Trendspotting: What’s trending in higher education finance?

Presenter:

Walter Goldsmith

2

What does a Financial Advisor do?

Typical financial advisor services:

Below is a partial listing of the financial advisory services typically provided:

• Debt Capacity Analysis

• Debt Structuring • Cash Flow Analysis

• Revenue Impact Analysis

• Debt Refunding Analysis

• Investment of Bond Proceeds

• Capital Improvement Planning

• Pro Forma Modeling • Fiscal Policy Guidelines

• Peer Comparative Analysis

• Credit Strategy • Public/Private Partnerships

• Historical Trend Analysis

• Debt Transaction Implementation

• Cost Benefit and Risk Analysis

3

Overview of First Tryon Advisors

Overview of First Tryon Securities, LLC

Founded eighteen years ago and headquartered in Charlotte, North Carolina, First Tryon Securities, LLC is a regionally focused independent, privately owned securities firm.

The firm operates a full service financial advisory practice serving the needs of colleges/universities, cities, towns, counties, utilities and not-for-for profits in the southeast region.

The firm is registered with both the Municipal Securities and Rulemaking Board and the Securities and Exchange Commission. First Tryon employs 24 registered representatives with an average of 18 years’ experience.

First Tryon Advisors

First Tryon Advisors (“FTA”) is a business of First Tryon Securities, LLC and operates as the Financial Advisory arm of the Firm.

First Tryon does not serve as an underwriter and only provides financial advisory services to our clients.

Municipal Sales & Trading Desk

The financial advisory team at First Tryon has access to real-time market information for tax exempt and taxable securities through our trading platform.

Our desk assists our clients when pricing bonds in the public markets – ensuring the proposed spreads provide the best deal for the client.

First Tryon’s total trade volume for 2014 exceeded $4 billion in par amount.

Office Locations

The firm has offices in Charlotte (NC), Atlanta (GA), Gulf Breeze (FL) and Jacksonville (FL).

The bankers at First Tryon Advisors are all located in the firm’s Charlotte, NC headquarters.

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SouthCarolina AndersonUniversity ConverseCollege2

FurmanUniversity SouthernWesleyanUniversity WoffordCollege2

ClemsonUniversity PresbyterianCollege USCUpstate

North Carolina Appalachian State University DavidsonCollege East Carolina University ElizabethState University Fayetteville State University Guilford College1

Lenoir-RhyneUniversity Mars Hill University2

Meredith College2

Methodist University NC Central University NC State University2

North CarolinaA&T Queens University of Charlotte UNC Asheville UNC Chapel Hill2

UNC Charlotte2

UNC Greensboro UNC Pembroke UNC Wilmington Western Carolina University WinstonSalem State University2

(1) Swap Advisory Engagement(2) Underwriter Engagement of Tripp Robinson

PrivateCollege/UniversityPublicCollege/University

Transaction in Progress

Higher Education Experience in the Carolinas

The bankers at First Tryon have significant experience working with Higher Education institutions, both public and private throughout the Carolinas.

Topics for Discussion

I. Interest Rate Environment

- The trends that influence interest rate environment

II. Debt Capacity and Debt Affordability

III. Rating Agencies

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Market Update

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10 Year MMD 30 Year MMD

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10 Year 30 Year

Municipal Market Update

Long-term tax-exempt rates fell 169 basis points from January 1, 2014 to a low of 2.50% on January 31, 2015.

Benchmark rates hit their 2015 highs in early May and still continue to rise.

The chart to the right shows the 20 year history of the 10 and 30 year MMD indices; rates today are near historic lows.

30/10 Year MMD Since 1/1/2014

4.19%

2.30%

3.28%

2.77%

May 19, 2015

Source: Thompson Reuters, as of May 19, 2015

30/10 Year MMD (20 year history) Index Low High Avg.10 Year 1.47% 5.90% 3.66%30 Year 2.47% 6.55% 4.57%

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0.80%

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1.20%

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1.80%

2.00%

Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016

Median Survey BAML Wells Fargo

RBC Credit Suisse Ray. Jay.

2.50%

2.70%

2.90%

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Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016

Median Survey BAML Wells Fargo

RBC Credit Suisse Ray. Jay.

Interest Rate Projections

Median Survey BAML

Wells Fargo RBC

Credit Suisse

Ray. Jay.

Q2 2015 2.80% 2.85% 2.77% 2.70% 2.74% 2.94%Q3 2015 2.93% 2.90% 2.89% 3.00% 2.90% 3.04%Q4 2015 3.10% 3.00% 2.99% 3.35% 2.95% 3.15%Q1 2016 3.25% 3.10% 3.09% 3.50% 3.00% 3.23%Q2 2016 3.39% 3.18% 3.70% 3.05% 3.30%Q3 2016 3.47% 3.39% 4.15% 3.05% 3.34%

Median Survey BAML

Wells Fargo RBC

Credit Suisse

Ray. Jay.

Q2 2015 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%Q3 2015 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%Q4 2015 0.75% 0.75% 0.75% 0.75% 0.75% 0.50%Q1 2016 1.00% 1.00% 1.00% 1.00% 1.00% 0.75%Q2 2016 1.25% 1.25% 1.25% 1.25% 1.25% 1.00%Q3 2016 1.50% 1.50% 1.50% 1.75% 1.75% 1.25%

30 Year US Treasury Projections Fed Funds Rate Projections

Source: Bloomberg

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15-Apr 22-Apr 30-Apr 7-May 15-May

Daily Change (%)Value ($)

Daily % Change S&P 500

Capital markets movement over the past month

Source: Bloomberg

Treasury yields move upward over past month10Y UST yield

Equities fluctuate over past monthS&P 500

Market Highlights

Employers added 223,000 jobs in April (matching consensus estimate) and revised March’s employment numbers down to just 85,000.

The Fed has not ruled out an interest rate increase in June, but it looks increasingly unlikely, given softer economic releases since the Fed’s last policy meeting (i.e. retail sales).

GDP slowed to a 0.2% seasonally adjusted annual rate in the first quarter, down from the previous two quarters (2.2% in the fourth quarter and 5% in the third quarter).

China cut interest rates for the third time in six months amid a worse-than-expected economic slowdown.

The US Dollar struggles as it experienced its worst month in four years due to weak earnings reports and lackluster economic results.

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30Y MMD

Municipal Market Snapshot

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MMD/UST 30Y MMD 30Y UST

Municipal Bond Fund Flows

Annual Municipal Bond Volume Tax-Exempt/Taxable Ratios

Source: Bloomberg

Source: The Bond Buyer Source: Bloomberg/Thompson Reuters

Debt Capacity

Overview of Debt Capacity & Debt Affordability

Debt Capacity : Refers to an institution’s ability to absorb additional debt onto the balance sheet. This is quantified by evaluating key metrics and the impact of the proposed debt.

Debt Affordability : Refers to an institution’s ability to manage the cost of the proposed debt.

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NC House Budget Bill

DEBT AFFORDABILITY STUDY FOR THE UNIVERSITY OF NORTH CAROLINA

SECTION 31.13. Chapter 116D of the General Statutes is amended by adding a new Article to read:

Article 5. "Managing Debt Capacity. “

§ 116D-55. Purpose. The purpose of this Article is to provide tools for sound debt management at The University of North Carolina by requiring each constituent institution to conduct an annual debt affordability study, by requiring the establishment of guidelines for maintaining prudent debt levels, and by establishing a system for prioritizing University capital needs when the needs exceed the University's capacity for new debt.

 

"§ 116D-56. Debt affordability study required.

 

(a) Study Required. – The Board of Governors shall annually advise the Governor and the General Assembly on the estimated debt capacity of The University of North Carolina for the upcoming five fiscal years. The Board shall oversee the undertaking of an annual debt affordability study and the establishment of guidelines for evaluating the University's debt burden. The guidelines should include target and ceiling ratios of debt to obligated resources 26 and target and floor percentages for the five-year payout ratio. The Board shall also recommend any other debt management policies it considers desirable and consistent with sound management of the University's debt.

 

(b) Board of Governors Reporting Required. – The Board shall report its findings and recommendations to the Office of State Budget and Management, the Joint Legislative Commission on Governmental Operations, the State Treasurer, and The University of North Carolina General Administration by February 1 of each year. The report shall be accompanied by each of the reports provided to the Board pursuant to subsection (c) of this section.

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NC House Budget Bill

DEBT AFFORDABILITY STUDY FOR THE UNIVERSITY OF NORTH CAROLINA

(c) Constituent Institution Reporting Required. – No later than November 1 of each year, each constituent institution shall report to the Board of Governors on its current and anticipated debt levels. The report shall be made in a uniform format to be prescribed by the Board of Governors. Each report shall include at least the following:

(1) The amount and type of outstanding debt of the institution.

(2) The sources of repayment of the debt.

(3) The amount of debt that the institution plans to issue or incur during the next five years.  

(4) A description of projects financed with the debt.

(5) The current bond rating of the institution and information about any changes to that bond rating since the last report was submitted.

(6) Information about the constituent institution's debt management policies and any recommendations for methods to maintain or improve the University's bond rating.

(7) Debt burden comparisons to comparable peer institutions.

(8) Any other information requested by the Board of Governors.

Ratio example of Debt Capacity & Debt Affordability

Expendable Financial Resources to Debt

Measures coverage of debt by financial reserves or funds a university can access in the intermediate term due to temporary spending restrictions, largely donor or sponsor imposed.

Debt to Operating Revenues

Measures coverage of debt from annual operating revenue.

Debt Service to Operations

Measures the scale of an institution’s annual debt service requirements as it related to Operations.

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Example of Debt Capacity Analysis

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Example of Debt Capacity Analysis

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Example of Debt Capacity Analysis

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Example of Debt Capacity Analysis

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Example of Debt Capacity Analysis

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Example of Debt Capacity Analysis

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Example of Debt Capacity Analysis

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Rating Agencies

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What is a credit rating?

Measure of ability to repay debt or financial obligations

• Assists investors in evaluating the credit worthiness of an institution (like a personal credit score)

• Evaluates quantitative and qualitative characteristics of an institution

• Letter grid rating with numerical (1,2,3) or plus/minus differentiators

Moody’s S&P Fitch

Aaa AAA AAA

Aa1 AA+ AA+

Aa2 AA AA

Aa3 AA- AA-

A1 A+ A+

A2 A A

A3 A- A-

Baa1 BBB+ BBB+

Baa2 BBB BBB

Baa3 BBB- BBB-

Non Investment Grade

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Factors considered by the Rating Agencies

Below are the factors considered by the Rating Agencies when evaluating institutions:

Market Position Ability to compete

effectively for tuition revenue, private gifts, research grants, and government support.

Operating Performance Ability to repay debt from

fiscal operations while providing funds for strategic investment in programs and facilities.

Balance Sheet and CapitalInvestment Ability to provide

continual financial support for the mission and to support long-term capital and financial planning horizons.

Governance andManagement Ability to enable an

organization to reach its full potential while avoiding financial stress.

Legal Security and DebtStructure Ability to maintain healthy

levels of debt and to appropriately manage potential risks associated with particular financing vehicles.

External Factors Ability to overcome cuts

in state and federal support, adverse economic conditions and other potential external risks.

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Importance of Peer Comparisons

Peer comparisons are a valuable tool used by the rating agencies during the rating process:

UNC Wilmington

Appalachian State

UniversityUNC

AshevilleUNC

Greensboro

Western Carolina

University2013 2013 2013 2013 2013

1 Current Senior Most Rating* A1 Aa3 A1 Aa3 Aa32 Expendable financial resources-to-operations (x) 0.34 0.38 0.37 0.57 0.473 Total Financial Resources-to-Operations (x) 0.60 0.59 0.65 0.93 0.67 4 Expendable financial resources-to-direct debt (x) 0.40 0.50 0.60 0.70 0.80 5 Total cash & investments-to-direct debt (x) 0.70 0.40 0.70 1.40 1.10 6 Debt service to operations (%) 6.39 7.41 4.93 4.31 5.01 7 Total Direct Debt ($, in millions) 237 275 48 264 1138 Expendable Financial Resources ($, in millions) 88 125 30 194 879 Total Financial Resources ($, in millions) 156.63 196.82 52.3 316.7 123.0810 Total Cash & Investments ($, in millions) 174 111 34 360 12611 Total Revenues ($, in millions) 269 342 79 362 19212 Total Enrollment FTE (#, may be estimated) 13,110 17,100 3,358 15,891 9,037 13 Primary Selectivity (%) 52.0 65.8 68.7 58.0 38.8 14 Primary Matriculation (%) 31.5 32.1 27.3 42.3 27.4 15 Net tuition per student ($) 6,978 6,065 6,867 5,213 5,67316 Operating margin (%) 3.1 3.0 (1.6) 5.8 4.5 17 Debt Service Coverage (x) 2.0 1.6 1.5 3.0 2.4 18 Tuition & Auxiliaries (%, of Total Revenue) 49.8 47.9 41.9 34.4 42.8 19 Available Funds ($, in millions) 152.8 160.4 36.5 148.7 93.0 20 Available Funds to Debt 0.64 0.58 0.91 0.56 0.82

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Ratio Definitions

Key Financial Ratios

Direct Debt ($)

– Measures direct obligations of institution.

– Institutions obligations (e.g. bonds, notes, commercial paper, capital lease, bank loans, and draws upon lines of credit)

Unrestricted Financial Resources ($)

– Amount of most liquid financial resources.

– Total unrestricted net assets less net investment in plant

Expendable Financial Resources ($)

– Measure of financial resources that are ultimately expendable.

– Total unrestricted and temporarily restricted net assets less net investment in plant

Total Financial Resources ($)

– Measures total financial wealth of institution.

– Total net assets less net investment in plant

Total Cash & Investments

– Measure base of assets that generate investment return.

– Total cash and investments

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Ratio Definitions

Capital Ratios

Unrestricted Financial Resources-to-Direct Debt (x)

– Measures coverage of direct debt by the most liquid financial resources.

– Unrestricted financial resources divided by direct debt

Expendable Financial Resources-to-Direct Debt (x)

– Measures coverage of direct debt by financial resources that are ultimately expendable.

– Expendable financial resources divided by direct debt

Total Financial Resources-to-Direct Debt (x)

– Measures coverage of direct debt by total financial resources including permanent endowments.

– Total financial resources divided by direct debt

Total Cash & Investments-to-Direct Debt (x)

– Measures coverage of direct debt by assets that generate investment return.

– Total cash and investments divided by direct debt

Debt Service to Operations (%)

– Measures burden of actual debt service payments relative to overall operating budget.

– Actual annual debt service divided by total operating expenses

Variable Rate Exposure (%)

– Measures the portion of direct debt issued in variable rate mode.

– Sum of par amount of debt outstanding under all series of bonds and other debt issued as variable rate securities, divided by direct debt. (variable rate bonds synthetically swapped to a fixed rate are included in variable rate debt)

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Ratio Definitions

Balance Sheet Ratios

Unrestricted Financial Resources-to-Operations (x)

– Measures coverage of annual operations by the most liquid financial resources.

– Unrestricted financial resources divided by total operating expenses

Expendable Financial Resources-to-Operations (x)

– Measures coverage of annual operating expenses by financial resources that are ultimately expendable.

– Expendable financial resources divided by total operating expenses

Total Financial Resources-to-Operations (x)

– Measures coverage of annual operations by the total financial resources.

– Total financial resources divided by total operating expenses

Operating Ratios

Operating Margin (%)

– Indicates the excess margin (or deficit) by which annual revenues cover operating expenses.

– Adjusted total unrestricted revenues (adjustments include limiting investment income to 5% of average of previous three years cash and investments and subtracting net assets released for construction and acquisition of fixed assets), less total unrestricted operating expenses, divided by adjusted total unrestricted revenues

Direct Debt Service Coverage (x)

– Measures actual margin of protection for annual debt service payments from annual operations.

– Annual operating surplus (deficit) plus interest and depreciation expenses, divided by actual principal and interest payments

Types of Borrowings Available

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Most common types of borrowings:

Publicly sold bond issues

With official statement / credit ratings

Fixed rate or variable rate

If variable rate, most are backed by a Direct Pay Letter of Credit

Bank placed loans (also known as “Direct Purchase”)

Can be either fixed rate or variable rate

Banks have strong appetite for shorter amortization

Banks typically want to include more covenants

Questions/Answers

Trendspotting: What’s trending in higher education finance?

Presenter:

Walter Goldsmith