internal banking
DESCRIPTION
2012 Treasury SymposiumTRANSCRIPT
Internal Banking all Grown Up
Susan Fitzgerald (Prager & Co.)James Matteo (University of Virginia)Chris Malins (University of Washington)
January 2012
INTERNAL BANKSAkin to academic medical centers:
“You see one internal bank, you’ve seen one internal bank”
Agenda:
• Definition/History
• Components/Issues
• Survey of internal banks
• Lessons learned
• Case Study: University of Virginia
• Case Study: University of Washington
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WHAT IS THE INTERNAL BANK?Definition – The adoption of one or more banking practices such as cash management, investment management, and debt management to (1) facilitate the flow of resources from external sources to internal uses and/or (2) create unrestricted resources.
General objectives for the Internal Bank:
Centrally manage financial resources
Loans
Investments
Cash balances
Create predictability in capital costs (and working capital returns) for budgeting and planning
Generate funds that can be used for a variety of purposes
Optimize capital financing sources to ensure attractive long-term risk adjusted cost of capital to overall enterprise
Provide a vehicle for working capital/liquidity management
Numerous institution-specific considerations involved in establishing and managing the Internal Bank.
Objectives for the Internal Bank must be determined by the Treasury or the Board
Policy and procedures for management of the Bank must be established
3
EVOLUTION OF THE CENTRAL BANK
Project Specific
Borrowing
Central Bank for Debt
Management
Merging of Debt and Liquidity
Management
Increasingly Sophisticated Management and Oversight
4
KEY DECISION POINTS
• Objectives for funds• Recycling to limit external debt• Redeployment for strategic initiatives• Equity in campus facilities
• Components:• Debt• Working Capital• Other Investments
• Operations:• Funding the bank• Establishing and adjusting the blended rate• Establishing and adjusting the payout rate• Rules for internal loans• Investment of funds• Ongoing monitoring and management
• Reporting:• Internal• Financial statements
• Governance: Board involvement?
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CASH MANAGEMENT/INVESTMENTS
Cash Management / Investing
Endowment Working Capital Internal Bank Cash
Capi
tal S
ourc
es Debt Service
Internal Bank
Project Funds/Internal Loans
• What are the investment considerations for Internal Bank funds?
• Duration
• Liquidity
• How will the Internal Bank reserves be viewed by member institutions?
• Will operating working capital and internal bank cash be co-mingled?
Discussion Questions
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PROJECT FUNDS/INTERNAL LOANS
Project 1 Project 2 Project 3
Internal Bank
Capi
tal S
ourc
es Debt Service
Cash Management / Investing
• What is the process/procedures for internal loan origination? What approvals are necessary?
• What is the structure of internal loans? Is there a uniform methodology?
• Principal and interest frequency?
• How are items like capitalized interest and costs structured?
• What is the rate charged to internal loans?
• Pass-thru rate? If equity funded, what is cost of capital assumption?
• Single/blended rate? If so, what is the setting methodology/calculation? How often is rate analyzed? How/when was rate adopted? How often has rate been reset? Are there loans included in the bank but excluded from blended rate?
Discussion Questions
Project Funds/Internal Loans
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REPORTING AND MANAGING
Outflows Inflows
Fiscal YearBeginning
Balance External DS Expenses Internal DSReinvestment
EarningsEnding
Balance PV @ 3.85%
2011 - (910,329) (80,731) 1,631,097 7,620 647,657 636,686 2012 647,657 (3,565,081) (161,462) 5,633,586 63,287 2,617,986 2,476,592 2013 2,617,986 (7,941,029) (161,462) 11,889,465 204,614 6,609,573 6,016,818 2014 6,609,573 (9,360,467) (161,462) 13,958,203 382,815 11,428,662 10,011,411 2015 11,428,662 (9,498,026) (161,462) 14,105,469 573,632 16,448,275 13,865,218 2016 16,448,275 (9,498,026) (161,462) 14,105,469 770,334 21,664,589 17,573,701 2017 21,664,589 (9,498,026) (161,462) 14,105,469 974,744 27,085,314 21,142,341 2018 27,085,314 (9,498,026) (161,462) 14,105,469 1,187,164 32,718,459 24,576,411 2019 32,718,459 (9,498,026) (161,462) 14,105,469 1,407,909 38,572,348 27,880,986 2020 38,572,348 (9,498,026) (161,462) 14,105,469 1,637,303 44,655,632 31,060,949 2021 44,655,632 (9,498,026) (161,462) 14,105,469 1,875,687 50,977,299 34,120,998 2022 50,977,299 (9,498,026) (161,462) 14,105,469 2,123,412 57,546,691 37,065,656 2023 57,546,691 (9,498,026) (161,462) 14,105,469 2,380,845 64,373,517 39,899,274 2024 64,373,517 (9,498,026) (161,462) 14,105,469 2,648,365 71,467,862 42,626,040 2025 71,467,862 (9,498,026) (161,462) 14,105,469 2,926,369 78,840,212 45,249,981 2026 78,840,212 (9,498,026) (161,462) 14,105,469 3,215,267 86,501,460 47,774,977 2027 86,501,460 (9,498,026) (161,462) 14,105,469 3,515,486 94,462,926 50,204,757 2028 94,462,926 (9,498,026) (161,462) 14,105,469 3,827,469 102,736,376 52,542,913 2029 102,736,376 (9,498,026) (161,462) 14,105,469 4,151,679 111,334,035 54,792,899 2030 111,334,035 (9,498,026) (161,462) 14,105,469 4,488,592 120,268,608 56,958,041
Simple Excel spreadsheet can monitor and model
• Outflows: Debt Service and other Expenses
• Inflows: Payments under internal loans
• Reinvestment earnings
• Ending balance
• Sensitivity to changes in blended rate charged to internal loan or changes in assumptions of reinvestment earnings
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REPORTING AND MANAGING:FINANCIAL STATEMENTS
Operating StatementRevenues
Internal Loan Interest 26,000 25,000 Investment Income 2,000 4,000
Total Revenues 28,000 29,000
ExpensesExternal Interest 26,000 26,000 Other 1,000 1,000
Increase in Bank Equity 1,000 2,000
Balance SheetAssets
Cash and Investments 46,000 50,000 Internal Loans Receivable 398,000 395,000
Total Assets 444,000 445,000
LiabilitiesLong-Term Debt 321,000 320,000 Commercial Paper 100,000 100,000
Total Liabilities 421,000 420,000
Equity 23,000 25,000
Blended Rate Component:
A blended, or single rate, is established to be charged to all internal loans.
Generally, the initial blended rate is established based on external cost of capital
plus certain administrative and interest rate buffers.
The rate is reviewed annually based on the actual and projected performance of
Internal Bank revenues and resources.
Internal Loan Component:
Procedures developed for application, approval, and tracking of loans.
Loan structures are independent of funding sources.
Internal loan program is presented to schools and divisions.
External Debt Component:
Model to track actual and expected debt service and costs taking into account
timing and risk in debt portfolio.
9
SURVEY OF INTERNAL BANKS IN HIGHER ED: PURPOSE
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Take Deposits
Op. Portf. Investment
Fund Common Benefits
External/Internal Debt
Source: Treasury Leadership Group Survey, 2010
10
SURVEY OF INTERNAL BANKS IN HIGHER ED: COMMON BENEFITS
0% 5% 10% 15% 20% 25% 30% 35% 40% 45%
Central administration
President/Provost
Capital project funding
Strategic initiatives
Source: Treasury Leadership Group Survey, 2010
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SURVEY OF INTERNAL BANKS IN HIGHER EDUCATION: INVESTMENT STRATEGIES
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1 2 3 4 5 6 7 8 9 10
Cash/MM Fixed Income Endowment Other
Source: Treasury Leadership Group Survey, 2010
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Constant evolution Written objectives, policies, procedures Ongoing communication―Administrative―Departmental―Governing body Consistency of application How often to change blended rate/payout rate Alterations to investment profiles/risk tolerance of
the bank How to treat certain borrowings and “one offs”:
taxable debt? Refinancing savings? Discipline
LESSONS LEARNED
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Case Study: University of Virginia
Presenter: Jim Matteo
UVA INTERNAL BANK - OBJECTIVES
Centrally manage financial resources and risks Provide settlement function for cash flows with
endowment
Generate unrestricted resources
Providing units with a full range of services:
Loans
Investments
Cash Balance Tracking
15
UVA INTERNAL BANK - OPERATING PROCEDURES
Bank Activities include debt management, investment management, and cash management.
Internal Bank serves as a settlement agent Executive management involvement is increasing. No
board involvement at this time Distribution of unrestricted resources the biggest
item to be considered
16
UVA INTERNAL BANK - COMPONENTS
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UVA INTERNAL BANK - FINANCIAL STATEMENTSBalance Sheetas of June 30, 2011
Assets
Cash
Investments - Short Term Internal Bank
Investments - Short Term CRP
Investments - Long Term Internal Bank
Investments - Long Term CRP
Investments - Restricted Debt Proceeds
Internal Loans Receivable
Internal Loans Receivable - Working Capital
Direct Loans Receivable (VCBA & State Issued)
Total Assets
Liabilities
Commercial Paper
Long Term Debt
Bond Premium or Discount
Build America Bonds rebate
Internal Investment Program Deposits
Due to Construction Projects
Due to Departments
Total Liabilities
Equity
Retained Earnings - CRP
Retained Earnings - Internal Bank
Distributions - Internal Bank
Net Assets
Total Net Assets and Liabilities 18
UVA INTERNAL BANK - FINANCIAL STATEMENTSIncome Statementfor the twelve months ended June 30, 2010
Revenues
Income on Bank Deposits
Escrowed Income
Income on ST Investments - IB
Restricted Income on Invested Bond Proceeds
Unrealized Gain/(Loss) on Investments
Unrealized Gain/(Loss) on Investments Restricted - CRP
Internal Loan Income Restricted - CRP
Internal Loan Income - Working Capital
BABS Subsidy
Total Revenues
Expenses
Bank Fees
UVIMCO Management Fee
UVIMCO Incentive Fee
PFM Management Fee
Debt Issuance Fees
Debt Maintenance Fees
Amortizations of Bond Premium
Interest Expense - External Debt
Interest Expense - Internal Investment Program
Operational Expenses
Total Expenses
Net Income
19
UVA INTERNAL BANK - FINANCIAL STATEMENTSStatement of Cash Flowsfor the twelve months ended June 30, 2010
Cash Flows from Operating Activities
Net Income
Unrealized Gain on Investments
Net Cash Flows Provided/(Used) by Operating Activities
Cash Flows from Financing Activities
Increase in Bond Premium/Discount
Decrease in Amounts Due to Departments
Decrease in Due to Construction Projects
Increase in Long-term Debt
Increase in Short-term debt
Decrease in Build America Bond rebate
Decrease in Internal Investment Program Deposits
Net Cash Flows Provided/(Used) in Financing Activities
Cash Flows from Investing Activities
Increase in Internal Loans ReceivableDecrease in Direct Loans ReceivableDecrease in ST Investments
Increase in LT Investments
Increase in Restricted Investments - CRP
Increase in Restricted Investments - Debt Proceeds
Net Cash Flows Provided/(Used) by Investing Activities
Decrease in Cash and Cash Equivalents
Cash and equivalents, July 1
Cash and equivalents, December 31
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UVA INTERNAL BANK - MODELING
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UVA INTERNAL BANK - MODELING
ReturnStandard Deviation
Target Endowment Weight 100.00% 75.00% Cash/Short Term Investments 0.00% 0.0%Long Term Investments 7.50% 10.0%
Minimum Initial Payout $10,000,000 $10,000,000 Internal Loans Receivable 4.74% 0.0%Capital Reserve Ratio 25.00% 10.00% Commercial Paper 0.12% 0.0%Payout Over X Years 10 10 Long Term Debt 4.17% 0.0%Payout Deferred for X Years 1 1 Internal Investment Program Deposits 0.00% 0.0%Payout Increase Limit Amount 20.00% 10.00% Due to Departments 0.00% 0.0%
Discretionary Payout Yes YesDiscretionary Payout Over X Years 10 -Discretionary Payout Threshold - $10,000,000
Stochastic Returns Yes YesDiscount Rate for PV Calculations 7.50% 7.50%
Treasury Operations Modeling - Consolidated
Assumption CRP IB
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
$250 $467 $684 $900 $1,117 $1,333 $1,550 $1,767
Probability
$MM Present Value
Present Value of Wealth Created
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
2010 2015 2020 2025 2030 2035
Probability
Year
Probability of Negative Equity Value
$0
$50
$100
$150
$200
$250
$300
$350
$400
$450
2010 2015 2020 2025 2030 2035 2040
Annual Payout $MM
Year
Annual Distribution Amount
99%
95%
75%
50%
25%
5%
1%
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UVA INTERNAL BANK - MODELING
-$20,000,000
$0
$20,000,000
$40,000,000
$60,000,000
$80,000,000
$100,000,000
$120,000,000
$140,000,000
$160,000,000
2010 2015 2020 2025 2030 2035 2040
Annu
al P
ayou
t
Year
Annual Payout
DiscretionaryPayout
-$500,000,000
$0
$500,000,000
$1,000,000,000
$1,500,000,000
$2,000,000,000
$2,500,000,000
$3,000,000,000
$3,500,000,000
$4,000,000,000
2010 2015 2020 2025 2030 2035
Asse
ts
Year
AssetsCash/Short Term Investments Long Term InvestmentsInvestments - Restricted Debt Proceeds Internal Loans ReceivableInternal Loans Receivable - Working Capital Direct Loans Receivable (VCBA & State I
$0
$500,000,000
$1,000,000,000
$1,500,000,000
$2,000,000,000
$2,500,000,000
2010 2015 2020 2025 2030 2035
Liab
ilitie
s
Year
LiabilitiesDue to Departments Due to Construction ProjectsInternal Investment Program Deposits Build America Bonds RebateBond Premium or Discount Long Term DebtCommercial Paper
$0
$200,000,000
$400,000,000
$600,000,000
$800,000,000
$1,000,000,000
$1,200,000,000
$1,400,000,000
$1,600,000,000
$1,800,000,000
$2,000,000,000
2010 2015 2020 2025 2030 2035 2040
Equi
ty
Year
Equity
Equity
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UVA INTERNAL BANK - GOVERNANCE
Treasury Management responsible for operation of the bank
Executive Management is getting involved in operation and distribution guidelines
Financial Statements are produced for CFO Statements are used for internal management only
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Case Study: University of Washington
Presenter: Chris Malins
OVERVIEW
Central bank began operations on 7/1/2008 Cost of funds at 5.5% General Revenue credit used for all university
borrowing Statutory authority to issue debt for all purposes
granted in 2007 Annual audited financial statements $10m in rate stabilization at 6/30/2011
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OBJECTIVES & DECISION MAKING
Program Goals• Achieve lowest risk-adjusted cost of capital for the institution• Provide stable and predictable rate for internal borrowers
Decision MakingDebt Advisory Committee meets quarterly• Reviews credit markets, debt strategy and structure for upcoming bond issues• Membership includes Washington Deputy State Treasurer, UW’s financial advisors, UW Investments team members, and underwriter representatives
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OPERATING STRUCTURE
Internal Debt Portfolio
External Debt Portfolio
UW Internal Borrower
Rate Stabilization
Account / Program Costs
External Debt Market
Capital
Debt Service
Internal Debt
Service
Internal Loan
Funding
External Debt
Service
Capital
Internal Lending Program
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INITIAL CHALLENGES AND OPPORTUNITIES
Creating the basic structure of the bank Institutional buy-in Strong policy Up-leveling key decisions Accounting and reporting
29
CURRENT CHALLENGES AND OPPORTUNITIES
State reporting Managing expectations and communicating the
message to borrowing units in a low interest rate environment
The role of the Treasury Office in decision-making Projects that wouldn't otherwise be financeable
can now be approved Need for additional resources
Staffing Modeling
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CURRENT CHALLENGES AND OPPORTUNITIES (CONTINUED)
Diversifying the debt portfolio through variable rate debt Making the case to senior management and
regents Policy amendment
Decisions made when starting a bank can make huge differences down the line Cash flow neutral to refundings generated
“windfall” revenues to the bank which are especially needed as the capital plan is funded.
Higher initial rate
31
FUTURE CHALLENGES AND OPPORTUNITIES
The “debt deluge” and its impacts on the future Institutional challenges and market forces could
increase UW’s cost of capital Federal funds reliance Widening credit spreads and overall rate
increases Stewardship of rate stabilization account Policy for excess funds
Use to fund future projects (equity and/or loan) Lower the rate to reduce reserve over time Rebate to departments
The asset side
32
FUTURE CHALLENGES AND OPPORTUNITIES (CONTINUED)
Higher assurance bank sufficiency measures Off the shelf model Homegrown model
Ongoing disclosure and credit review “early warning” system Project early warning vs. institutional risk
management Reporting that drives decision-making
Board level Senior leadership
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Appendix
School 1― Two banks effective July 1, 2010:
― The University Bank manages all non-endowed cash and investments ― The Capital Bank is somewhat of a 'debt pool' and manages amortization schedules, capital plans, swap issues, debt
structure, and market risk and defines the appropriate rate to charge divisions and schools for allocated outstanding debt
― Capital Bank started with minimal assets on July 1, 2010― ‘Assets' of the Capital Bank are claims on cash managed in the University Bank (i.e., the Capital Bank will not have real
cash and investments)
School 2― Bank was funded by GO debt and school cash balances and is used to make internal loans to schools and centers― The bank’s assets are these internal loans, investment in intermediate treasuries, the endowment and cash. ― Now implementing statements on the bank
School 3― Bank includes debt, investment, and cash management― Bank is designed to be self-sustaining ― Funding is derived from fees and positive spreads between the cost/return on funds and the interest received/paid from
or to units
School 4― Internal Bank is primarily funded with externally issued debt ― Secondary funding sources include: spread between blended rate and actual portfolio rate; dedicated institutional
allocation of a portion of overhead receipts; and a portion of operating assets (liability)
INTERNAL BANKS IN HIGHER EDUCATION
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School 5― The bank operates between four offices – CFO (approvals), Financial Services(Investment and Debt Management,
Controller (Accounting) and Resource Planning (Analysis) ― The bank is self-sustaining through spread management
School 6― “Internal Bank” has enhanced and expanded long-term structures for managing internal/external debt and cash
operations/projections ― The “Bank” provides policies and tools for aggregating data for analyses, decision-making and managerial refinements
School 7― Operating Bank: self-sustaining with approved depts/schools/units receiving interest on avg. cash balances based on 3m
T-bills― Capital Bank: Beginning deposit of quasi endowment. Self-sustaining with monitoring of minimum balance ($100mm).
Internal borrowers pay level amortization. External debt managed on a portfolio basis. Bank receives some annual unrestricted spending from endowment. Long term invested with endowment and short term needs invested in the operating bank. All debt part of bank
School 8― School has a debt bank, and separately working capital fund balances are managed by the management company and
cross invested into the merged pool ― President has the discretion to determine % of working capital fund balances are invested in Merged Pool (between 70
and 90%)― Fund holders receive a guaranteed money market return, excess returns are deposited 1st into a buffer = 35% of fund
balances, then into funds functioning as endowment controlled by the President ― These funds are typically used to co-invest or provide seed funding for new strategic initiatives
INTERNAL BANKS IN HIGHER EDUCATION
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1. This presentation is for your internal use alone, for the limited purpose of assisting an evaluation of your potential interest in the strategies described, and is confidential as to third parties (with the exception that there is no limit on any disclosure of the US tax treatment or tax structure of any transaction). This material may not be given to third parties without our prior written consent. Information regarding values should not be relied on for maintaining books and records.
2. This presentation is not contractual, not a research report nor an offer to buy or sell or a solicitation of an offer to buy or sell any security or interest. Contractual obligations will be created only by formal written agreement. Information regarding pricing, interest rates, and transaction costs is preliminary and indicative only. We invite inquiry into the assumptions underlying future projections and other forward looking statements in the presentation.
3. Except as compelled by applicable law we make no warranty, express or implied of any nature as to any information or technique herein and do not guarantee satisfactory results. In no event may we be liable for any special or consequential damages that may be incurred in using the data provided. Before entering into any transaction, you must independently determine the economic risks, and your institution’s ability to assume the risks. Senior management should be involved in or informed as to this process.
4. Risk assessment of derivative products is complex. One must also consider the implications of accounting and financial disclosure rules such as the FASB requirements for mark-to-market procedures or the extensive GASB reporting requirements.
5. We are not lawyers, accountants or tax specialists; you should seek and rely on independent advice as to such matters from properly qualified firms or individuals.
DISCLAIMERS
INTERNAL LOAN TERM SHEET EXAMPLE
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