanding this limitation, the University may maintain a level of net floating interest rate exposure in an amount not exceeding 40% of its aggregate debt portfolio.
  • Derivative products may be used for the purposes of managing interest rate exposure and reducing debt service costs.  The University will seek to execute derivative transactions only with counterparties with credit ratings of “AA” category and above as of the date of the transaction.  Counterparties with credit ratings below the “AA” category will be considered only if credit enhancements, e.g., collateral or guarantees, are secured.
  • The inclusion of variable rate debt in the debt portfolio and the use of derivative products are subject to the approval of the Board of Trustees.

Policy Ratios:

One of the policy’s objectives is the maintenance of the highest acceptable credit rating for the University.  Maintaining the highest acceptable credit rating will permit the University to continue to issue debt and finance projects at favorable interest rates while meeting its strategic objectives.  The University will limit its overall debt to a level that will maintain an acceptable credit rating with the bond rating agencies.  These agencies help maintain the confidence of the public and purchasers the debt with regard to the ability of an issuer to service and repay bonds.  Administration will provide the rating agencies with full and timely access to required information.  To meet this policy objective, the University has established limits for overall debt using two ratios.  These ratios are consistent with the measures used by rating agencies.  However, the agencies monitor a number of other statistics and ratios in developing their opinions.  Administration will review annually all key-rating agencies’ ratios to monitor compliance with rating guidelines.

The following ratios are to be used as a guideline for monitoring and evaluating University debt levels by the Business and Financial Affairs Committee:

Ratio #1:  Viability Ratio = Expendable Net Assets/Long-Term Debt

The viability ratio measures the availability of expendable net assets (unrestricted net assets + temporarily restricted net assets – plant equity) to cover debt should the University be required to repay its outstanding obligations.  The ratio should be not less than 200%.  If the University’s viability ratio begins to move closer to a 1:1 ratio, then it will be difficult for the University to respond to adverse conditions from internal resources.  It will also impact its ability to attract debt financing from external resources to fund capital initiatives.

Ratio #2:  Debt Burden = Actual Debt Service/Total Expenditures

The debt burden ratio measures the relative cost of debt to overall University expenditures (total expenditures – depreciation + repayments).  By maintaining an appropriate proportion of debt service to total expenditures, other critical and strategic needs can be met as part of the expenditure base.  The ratio should be no greater than 8%.  A level trend will provide an indication that there is sufficient coverage for debt service while not impeding financial resources to support institutional requirements.  A rising trend will signify a demand on financial resources to cover the debt service, which may result in budgetary reductions.

Policy Review:

The Debt Management and Derivatives Policy will be reviewed by the Business and Financial Affairs Committee at least every two years and modified as necessary to reflect changing conditions.

The Office of the Vice President for Finance and Administration will provide an annual debt report to the Board of Trustees through the Business and Financial Affairs Committee of the Board.  The debt report will cover updated ratios, covenant compliance, debt outstanding, annual debt service, available capacity, and bond rating.

Each new debt, including derivative instruments, will be presented to the Board of Trustees for approval.