April 2, 2009

Bond Sale Secures Liquidity

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When the University decided that it would take on $500 million in debt to raise liquidity on March 6, Cornell’s financial officers went to work picking a date during which the bonds would fetch the best interest rate in this dramatically fluctuating market. The coupon rate, or rate of interest on which the bonds sell, depends heavily upon events like release of jobless rates, corporate earnings reports, other assets being sold that day and religious holidays, according to Joanne DeStefano, vice president of finance.
However, when the University, along with its team of investment bankers, decided to sell its bonds during a conference call last Thursday morning, the bonds ended up being sold in less than 30 minutes. The traders kept accepting offers until about noon, at which point four times as many investors had subscribed as there were bonds available. After allocating the bonds to “mostly large investment-type firms” like insurance companies and financial institutions, DeStefano said, the University was able to lock in an interest rate of 4.35 percent for its $250 million of 5-year bonds and 5.45 percent for its $250 million of 10-year bonds.
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“The bonds were well executed and we were in the market at a very good time,” Patricia Johnson, associate vice president of finance and University treasurer, who was involved in planning the bond sale, stated in an e-mail. “For the taxable bonds, the funds allow us some flexibility with any additional needs the University may have to support our programs.”
DeStefano added that the quick sale of bonds was an endorsement of the Cornell brand and the trust that investors have in the University.
Finding the right time to sell was only one of many decisions that went into planning the bond sale. The finance team — made up of DeStefano, Johnson and Chief Investment Officer James Walsh, among others — had originally considered selling only $300 million in bonds, as that was the amount that the University needed to solve its liquidity need. However, with an uncertain economy, the team decided that $500 million would adequately provide for any additional needs. The team also hired underwriters to write the bonds and bond council attorneys to review them, a process that DeStefano termed “costly and time-consuming.”
Cornell’s decision to take on debt in order to provide for capital needs is not unique among institutions of higher education. Harvard decided to sell $1.5 billion worth of bonds in December while Princeton sold $1 billion in January. For 10-year bonds, Cornell’s 5.45 percent interest rate sits between Princeton’s 4.95 percent and Harvard’s 6.06 percent, according to Bloomberg, which indicates that Cornell secured a better deal than Harvard but a worse deal than Princeton. Cornell’s five-year bonds sold at an interest rate of 4.35 percent while Harvard’s five-year bonds sold at a higher interest rate of 4.98 percent, further showing that Cornell fared better than its Ivy League peer. Harvard was one of the first schools to sell taxable bonds, according to to DeStefano. Fluctuations in the market likely contributed to Harvard’s inability to secure a lower interest rate.
With the sale of bonds, Cornell’s credit rating was lowered from AA+ to AA by Standard & Poor’s Rating Services, a move propagated by its need to issue long-term debt, its $650 million increase in debt over the last fiscal year and its decreasing financial resources to debt ratio, according to an S&P press release. DeStefano added that the University’s decrease in endowment returns, its estimated $200 million budget shortfall and its potential need to begin new construction projects were all contributing factors to the lowered credit rating. She emphasized that Cornell owed about $1 billion in debt at the end of June whereas it now owes $1.7 billion in debt.
DeStefano said that the University was expecting to see a slide in its credit rating. In fact, she expressed satisfaction that the credit rating only dropped as much as it did, considering that Cornell told three credit rating agencies that it did not expect to make money off its endowment until fiscal year 2011.
“We expected a downgrade, so we are really happy to have one downgrade and one [agency] maintaining [the same rating],” DeStefano said.
However, if the University’s endowment continues to lose money, this could result in further downgrades in credit rating, which would make borrowing money costlier. DeStefano said further endowment losses would force the University to reevaluate and readjust its policies.
“We are not anticipating another ratings drop in the near future. We feel we have a good plan to balance our budget over the next few years,” Johnson stated. “If it did drop, it would mean that the costs for us to borrow would be higher, so we would need to use less debt in financing our projects.”
While Cornell’s sale of taxable bonds has made headlines recently, the University’s relatively overlooked sale of nontaxable bonds has also caused the University to take on substantially more debt. On Tuesday, the University sold $305 million in nontaxable bonds to coincide with its sale of taxable bonds. The bonds sold nearly as quickly, with twice as many subscribers as there were spots for investors. These bonds, which are generally sold on a biannual basis to raise money for current and future capital construction projects, were open for any investor to buy through an investment bank. Funds raised from nontaxable bonds must be spent within two years of their sale in order to retain a nontaxable status.
With $1.7 billion in current debt — $500 million of which must be repaid within the next 10 years — Cornell faces many challenges in the coming fiscal years. The University makes payments on its bonds on a monthly basis, much like a mortgage. DeStefano said that the University is currently contemplating moving towards managing a portion of its investment portfolio as a reserve, in order to contribute towards these repayments.
However, on the whole, the University’s financial officers were pleased with the sale of its bonds and the way the University is transitioning through the financial crisis.
“We put together a plan that we think addresses the most likely scenario,” Johnson stated. “We will continue to monitor our budget and address any issues that may arise.”