|Approved by:||Board of Trustees|
|History:||Issued -- March 6, 2000|
|Revised -- February 28, 2007|
|Last Revised --|
|Responsible Official:||Vice President for Finance and Treasurer tel. 202-319-5606|
To fulfill its mission, the University will need to make capital investments, driving capital decisions that impact the University's credit. Appropriate financial leverage serves a useful role and should be considered a long-term component of the University's balance sheet. Just as investments represent an integral component of the University's assets, debt is viewed to be a continuing component of the University's liabilities. Debt, especially tax-exempt debt, provides a low-cost source of capital for the University to fund capital investments to achieve its mission and strategic objectives. This policy provides the framework by which decisions will be made regarding the use of debt to finance particular capital projects.
This policy applies to all University staff in analysis of the University's debt capacity.
- To provide a guideline on the use of debt proceeds to support the University's capital needs while achieving the lowest overall cost of capital. Management and the Trustees must continue to have the ability to make judgments as to the wisdom and timing of such investments.
- To provide selected financial ratios with specific targets to ensure that the University continues to operate within appropriate financial parameters while allowing the University to maintain the highest acceptable credit rating that permits it to continue to issue debt at favorable rates. Use of key financial ratios provides management and the Trustees with feedback and assurances that the University is not exceeding its desired use of credit capacity. Management will regularly update the ratios to provide the Trustees with an overview of the financial health of the institution and its self-imposed debt capacity.
- To bridge the cash flow gap between the University's available funds and capital needs, management should always ensure that the appropriate leverage exists between cash reserves and the borrowing of debt.
III. Debt Operating Guidelines
Given that the University has limited debt resources, management will allocate the use of debt financing within the University with the approval of the Board of Trustees. This will include the prioritization of debt resources among all uses, including academic projects, equipment financing, real estate investment financial opportunities, and other projects. Generally, the following guidelines will be used, although they are not intended to be all-inclusive. Judgment by management and the Trustees ultimately will determine the use and amount of debt.
- Only projects that relate to the core mission of the University will be considered.
- A project that has a related revenue stream or can create budgetary savings will receive priority consideration. For these projects, the use of debt must be supported by an achievable financial plan that includes servicing the debt and meeting any new or increased operating costs, which could include the funding of a replacement and renovation reserve. For projects that can create budgetary savings, the budget will be reduced to fund the debt service and any additional savings will be invested into other critical capital projects. However, this priority consideration is not meant to exclude other projects that are key to the University's mission.
- The useful life of a project should be taken into consideration when using long-term debt for the capital investment.
- Fund raising for capital gifts are expected to be a major source of financing the University's investments. A cohesive, long-range facilities plan that addresses the strategic needs of the University and can be clearly articulated to potential donors is key to the success of capital fund raising efforts. In assessing the possible use of debt, all other revenue sources will be considered. Philanthropy, project-generating revenues, Federal and State grants, expendable reserves, and other sources are expected to finance a portion of the cost of a project. Debt is to be used conservatively and strategically.
To fulfill their respective fiduciary responsibilities, it is critical that the Board of Trustees and management know the extent of debt obligations. Debt is defined to include all short- and long-term obligations, guarantees, and instruments that have the effect of committing the University to future payments. The assumption of debt, both direct and indirect, will be subject to Trustees' approval. Any debt issued by subsidiary entities is subject to these policies.
It is recognized that in managing a liability portfolio, the use of derivative projects can be appropriate and advantageous for the purposes of limiting interest rate exposure and reducing debt service costs. Another consideration in the structure of the debt portfolio is the inclusion of variable rate debt. Fixed rate debt provides more long-term interest rate stability than variable rate debt. However, variable rate debt is a desirable component of the debt portfolio because it is typically at lower interest rates. Variable rate debt includes floating rate issues and commercial paper, as well as any "synthetic" variable rate debt created by use of fixed-to-floating interest rate "swaps". The use of variable debt does expose the debt portfolio to interest rate fluctuations. Therefore, the University will limit the use of variable rate debt to not more than 40% of the debt portfolio, and only include it in the debt portfolio when advantageous. The Board of Trustees will approve the use of derivative products and the inclusion of variable rate debt in the debt portfolio.
One of the policy's objectives is the maintenance of the highest acceptable credit rating for the University. Maintaining the highest acceptable credit rating will permit the University to continue to issue debt and finance capital projects at favorable interest rates while meeting its strategic objectives. The University will limit its overall debt to a level that will maintain an acceptable credit rating with the bond rating agencies. These agencies help maintain the confidence of the public and purchasers of the debt regarding the ability of an issuer to service and repay bonds. Management will provide the rating agencies with full and timely access to required information. To meet this policy objective, the University has established limits for overall debt using three ratios. These ratios are consistent with the measures used by rating agencies. However, the agencies monitor a number of other statistics and ratios in developing their opinions. Management will review annually all key rating agencies' ratios to monitor compliance with rating guidelines.
IV. Debt Ratios
The following ratios are not to be exceeded using the forecast of the current year without express approval of the Board of Trustees.
Ratio #1: Viability Ratio = Expendable Net Assets/Long-Term Debt:
The viability ratio measures the availability of expendable net assets (unrestricted net assets + temporarily restricted net assets - plant equity) to cover debt should the University be required to repay its outstanding obligations. The ratio should be no less than 140%. If the University's viability ratio begins to move closer to a 1:1 ratio, then it will be difficult for the University to respond to adverse conditions from internal resources. It will also impact its ability to attract debt financing from external resources to fund capital initiatives.
Ratio #2: Debt Burden = Actual Debt Service/Total Expenses:
The debt burden ratio measures the relative cost of debt to overall University expenditures (total expenses - depreciation + principal payments). By maintaining an appropriate proportion of debt service to total expenses, other critical and strategic needs can be met as part of the expense base. The ratio should be no greater than 7%. A level trend will provide an indication that there is sufficient coverage for debt service while not impeding financial resources to support institutional requirements. A rising trend will signify a demand on financial resources to cover the debt service which may result in budgetary reductions.
Ratio #3: Leverage Ratio = Available Net Assets/Long-Term Debt:
The leverage ratio is the ratio of the University's net assets less permanently restricted net assets to its debt portfolio. This ratio includes plant equity unlike the viability ratio and is similar to a debt-to-equity ratio. The ratio measures the amount of leverage on the University's assets. The target for this ratio is to be no less than 200%. If the ratio would fall below the 2:1 ratio, there would be concern that the university would have difficulty in making its loan repayments especially if there was deterioration in long-term economic conditions.
The Debt Policy will be reviewed by the Board of Trustees at least every two years and modified as necessary to reflect changing conditions.
The Office of the Vice President for Finance and Treasurer will provide an annual debt report to the Board of Trustees through the Finance Committee of the Board. The debt report will cover updated ratios, debt outstanding, annual debt service, available capacity, and bond rating.Each material new borrowing will continue to be presented to the Board of Trustees for approval.