College and university finance leaders, together with their advisors, turn to some common benchmarks as they establish a range of debt capacity. Knowing that range is critical when constructing a debt strategy.

Along with current market trends and interest rates, financial executives focus on credit evaluations as they seek to establish debt capacity. Not all debt capacity analysis is created equal due to the specific circumstances of each institution, its existing debt structure and covenants, and unique aspects of its capital and financial plan.

Following is an overview of some broadly instructive tests. The results, together with information about rating agency medians and peer institutions, provides tremendous insight regarding debt capacity at your institution’s current rating level (or with an assumed rating change).

Wealth and liquidity

The following wealth and liquidity metrics are key areas when focusing on the assets side of a college or university’s balance sheet:

  • Total cash and investments ($)
  • Endowment ($) and restricted nature of endowment assets ($)
  • Endowment portfolio investment allocation (%s)
  • Spendable cash and investments ($)
  • Spendable cash and investments to operating expenditures (%)
  • Monthly days cash on hand (#)

These measures provide insights into the overall wealth of the institution, but also the ready access to liquidity (reserves) that have been needed or are available to support operations and capital expenditures, as well as the repayment of debt service. The magnitude of operating reserves for an institution is measured using the metric of spendable cash and investments compared to operating expenditures and monthly days of cash-on-hand.

As with any set of metrics, a reviewer may track trends across multiple historical fiscal years (typically looking back five years) and will work with the institution to understand forward-looking financial outcomes given expected operations and planned spending.

Operating performance

An institution’s overall operating size, pricing power and revenue diversity carefully factor into a credit review. Additionally, an institution’s ability to consistently operate at a surplus and generate solid cash flow are closely evaluated for a single fiscal year as well as establishing trends over time.

Key measurements include:

  • Total operating revenue ($)
  • Highest revenue category contributor (%)
  • Annual change in operating revenue (%)
  • Net tuition revenue ($, total and per student)
  • Total tuition discount (%)
  • Operating margin ($ and %)
  • Operating cash flow ($)
  • Operating cash flow margin (%)

Operating cash flow is a key measure when considering debt capacity and the ability of an institution to pay on its debt service obligations. The underwriting process will factor in changes in individual revenue and expense line items (ongoing or one-time charges) and the pressures the institution may face over time that will influence its ability to generate positive operating cash flow.

Leverage and debt affordability

Regarding financial leverage and affordability, a handful of metrics are predominately used to establish current and proforma capacity and balance sheet impact:

  • Spendable cash and investments to total debt (x)
  • Total debt to cash flow (x)
  • Debt service burden (%)
  • Annual debt service coverage (x)
  • Maximum annual debt service coverage (x)
  • Operating revenue to total debt (x)

These metrics are of particular significance as they are directly impacted by a new capital plan, refunding for savings, restructuring principal repayments, and/or defeasance strategies. When layering in the new capital plan, it is critical to establish clear assumptions and inputs and run live debt service schedules that overlay historical and pro forma financial analysis.

Student demand

Colleges and universities are under significant competitive pressure to recruit and attract students to campus (matriculate), then ensure their growth and success through graduation. To understand how an institution is positioned within the marketplace amongst its peers, a credit evaluation looks at the following measures:

  • Applications, acceptances and matriculations (number, by cohort)
  • Selectivity for first-time freshmen and other cohorts (%)
  • Matriculation for first-time freshmen and other cohorts (%)
  • Total enrollment and enrollment by student-type, i.e. undergrad, grad, etc. (number)
  • Retention (%)
  • Graduation (%)
  • In- vs. out-of-state students (%)
  • Residential students, those living in university housing (%)

Strategic positioning and management

The competitive higher education landscape is rapidly changing and evolving, which only increases the importance for an institution to be thoughtful, nimble and well positioned for future success.

The institution’s management and the board of directors’ approach to strategic planning and investment in personnel, programs, and facilities are critical to maintain market position, reputation and ensure the long-term viability of the institution. Too little investment over several years may diminish the attractiveness to students, donors and the community at large, as well as potentially reduce research or grant funding. However, too much investment, especially with the use of debt, may apply too much weight via high fixed costs and create an unsustainable business model.

Although this category of a credit evaluation is more qualitative in nature, these metrics provide awareness of the effectiveness and sophistication of an institution within its short- and long-term planning, ongoing self-assessment and benchmarking, policies, procedures, controls and accountability. Board turnover as well as senior administration/management and the potential impacts of change in leadership and vision can also be considerations in your institution’s credit review. The ability to set objectives and goals, measure them over time, and follow through with continuity amongst senior administration can be of great value.

Financial covenants and municipal advisory approach

For purposes of structuring bond issues, we take a multi-faceted approach to establishing financial covenants and additional bonds test, as applicable depending upon the credit strength of the institution. We must balance the credit strength of the institution and its future capital plans with the desire of the investor to monitor and maintain its investment to maturity or redemption. We seek to structure financial covenants such that they afford an investor good protection, but also with a margin of safety that allows the institution to satisfy its obligations going forward.

When appropriate within market circumstances, investor requirements and the credit strength of the borrower, we will structure covenants that ensure ongoing balance sheet strength, i.e., financial leverage, and the ability to generate cash flow and repay debt service, i.e., debt service coverage. When writing covenants, we use understood terminology and numbers that tie back to the audited financial statements or that management can prepare and present consistently.

Securing financing for your institution through bonds is a niche type of credit that requires careful analysis, planning and implementation.

Learn more about how UMB Financial Services, Inc. municipal advisors can assist to help find a quality path forward during these complex conditions. Contact us to connect with a municipal advisory team member.

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