1801 Debt Management
Subject Area: Debt Financing
Responsible Office: Financial Services
Sponsor: Chief Financial Officer
Originally Issued: October 1992
Revised: August 2000, February 2004, October 2007, January 2010, January 2015
Refer Questions To: John Kroll, 773-702-1941
Purpose: To establish responsibility for issuance and management of external debt
- Responsibility – The Executive Vice President for Administration and Chief Financial Officer is responsible for the recommendation to issue external debt.
- Approval – All external debt financings, including issuance of taxable or tax-exempt debt, the structure of that debt, bank lines of credit, and liquidity enhancements must be approved by the Board of Trustees.
- Debt Capacity of the University – The Debt capacity of the University will be governed by its ability to support annual debt service through the operating budget and the long-term credit rating of the University assigned by the rating agencies.
- Refunding and Restructuring of Debt – Management will periodically review all outstanding debt to determine if there are refunding opportunities that would provide a net economic benefit to the University.
- Debt Service and Compliance – Financial Services is responsible for administering debt service requirements and ensuring compliance with applicable debt covenants.
Following is a background discussion of this policy.
The University of Chicago funds its operational and capital needs from a variety of sources. The University has predictable annual revenue that derives from tuition and other charges as well as a draw on its endowment. These sources support the annual operating budget including ongoing facilities maintenance. Donations and proceeds from debt issuance can be two other major sources of funds to provide support for new programs and capital needs. However, with each new program or capital project, whether funded from donations or debt, comes an increase in the operating budget. This necessitates careful planning and resource allocation, as well as prudent funding decisions.
The following principles will serve to guide the University’s use and management of debt. These principles are intended to apply to all debt of the University, both short and long-term, including capital leases, revenue bonds, certificates of participation in financing leases and other similar capital market borrowings.
- Debt is an important tool in the management of the University’s balance sheet. Debt should be used to leverage the assets of the University, making available resources that enable the University to fund its mission of teaching and research.
- Debt is an integral part of the management of the University’s balance sheet that must be managed in conjunction with the University’s assets. The University will manage its debt portfolio consistent with the standards and manner in which it manages its investment portfolio. Diversification within the debt portfolio can be used to reduce interest rate exposure.
- The University will pursue strategies that maintain access to debt markets at reasonable costs.
- The debt capacity of the University will be governed by its ability to support annual debt service through the operating budget, the long-term credit rating assignments of the rating agencies, and a number of key financial ratios.
- Debt Capacity Criteria
- Credit Rating. The University shall maintain a long-term credit rating in the AA category through its management of the operating budget and its balance sheet. The University shall not propose issuance of incremental debt if it would cause the long-term bond rating from Moody’s Investors Service and Standard & Poor’s to fall below the AA category. More specifically, the pro forma issuance of debt shall not result in a rating below the Aa3/AA- level.
- Total Resources to Debt. The University shall strive to maintain the level of total resources to debt above 3:1. This ratio is a broad measure of the University’s leverage position. Total Resources is defined as total net assets less net investment in plant, or less the difference between the University’s value of property, plant and equipment and debt related to such assets.
- Expendable Resources to Operations. The University shall strive to keep the level of expendable resources to operations above 1.75:1. While this measure of liquidity is less directly affected by the issuance of new debt, it does provide a useful indication of a financial cushion relative to operations. An expendable resource is defined as net assets less net investment in plant less permanently restricted net assets.
- Interest to Operations. While debt service to operations has traditionally been used to asses debt service burden, the increasing use of bullet maturities and other variations of deferred principal makes the calculation of debt service more difficult. Moreover, maturing debt can be, and frequently is, extended to increase the average life of the debt in accordance with the economic life of the assets financed. As a result, the regular payments of interest, which generally cannot be deferred, are a more appropriate measure of the current burden on operations from debt. The University shall strive to keep interest expense at no more than five percent of operating expenses.
- Length and Structure of Debt Maturity
It is the policy of the University that debt will be structured so as to be consistent with a fair and equitable allocation of costs to current and future beneficiaries or users of the asset(s) being financed with the proceeds of debt. The intent of this policy is to require that debt be issued only for a time period that is consistent with the life of the project for which the debt was issued. Tax-exempt debt must meet the “120 percent of useful life” test set forth in federal tax law. This test requires that tax-exempt borrowings be limited to a term of not more than 120 percent of the estimated useful life of the asset(s) being financed with the proceeds of the issue.
The use of bullet maturities is not precluded by this policy if it can be demonstrated that the retirement of such bullet maturities has been adequately and appropriately planned for.
- The Use of Calls, Derivatives and Other Hedging Products
The University will seek to maintain flexibility in its debt portfolio as insurance against unforeseen capital needs. Accordingly, the University may consider, with the approval of the Financial Planning Committee of the Board of Trustees, the use of call options, derivatives and other synthetic products when such use functions to either reduce the University's overall cost of capital and/or provides structuring advantages not available in the traditional public finance marketplace.
The issuance of debt without a call provision, or with a call provision longer than ten years requires the approval of the Financial Planning Committee of the Board of Trustees in that under certain circumstances, such as the sale, disposition or sharing of any asset financed with tax-exempt debt may first require the repayment of such debt. Moreover, in some interest rate environments and because of potential future tax changes, long-term non-callable debt may work to the disadvantage of the University.
- Fixed and Variable Rate Debt
The University will always seek to borrow in the interest rate market that provides the lowest possible cost of funds, consistent with the prudent consideration and management of interest rate risk. Long-term fixed rate debt is usually reflective of the greater credit and inflation risks that may occur over long periods than are interest rates that can vary in response to these forces.
Variable rate debt is defined as all debt with a rate of interest that must be reset except for any debt that is synthetically fixed by way of an interest rate swap. As such, commercial paper notes or tender date bonds with mandatory conversions shall be considered variable rate bonds.
Further, in calculating the amount of variable rate debt, the University shall deduct the average amount of short-term cash or cash equivalent investments it held over the last year or expects to hold over the current or next year. The purpose of this is to consider the extent to which the risk associated with variable rate debt is hedged by short-term cash or cash equivalent investments.
Any debt swapped from a fixed rate to a variable rate shall be considered variable rate debt.
This policy makes no direct recommendations regarding the use of any particular variable rate product but anticipates the University will regularly assess traditional variable rate products as well as developing markets for new products such as auction rate securities, alternative forms of liquidity, tender bonds, and synthetic floating rate debt.
The University may choose to issue debt securities that pay a rate of interest that is fixed at the time of the offering of the securities, or at some date in the future, according to a prearranged mechanism. The University may elect to control its interest rate exposure on such fixed rate debt through the use of products designed to offset such risks, as discussed below.
The University will consider the use of non-traditional financial products on a case-by-case basis. Examples of such non-traditional products include: interest rate swaps, interest rate caps and collars, “synthetic” refunding transactions and float contracts. The use of such non-traditional products will only be undertaken upon the recommendation of the Chief Financial Officer and with the approval of the Financial Planning Committee of the Board of Trustees.
This policy recognizes that the selection of the type of interest rate arises from the specific facts and circumstances of individual borrowings, and is driven by factors such as the expected life of the debt, the interest rate environment, the probability of changes in interest rates over the expected life of the borrowing, the mix of assets and liabilities on the University’s balance sheet, and demonstrated investor preferences for one type of rate over the other. As a general rule, variable rate borrowings present the least costly funds, albeit at somewhat greater risk.
The University believes that the issuance procedures and costs associated with permanent, fixed rate debt should limit the use of such debt to circumstances where interest rates are historically low, the borrowing can be accomplished at better than representative rates for similarly situated issuers, and the assets being financed have long useful lives.
In view of these considerations it is the policy of the University to maintain, over long periods of time, a mix of fixed rate debt to variable rate debt that is roughly equal.
- Refunding and Restructuring of Debt
Periodic reviews of all outstanding debt will be undertaken to determine refunding opportunities. Refunding will be considered (within federal tax law constraints) if and when there is a net economic benefit of the refunding or the refunding is essential in order to modernize covenants essential to the University’s financial or operating position.
In general, refunding for economic savings will be undertaken when net present value savings of at least three percent of the refunded debt can be achieved. Refunding with savings of less than three percent or with negative savings may be considered if there is a compelling policy objective such as to restructure principal or any financial or legal covenants that prove disadvantageous to the University.
The Chief Financial Officer is the University officer responsible for the management of the University’s debt portfolio and implementation of this policy in consultation with other University officers including the Vice President and Chief Investment Officer and the Associate Vice President for Finance.
On an annual basis the Chief Financial Officer will undertake a review of the University’s debt portfolio, with particular attention to the various criteria set forth in this policy, and shall report the findings of such a review to the Financial Planning Committee of the Board of Trustees.