F 4 STANDING COMMITTEES. Finance and Asset Management Committee. Debt Management Annual Report INFORMATION. For information only.

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1 STANDING COMMITTEES F 4 Finance and Asset Management Committee Debt Management Annual Report INFORMATION For information only. BACKGROUND The Board of Regents is charged with oversight of the University s internal and external debt portfolios. Oversight of the University s external debt portfolio is accomplished by adopting the University s Debt Management Policy, guiding credit standards, authorizing the issuance of external debt, and ensuring compliance with bond covenants and IRS regulations. Internally, the Board approves the use of financing programs to fund projects, monitors internal loans, and approves Financial Stability Plans. The Board also approves changes to the Internal Lending Program rate and authorizes distributions from the Rate Stabilization Account. The Debt Management Annual Report provides the Board with a broad overview of the internal and external debt portfolios, macro challenges, and how the University is managing those challenges. Its purpose is to provide the Board with information and context to inform decisions about the University s external borrowing and internal lending activities. This report does not require Regental action. Attachment University of Washington Debt Management Annual Report F 4/204-17

2 UNIVERSITY OF WASHINGTON Debt Management Annual Report Board of Regents Finance and Asset Management Committee April 13, 2017 ATTACHMENT

3 AGENDA > External Borrowing Portfolio Overview Project Capacity > Internal Lending Portfolio Overview Rate Recommendation > Initiatives Debt Management Annual Report 2

4 EXTERNAL BORROWING AND INTERNAL LENDING OVERVIEW External Borrowing Mission > The mission of the external portfolio is to achieve the lowest risk adjusted cost of capital Regental Roles > Adopt Debt Policy > Approve annual bond resolution > Review portfolio performance > Guide University credit and issuance standards, including debt capacity Reporting > Bondholders Report including audits to investors > Monthly Debt Report to Regents > Future Debt Report to Rating Agencies > Self-Liquidity Report Rating Agencies Internal Lending Mission > The mission of the internal portfolio is to offer stable and predictable interest rates to campus borrowers and to allow for capital funding in a rising rate environment Regental Roles > Approve and monitor ILP loans > Approve use of Capital Assets Pool > Approve Financial Stability Plans > Approve ILP rate and Rate Stabilization Account (RSA) distributions Reporting > Semi-Annual Borrower Report > Semi-Annual ILP Report > Debt Management Annual Report > Annual ILP Audit External Borrowing- Portfolio Overview 3

5 External Borrowing

6 ISSUANCE HISTORY Jul-11, $211m with an interest cost of 3.88% 5.00% 4.50% 4.00% 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% Mar-12, $268m with an interest cost of 3.67% Dec-12, $300m with an interest cost of 3.02% Jan-14, $29m with an interest cost of 3.87% Sep-13, $146m with an interest cost of 4.47% Aug-14, $115m with an interest cost of 3.39% Oct-15, $132m with an interest Jan-15, $218m cost of 3.81% with an interest cost of 3.17% Sep-15, $195m with an interest cost of 3.48% Oct-16, $205m with an interest cost of 3.39% External Borrowing - Portfolio Overview Long Term Borrowing Rate Short Term Borrowing Rate > Since fiscal year 2012, the University has borrowed $1,819 million (including refundings of $616 million), at a rate of about 3.5% > The University s borrowing rate is impacted by a variety of factors including term, debt type, tax status, couponing, etc. > The University issued $205 million of new money and refunding bonds in 2017 to fund Life Sciences, ARCF, Housing and Dining Phase 4a and UWMC Phase 2 5

7 CREDIT OVERVIEW Credit Strengths > Strong market position > Significant national research profile, good student demand with diverse enrollment, major clinical care provider for the Pacific Northwest > Good financial flexibility with $1.6 billion of unrestricted financial resources > Consistently favorable operations and diversified sources of revenue > Integrated planning, active debt and project management, and very good disclosure Macro challenges > A December 2016 Moody s sector report provided a stable outlook in higher education, however: Rising pension liabilities, increasing labor costs and uncertainty around future federal policies and funding could stress the sector Uncertainty in health care presents challenges to universities with a clinical enterprise Budget challenges at the State level could pose financial risk Increasingly competitive research funding environment with uncertainty surrounding levels of federal support for research Source: Moody s Investors Services Institutional opportunities and challenges > Current and projected financial performance puts stress on Aaa rating Credit Weaknesses > Increasing leverage, debt issuance outpacing growth of financial resources and revenues > Slowing growth in net tuition revenues with the state reassuming full tuition setting authority for in-state undergraduate tuition > Increasingly competitive research funding environment > Significant healthcare exposure with lower margins and liquidity > Declining unrestricted liquidity, comparably lower than peers > Increased financial planning efforts provide management with analytical tools to make strategic decisions External Borrowing - Portfolio Overview 6

8 EXTERNAL DEBT PORTFOLIO Millions > The debt portfolio consists primarily of fixed rate debt with $67 million of variable rate debt through the Commercial Paper program (CP) > Average borrowing rate for portfolio is 3.44% > There is approximately $230 million in authorized debt remaining to be issued over the next two years > Approximately $80-$100 million of principal is repaid annually > More than 70% of debt has been issued as General Revenue Bonds $210 $180 $150 $120 $90 $60 $30 $0 Maximum Annual Debt Service $206M Other, $15, 1% State Issued Bonds, Payable by UW, $127, 5% Outstanding Debt by Type Total Debt: $2,380 (In millions as of Feb 28 th, 2017) CP, $67, 3% NWH, $8, 1% Lease Revenue Bonds, $395, 17% General Revenue Bonds, $1,767, 74% External Borrowing - Portfolio Overview General Revenue Bonds State Issued Bonds, Payable by UW Lease Revenue Bonds Other CP (1) NWH (1) Excludes principal payments on Commercial Paper (CP) 7

9 PROJECT CAPACITY OVERVIEW > What is Project Capacity? Estimated annually, Project Capacity is the combination of debt and reserves that can be used to finance capital over a five-year period > How has it been estimated? Financial forecasts are used to estimate how much debt the University can issue while staying at or above peer minimums in three ratios: > Debt Service Coverage > Debt to Operating Revenue > Spendable Cash and Investments to Debt Institutional reserves available for capital projects (Capital Assets Pool) supplement how much debt can be issued External Borrowing - Project Capacity 8

10 PEER GROUP BENCHMARKS > Moody s rates over 500 colleges and universities > The peer group is evaluated annually > 13 schools meet University of Washington s peer criteria: Public institutions Over $1 billion annual operating revenue At least 10% health care exposure Aa2 or higher rating Not a state system (e.g. California, Texas) Institutions Rated by Moody s: 547 Public Institutions Only: 286 Public Institutions with >$1B in Operating Revenue: 60 Public Institutions with >10% Health Care Exposure: 23 Public Institutions rated Aa2 and higher: 20 No State- Wide Systems: 14 External Borrowing - Project Capacity UW s Peers: University of Alabama at Birmingham University of Nebraska Ohio State University University of Arkansas University of New Mexico Pennsylvania State University University of Colorado University of North Carolina at Chapel Hill State University of Iowa University of Kentucky University of Utah University of Michigan University of Virginia 9

11 PROJECT CAPACITY DRIVERS Within the University s influence: > Principal repayment: Repaying principal increases capacity > Project approval: Approving projects decreases capacity > Growth: Growth in net operating income improves financial ratios and increases project capacity > Use of institutional funds: CAP (Capital Assets Pool) allows projects to be funded without external borrowing. The CAP limit is 10% of the Invested Funds (IF), which changes as the value of the IF changes Outside the University s influence: > Changes in peer behavior: The University estimates project capacity based on peer medians. Peer behavior can either increase or decrease project capacity > Interest rates: Future increases in interest rates decrease project capacity External Borrowing - Project Capacity 10

12 PROJECT CAPACITY ESTIMATES > The University has outstanding debt of about $2.4 billion $410 million in principal payments between , averaging $82 million per year > In 2016, the 5-year estimated project capacity was $425 million, including $100 million from CAP Above borrowing for previously authorized projects > In 2017, the 5-year estimated project capacity is $95 million, generated from the CAP Reflects continued growth of expenses over revenue and state/federal funding uncertainty > Additional debt capacity will depend on financial performance and future expectations External Borrowing - Project Capacity 11

13 Internal Lending

14 LENDING PROGRAMS Program Purpose Program Description Internal Lending Program (ILP) Provide stable long-term rate to campus borrowers Loans for long-lived capital assets Proposed Short-Term Financing Program (FASTER) Finance short-term assets at low cost of funds Provide small short-term (up to 10 years) fixed rate loans to campus borrowers Bridge Short-term loans for gift funded capital projects (up to 5 years) Fund timing gap of construction cash flows and gifts Financing Rate ILP Rate, currently 4.50% Short-term market rate Short-term market rate Funded by Debt and CAP ILP Balances ILP Balances Internal Lending - Portfolio Overview Note: Debt issued by an external entity or repaid from appropriated local funds, personal property financings and credit lines reside outside these lending programs 13

15 LENDING PROGRAMS (CONTINUED) Funding Long-Term Assets Fund Externally ILP Fund Internally CAP > Long-term assets pay the ILP rate Funding Short-Term Assets Fund Externally Fund Internally FAST FASTER (1) > Short-term assets and gift-funded projects pay a market rate Funding Long-Term Assets Fund Internally BRIDGE Internal Lending - Portfolio Overview (1) Small loans for short-term assets may be funded with Treasury assets 14

16 MECHANICS OF LENDING PROGRAMS Interest Payments Rate Stabilization Account (RSA) - Program support - General revenue support Campus Borrowers Program Fund Rebalance Principal Payments Residual Account - Bond proceeds - Timing differences - Loan programs Internal Lending - Portfolio Overview Debt Service Payments External Lenders and Capital Assets Pool 15

17 HOW IS THE ILP RATE EVALUATED? Treasury evaluates the ILP rate and sufficiency of the RSA and Residual Account annually > Step 1: Evaluate the sufficiency of the Residual Account The Residual Account is evaluated to ensure sufficient funding for future debt service payments and loan programs Any excess funds are transferred to the RSA > Step 2: Determine RSA sufficiency The RSA represents how many years the current lending rate could be maintained in a rising external rate environment Current balances in the RSA reflect 11 years of sufficiency > Step 3: Board approves ILP rate changes or distributions, if any Overfunded RSA: 11+ Years Target Sufficiency Range: 5-10 Years -Decrease ILP Rate -Distribution of Funds Internal Lending - Rate Recommendation -Increase ILP Rate -Residual Account Rebalance Underfunded RSA: < 5 Years 16

18 Initiatives

19 INITIATIVES Campus Partnerships > Strengthen relationship with internal borrowers through dedicated Asset Liability Management credit analysts > Partnership on deferred maintenance strategy with University Facilities and Capital Planning and Development Industry Engagement > Formalizing strategic investor outreach Program Development > Private use: Improved Polices and Procedures help ensure compliance with Federal tax-exempt guidelines. Developing workshop and better tracking system for private business use across campus > Efficient use of Treasury balances Initiatives Debt > Medicine disclosure/consolidating credit > Refresh Commercial Paper disclosure document to better align with current asset reporting > Next debt issuance expected to be in January