Financial Asset and Liability Management FIN Al Rodack Vice President Finance & Administration

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1 Financial Asset and Liability Management FIN 2241 Al Rodack Vice President Finance & Administration

2 The Challenge Before Us Limited tuition increases Enrollment declines Low investment returns on cash More compliance 2

3 The Opportunity Before Us Liquidity base of higher education Identifying how liquid higher education is The concept of an internal bank 3

4 Higher Education Unique Characteristics Dependable deposit base Liquid balance sheet Separation of endowment and non endowment Highly decentralized organizations Lack of coordinated balance sheet management 4

5 Tuition & Fees University Cash Flows Liquidity Flows Sources Uses Grants and Other Sources Annual Fund Flows Auxilaries Liquidity Needs Liquid Contingency Payroll Operating expenses Facilities management Funds from Endowment Quasi Endowment Funds Core Deep Core Auxiliary services Debt service 5

6 Deposits (non electronic) EA 003, NW 006, SE 008 IN 012, IN Pkg 121, IN CEP 122, IN Foundation 115, IN Acctg. 123, Area 9 333, SLA, UITS Telecom Lockboxes A/R, Hum. Res., Cobra Foreign Drafts REPO Bank Bond Proceeds Disbursements: Check Payroll Bursar Refunds Travel Refund Foreign Drafts UNIVERSITY Banking & Investment Accounts Concentration Account Depository Account Investment Account Trust Account Custody Savings Account Deposits (non electronic) BL 010 Mktg Svcs 101 BL Pkg 102 BL Bus 103 Copy Mach 036 Foundation 015 Connersville/EA 303 Athletics 130 CO 004 SB 007 Area Lockboxes Bursar, SLA REPO Banking Concentration Bank MMF Bank Bank Disbursements: Electronic Direct Deposits Bursar Travel, Accounts Payable, Univ. Benefits/Nyhart WIRE/ACH Deposits (Electronic) WIRE/ACH ACH Debits Cr Card Settlements IU Athletics 222 Endowment Short Term Investments Intermediate Term Investments Joint Gift Ofc. Newcastle/EA Bank Bank Bank Bradford Woods KO 005 Long Term Investments 6

7 Three Problems of Cash Flow Unsynchronized Uneven Uncertain 7

8 Cash Flow Timeline Payables Period Credit Period Collection Period Purchase Made Payment Made Enroll Statement To Student Student Mails Payment School Receives and Processes Payment School Deposits Payment School Receives Good Funds Day s Payables Days Receivables 8

9 Forecasting 80,000, ,000, ,000, ,000, FY 14 FY 15 FY 16 (20,000,000.00) (40,000,000.00) (60,000,000.00) 9

10 Objectives of Cash Forecasting Liquidity Management Financial Control Strategic Objectives Capital Budgeting Cost Management Currency Exposure 10

11 The School as a Bank Short Term Investments Long Term Investments Deposits Withdrawals Short Term Borrowings Long Term Borrowings 11

12 What is ALM? Asset and Liability Management Overview Coordinate management of investment portfolios and debt. View assets and liabilities as a whole, rather than as unrelated portions of the balance sheet. ALM Objectives Reduce net interest expense, the difference between interest paid on debt and interest earned on investments. Mitigate effect of interest rate changes on net interest expense, using variable debt to offset short term investments or longer term investments to offset long term liabilities. 12

13 Asset Liability Management Evaluate Like a Bank Would When a new bond issue is contemplated, the amount of fixed and variable rate debt will also effect the amounts invested within the three investment portfolios and vice a versa. Liquidity Repayment schedules Interest rate risk 13

14 Matching Asset and Liability Duration More Closely Reduces Net Interest Expense Volatility. Rate Sensitive Interest Income RATE SENSITIVE INTEREST EXPOSURE Rate Sensitive Interest Expense INTEREST RATE SENSITIVE ASSETS VARIABLE RATE DEBT NET INTEREST EXPENSE LONG TERM ASSETS Fixed Interest Income FIXED INTEREST EXPOSURE Fixed Interest Expense FIXED RATE DEBT 14

15 What Are Your Real Liquidity Needs? (Hypothetical) Fiscal 2000 Fiscal 2001 Fiscal 2002 Fiscal 2003 Fiscal 2004 Liquid Contingency Cash July August September October November December January February March April May June Daily Liquidity Needs assets that are accessed on a routine basis Contingency Assets assets unlikely to be accessed in the next 1 to 3 years Core Cash assets NOT likely to be accessed in the next 3 to 5 years Deep Core Cash assets almost never needed or restricted Core Cash Deep Core 15

16 Perpetuity Your Organization s Financial Assets High Risk Long Term Investments Limited Term Assets Cash Investments Intraday Cash Management (Banking Transactions) Low Risk 16

17 External Environment Economic Influences on Operating Assets Endowment performance Access to debt Enrollment State appropriations Giving Auxiliary income 17

18 Cash Review Liquidity program daily needs Contingency program annual needs Core Cash program all other funds 18

19 Proper Level of Liquidity Insufficient liquidity Excess liquidity Maintain adequate, but not excessive, liquidity. Time needed to secure credit Credit availability Losing interest earnings Paying more interest than needed 19

20 Liquidity Dynamics A sliding scale based on investment policy / current operating needs 20% Core Limited Term The Endowment Hedge Strategies Private Capital 1 15% RETURN 10% 5% 3-Month T-Bill Private Real Estate Distressed Debt U.S. High Yield Bonds U.S. Government Bonds International Bonds 25% S&P500 / 25% Lehman Agg. / 25% 1-3 yr ML Index / 25% 3 Mo T-Bill 50% 3 Mo T-Bill / 50% 1-3 yr. ML Index 70% S&P 500 / 30% Lehman Agg. U.S. Large Cap Equities U.S. Small Cap Equities International Equities Emerging Markets Equities 0% 0% 5% 10% 15% 20% 25% 30% RISK 20

21 Developing an Investment Plan 21

22 Using Short Term Investments for Liquidity Management Precautionary and opportunistic requirements Earmarked funds Temporary surplus funds Ongoing operations Asset sales Securities issuance Seasonal performance Short vs. long term investments Price risk Yield pick up

23 Short Term Investments Demand Deposit Accounts Money Market Deposit Accounts Savings Accounts Earnings Credit CDs 23

24 What are Limited Term Assets? Limited Term Assets: Cash (Operating & Endowment) makes up the largest part of this asset pool. However, many other highly liquid funds that have a life expectancy of 3 to 5 years also fit into this category. Some examples: Operating Reserves, Cash Proceeds from Liability Management, Quasi Endowments, Self Insurance Reserves, Committed Grants not disbursed, Construction Project Funds, and Bond Proceeds. 24

25 Tax Exempt Interest Rates 8% 6% 4% 2% 0% 1/1/1998 1/1/2000 1/1/2002 1/1/2004 1/1/2006 1/1/2008 1/1/2010 1/1/2012 1/1/2014 Long Term Rates Short Term Rates 25

26 Determining your Limited Term Assets Determining your Total Liquidity Pool Commercial paper / debt issuance / credit lines Internal concentration of all limited term assets Gifts / fundraising proceeds / other sources of incoming cash Looking at the Future Demands on Cash flows Daily / Weekly / Monthly expenditures Capital Projects Debt Repayment Efficiently Managing Limited Term Portfolios Liquidity needs current vs. long term Credit quality constraints Volatility limits & asset class restrictions Discussion and/or development of Operating Funds Policy 26

27 Limited Term and Long Term Operating Investments Reality Potential for significant losses Accuracy of forecasts Illiquidity Significance Non cash investments are not a reliable source of liquidity What risk tolerance/return objective is appropriate for Operating Assets? Need organizational commitment to longer time horizon Accounting and budget implications Lack of a smoothing mechanism Are investments alongside the endowment appropriate? Institutions are inherently exposed to risks in the endowment 27

28 Opportunity Cost of Cash Growth of a Dollar through December Month T-bill Barclays Aggregate 60% S&P, 40% Barclays Aggregate

29 Funding Capital Budgets Tuition Other Fees State appropriations Gifts and Grants Endowment Income Earnings 29

30 Funding Capital Budgets Source of Capital Cash Internal Loans Bank Loans Bonds Certificates of Participation Capital Leases 30

31 Why Borrow? Facilities and Capital Budgeting Long term expenditures Buy or build assets Renovate assets Major maintenance Large equipment purchases 31

32 Higher Education Bond Market Increased dramatically in 1980 s Before then: Private institutions relied on fund raising Public institutions relied on state appropriations Better endowed, more sophisticated issuers of debt 32

33 Overall Borrowing Strategy Access to Capital Benefits of Using Financial Leverage Coordination with Capital Budgeting 33

34 Decisions/Issues to Consider in Borrowing Strategy Source Debt vs. Cash Maturity Short or Long Interest Rate Characteristics Secured vs Unsecured On and Off Balance Sheet Financing 34

35 Principles Regarding Use of Debt Unit access (Academic or Auxiliary). Institutional Approvals. Credit Rating/Debt Capacity. Percent of Annual Operating Expenditures. for Debt Service. Useful Life of Asset. Capitalization of Interest. 35

36 Higher Education Debt Categories Fixed Note Variable Rate Debt Portfolio Certificate of Participation Line of Credit Commercial Paper Master Lease Government Loans Capital Leases 36

37 Building Blocks of the Internal Bank Assets Liabilities Limited Term Assets Debt Portfolio Cash Management 37

38 Deposits Internal Bank Loans Spread Spread 35% General Fund INVESTMENTS LOC & Internal Loans 6% 55% Earnings Units Short Term 51% Capital Projects 92% 10% Other Intermediate Term 22% Leases 2% Long Term 27% Spread DEBT Fixed Notes Variable Rate CP Master Lease Cap Leases 73% 24% 1% 1% 1% 38

39 Internal Lending Process Credit Analysis Project Approval Financing Agreement Expenditure Funding Debt Repayment 39

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41 Other Asset Opportunities Look at all university assets. Determine what is core to the university. What assets do we manage well. Can assets be sold, outsourced or monetized? Are there opportunities to establish partnerships? 41

42 Asset Opportunity Examples Housing Energy Parking Trademarks and Licensing Bookstores Banking Telecommunications Hardware and Software 42