higher education debt financing
DESCRIPTION
TRANSCRIPT
Table of ContentsIPED
Section 1 Why are Schools Issuing So Much Debt?
Section 2 Market Conditions
Section 3 Issuance Process
Section 4 Debt Structure
Appendix A Disclaimer
Section 1
Why are Schools Issuing So Much Debt?
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Why are Schools Issuing So Much Debt?
Borrowing Annually for New Construction Projects and Refinancing
Higher Education Bond Issuance
Source SDC Platinum, Thomson Financial
1
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update
$-
$4,000
$8,000
$12,000
$16,000
$20,000
$24,000
$28,000
$32,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
New Financings Refinancing
Volume
$MM
Why are Schools Issuing So Much Debt?
Key Questions Asked by Board Members
• Why are colleges and universities using debt?
• Should we issue fixed-rate or variable-rate debt?
• What are the relative advantages to using derivatives?
• How should we amortize our debt?
• How might future decisions be constrained by decisions made now?
2
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Section 2
Market Conditions
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Market Conditions
Historical Endowment Returns and Interest Rates
3
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
3 Mo LIBOR BMA NACUBO Annual Investment Return NACUBO Avg
• The difference between investing and borrowing is about 6% or 600 bps
– Or, for every $10 million that is $600,000 annually of free cash flow
• Green line shows the average endowment return*
– Average: 9.75%
• Blue line is floating taxable index
– Average: 4.725%
• Red line is floating tax-exempt index
– Average: 3.167%
– * National Association of College and University Business Officers
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Market Conditions
Historical Review of Interest RatesAs of February 23, 2006
Notes
1. 30-year Treasury Historical Data since January 1, 1981.
2. The Bond Buyer Revenue Bond Index is the arithmetic average of the yields to maturity for 25 A1 rated, 30 year revenue bonds. BBRBI began in 1979.
3. The Bond Market Association Municipal Swap Index (formerly the PSA Index) tracks non-AMT, weekly-reset bonds and began in 1989. JJ Kenny Index is the precursor to the BMA and
began 1982.
4. The Short Term Average is the average of BMA rates from a specific date until today. The JJ Kenny Index rates are used for the Short Term Average for the time period before the
inception of BMA.
4
Historical Averages
%30-Yr.
Treasury BBRBI BMA1-Yr Average 4.56% 4.99% 2.60%5-Yr Average 5.03% 5.20% 1.75%10-Yr Average 5.57% 5.47% 2.66%
High 15.07% 14.32% 7.89%Low 4.18% 4.72% 0.70%
4.50%
3.18%
5.14%
0%
2%
4%
6%
8%
10%
12%
14%
16%
30-Year US Treasury BBRBI BMA/JJ Kenny Short-Term Rolling Average
% Current Rates
(2) (3) (4)(1)
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3.90%
3.95%
4.00%
4.05%
4.10%
4.15%
4.20%
4.25%
4.30%
02-J
an-0
7
09-J
an-0
7
16-J
an-0
7
23-J
an-0
7
30-J
an-0
7
06-F
eb-0
7
13-F
eb-0
7
20-F
eb-0
7
27-F
eb-0
7
06-M
ar-0
7
13-M
ar-0
7
20-M
ar-0
7
27-M
ar-0
7
03-A
pr-0
7
10-A
pr-0
7
17-A
pr-0
7
24-A
pr-0
7
01-M
ay-0
7
08-M
ay-0
7
15-M
ay-0
7
22-M
ay-0
7
29-M
ay-0
7
30-YR AAA MMD Rate
Market Conditions
Tax-Exempt Fixed Rates Heading Up?
5
Historical 30-Year MMD Rates January 1, 2007 to Present
Source Morgan Stanley, Market1
Notes1. Assumes 5% callable bond refunding structure; savings are discounted back to delivery date at rate equal to arbitrage yield2. As of market conditions May 22, 2007
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Market Conditions
Taxable Rates are Nearer 5 Year Highs
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Section 3
Issuance Process
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Finance Team Core Members
Underwriter’s Counsel
Underwriter
Credit Enhancer
Issuance Process
7
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Borrower
Borrower Counsel
Credit Enhancer CounselBond Trustee Bond Trustee Counsel
Conduit Issuer
Rating Agency
Bond Counsel
Issuance Process
Overview of the Financing Process
DocumentsDrafted
CreditEnhancer
Solicitation
BorrowerDecidesto IssueBonds
WorkingGroup
Selected
PreliminaryPlan ofFinance
Determined
RatingAgency
Presentation
FinalizeDocumentsand Finance
Plan
MarketingPricing
andPost Sale
8
2-3 Months
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Section 4
Debt Structure
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Debt Structure
Fixed or Variable
9
• Budget process
• Asset-Liability Management
• Institutional preference
• Interest rate risk
• Credit risk
• Tax risk
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This material is not a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. This material was not prepared by the Morgan Stanley research department. Please refer to important information and qualifications at the end of this material.
Debt Structure
10-400+ Basis Point Decision
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• Lower financing costs / relative value analysis
• 10 to 150 bps decision with concurrent risks
• Transfer or assume individual market risks
– Interest Rate Risk
– Credit Risk
– Tax Risk
• Customize structures
– Start dates
– Call options
– Knock-out options
– Conversion options
– Fixed / floating mix
This material is not a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. This material was not prepared by the Morgan Stanley research department. Please refer to important information and qualifications at the end of this material.
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• Derivative transactions are ‘marked to market’ on financial statements
Debt Structure
BMA / LIBOR RatiosTax Efficiency of Short-term Market and Inefficiency of Long-term Market
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0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
BMA / LIBOR 1 - Marginal Tax Rate
BMA to LIBOR Swap Ratios
Tax Efficient Tax Inefficient
Focus on Long Term
Market
Focus on Relationship in
Short Term Market
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This material is not a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. This material was not prepared by the Morgan Stanley research department. Please refer to important information and qualifications at the end of this material.
Historical 20-Year BMA/LIBOR Ratio
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Current: 81.25%
72%
74%
76%
78%
80%
82%
84%
05/1997 05/1998 05/1999 05/2000 05/2001 05/2002 05/2003 05/2004 05/2005 05/2006 05/2007
20 Year BMA/LIBOR +/-2 Std Dev +/-1 Std Dev Average
Historical 20-Year BMA/LIBOR Ratios
Source Morgan Stanley
Statistics20-Year BMA/LIBOR Ratios
January 1997 - May 2007
Average 77.87%
Standard Deviation 2.16%
Maximum 82.88%
Minimum 73.13%
Current Ratio: 73.31%
Debt Structure
Original Basis Swap Execution
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This material is not a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. This material was not prepared by the Morgan Stanley research department. Please refer to important information and qualifications at the end of this material.
Debt Structure
U.S. Historical Marginal Income Tax Rates
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0
10
20
30
40
50
60
70
80
90
100
1916 1920 1924 1928 1932 1936 1940 1944 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008
Top Federal Tax Rates Since 1916%
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This material is not a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. This material was not prepared by the Morgan Stanley research department. Please refer to important information and qualifications at the end of this material.
Financing Opportunities
Cancellable Swap Mechanics
• Borrower pays a fixed rate and receives floating through cancellation date
• Morgan Stanley owns the ongoing right to cancel swap beginning at the cancellation date and semi-annually thereafter
• Current floating rates are about 3.65% so an immediate 40-60 bps savings for borrower indifferent to fixed or floating
To Cancellation Date From Cancellation DateCancellable at Morgan Stanley’s option
Fixed Swap Rate
Floating Rate
Borrower
Bonds
Floating Rate
Borrower
Bonds
Fixed Swap Rate
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Debt Structure
Indicative Pricing for Series 2007
Index Paid Fixed Rate
BMA 4.16%
68% of 3M LIBOR 3.77%
68% of 3M LIBOR with Cancellation Option:3 Years 3.10%
68% of 3M LIBOR with Cancellation Option:5 Years 3.22%
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This material is not a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. This material was not prepared by the Morgan Stanley research department. Please refer to important information and qualifications at the end of this material.
Appendix A
Disclaimer
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Disclaimer
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General Risks. In addition to any specific risk factors that may be discussed herein, there are other factors that may influence the performance of a specific municipal derivative product. Although the foregoing list is not exclusive, listed below are general risks associated with typical municipal derivative structures.
Counterparty Risk. The risk that your counterparty will not perform pursuant to the contract’s terms thus exposing the issuer to variable rate bonds (i.e., not be hedged) and/or owing a termination payment. Issuers should carefully assess counterparty risk when engaging in municipal derivatives transactions.
Basis Risk. Basis risk refers to the mismatch between the variable rate payments received on a swap contract and the interest payment actually owed on the bonds. The two significant components driving this risk are credit and BMA/LIBOR ratios. Credit may create basis risk because an issuer’s bonds may trade differently than the swap index as a result of a credit change in the issuer. BMA/LIBOR ratios (or spreads) may create basis risk under percentage of LIBOR swaps if the issuer’s bonds trade at a higher percentage of LIBOR than the index received on the swap. This can occur due to many factors including, without limitation, changes in marginal tax rates, tax exempt status of bonds, and supply and demand for variable rate bonds.
Amortization Risk. This risk represents the potential cost to the issuer from a mismatch between outstanding underlying bond amortization and the outstanding notional amount of the swap. Amortization mismatches could also result in terminations of portions of the swap prior to maturity and under unfavorable conditions.
Termination Risk. The risk that the swap could be terminated as a result of certain events including a ratings downgrade for the issuer or swap counterparty, covenant violation, bankruptcy, payment default or other defined events of default. Termination of a swap may result in a payment made by the issuer or to the issuer depending upon the market at the time of termination.
Fundamental Risks of DerivativesIPED
Disclaimer
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