Primer on Debt Financing and Treasury Management Presented by Erin Gore Executive VP, Wells Fargo Bank, N.A. Doug Brown Director, Wells Fargo Securities
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Agenda History of Treasury What is Treasury? Rating Agency View Debt Primer Treasury Automation
History of Treasury Subhead
ACH Banking Automation What is Treasury? Cash Management Receivables Debt Bond Indebtedness Investment Endowments Analytics Efficacy Reconciliation Card Cashflow Accounts Payable Data Flow of Funds Focus Today: Debt and Treasury Trends Liquidity Payments
Total Financial Resources ($000) S&P Rating & Outlook Changes 1 Rating Agency View Rating Changes as of January 1, 2014 2010 2011 2012 2013 Upgrades 26 26 12 12 Downgrades 4 17 16 19 Total 30 43 28 31 % of Rating Downgrades 13% 40% 57% 61% Rating Outlook Revisions as of January 1, 2014 2010 2011 2012 2013 Positive 16 25 20 17 Negative 28 13 14 33 Total 44 38 34 50 % of Negative Outlooks 64% 34% 41% 66% In 2014, both Moody s and S&P assigned not-for-profit higher education negative outlooks, citing the sector s challenges regarding student affordability concerns, rising costs, and reduced government funding. Growth in Financial Reserves is a Credit Stabilizer 2,3 MOODY S MEDIAN FINANCIAL RESOURCES 290,000 270,000 250,000 Factors Influencing the Negative Outlook Operating margins continue to compress Flat or declining tuition revenue Declining enrollment 230,000 210,000 190,000 170,000 2009 2010 2011 2012 2013 Public Universities Growth since 2009: Public : 37% Private : 45% Private Universities (1) Source: S&P: Many Factors Burden The U.S. Higher Education Sector In 2014 as of February 6, 2014. (2) Source: Moody s: Growing Pressure Evident in Fiscal 2013 Public University Medians as of July 11, 2014. (3) Source: Moody s: Stability of Fiscal 2013 US Private University Medians Masks Underlying Pressure as of July 11, 2014. Credit Positives in the Higher Education Sector Long-term demand for higher education is still strong Increases in reserves, due to favorable portfolio returns and gift giving Increases in efficiencies/cost cutting Decreases in capital spending and less appetite for debt
College & University Financing in the Municipal Markets $3.6 Trillion total municipal bonds ( munis ) outstanding -- Issued by states, localities, school districts, public universities, nonprofits, airports, and other municipal authorities $36 billion of new security issues for education borrowers in 2014 Lower financing cost Investors generally do not pay taxes on the interest In theory, an investor receiving 10% interest from a corporate bond would expect 6.5% interest from a tax-exempt bond (assuming a 35% marginal tax rate) In reality, municipal benchmarks are often closer to 80-90% of taxable rates (10-yr AAA MMD is currently 102% of 10-yr US Treasury) comes with greater restrictions from the IRS Tax-exempt financing generally limited to eligible capital expenditures Construction costs (including soft costs ) Other capital improvements Ongoing compliance with respect to eligible use of the facilities financed Earnings in bond fund (construction, escrow, etc.) are rate restricted (by the bond s arbitrage yield ) Weighted average maturity of the bonds cannot exceed 120% of the useful life of the assets financed Source: Federal Reserve, Flow of Funds, Balance Sheets, and Integrated Macroeconomic Accounts Third Quarter 2014 (statistical release December 11, 2014); Securities Data Corporation.
Traditional Tax-Exempt Bond Structures Fixed Rate Variable Rate Synthetic Fixed Rate Borrower Borrower Letter of Credit Fee LOC Bank Borrower %LIBOR or SIFMA Fixed Rate Swap Counterparty Fixed Rate Variable Rate Remarketing Fee Variable Rate Bond Holders Bond Holders Remarketing Agent Bond Holders PROS Lowest risk debt structure Committed capital 10-year call option CONS Higher cost Requires public rating PROS Historically very low cost Flexible repayment Available to unrated borrowers CONS Risk of increasing rates Requires ongoing bank credit support PROS Low cost fixed structure CONS Complex structure Swap introduces new risks Requires ongoing bank credit support
Bank Direct Purchase Bank directly purchases variable rate bonds Newer Tax-Exempt Structures Floating Rate Notes (FRNs) Investors purchase variable rate notes based on borrower s credit Taxable Debt of All Kinds Corporate CUSIP vs. municipal CUSIP Borrower Borrower Maturity: 5 to 100 years Bank % LIBOR + credit spread Note Holders % LIBOR (or SIFMA) + credit spread Call Features: Make Whole versus Par Call Trend at larger universities toward using taxable for a strip of all projects PROS No remarketing fee, no rating No exposure to failed remarketing / bank downgrades during the credit period Potentially less disclosure CONS Bank renewal risk More complicated renewals PROS No bank support required Generally light covenants Low spreads in today s market CONS Market risk: spread not set until day of pricing Volatility in spreads / investor appetite Refunding of bonds not eligible to be refunded with tax-exempt debt
Bond Transaction: Who is Involved and What Do They Do? Investment Bank/Underwriter Bond Counsel Trustee Investment Bank/Underwriter Overall deal management (often in conjunction with the borrower s Financial Advisor) Debt structuring and analysis Review documents Rating agency strategy and presentation Market and price the bonds Bond pricing/execution review and analysis Borrower s Counsel Represents the borrower Negotiates documents: Loan Agreement Security documents, if applicable Bank documents, if applicable Reviews all documents for the borrower Gives advice on potential risks to borrower Bond Counsel Provides Tax-exemption opinion Hired by borrower but acts on behalf of bondholders Drafts documents that ensure: The proper procedures are in place The documents are enforceable The pledged revenues are legally available as security for the debt Underwriter s Counsel Represents the underwriter(s) Provides to the underwriter(s) an opinion that the offering document does not contain any untrue statement of a material fact or omit to state a material fact Conducts due diligence and reviews: Official Statement Continuing disclosure certificate Prepares: Bond Purchase Agreement Blue sky memorandum Trustee Hired by borrower but acts on behalf of bondholders Holds funds under the indenture Accounts for funds and investment earnings Receive debt service payments: Principal payment Interest payment Other funds defined in indenture May act as dissemination agent for continuing disclosure Borrower s Counsel Underwriter s Counsel Rating Agency/ Credit Provider Rating Analyst / Credit Provider Rating agency reviews credit materials and visits the issuer/borrower to evaluate the credit rating Third party credit support provider reviews credit materials and visits the issuer/borrower to determine pricing of the credit package Credit enhancement may lower overall cost Third party credit support provider will require security and covenant package
Typical Tax-Exempt Transaction Timeline Issuance process typically takes 10-12 weeks from the date of mandate for existing issuers Engage Finance Team Determine Bond Structure Solicit and Secure Credit Rating and/or Credit Enhancement Prepare Disclosure and Legal Documents Mail POS / Pre-marketing of Bonds Bond Sale Close Transaction Weeks 1-2 Weeks 8-10 Weeks 4-8 Weeks 10-11 Weeks 11-12 Weeks 3-4 Secure Approval from Conduit Issuer (Private) or Governing Body (Public) TEFRA Public Hearing Notice Published (Private)
($ Billions) ($ Billions) (%) (%) (%) Snapshot of Today s Market Tax-Exempt/Taxable Ratios Short-Term Interest Rates Remain Compressed 5.5 5.0 4.5 4.0 30Y MMD 30Y UST MMD/UST Min 2.47% 2.25% 87.9% Max 4.51% 3.97% 120.6% 10Y Avg 4.06% 4.03% 100.7% Current 2.50% 2.25% 111.1% 140 120 100 0.5 0.4 0.3 SIFMA is currently 0.02%, its all-time low; LIBOR is currently 0.17%, 2bps above its all-time low. 3.5 3.0 2.5 80 60 0.2 0.1 2.0 40 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 0.0 Jan-12 Jan-13 Jan-14 Jan-15 MMD/UST 30Y MMD 30Y UST Sources: TM3 and Bloomberg, as of January 30, 2015 Source: Bloomberg, as of January 30, 2015 SIFMA 1M LIBOR 450 400 350 300 250 200 150 100 50 0 Annual Municipal Bond Volume* 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Annual Total Annual Average 2.0 1.0 0.0 (1.0) (2.0) (3.0) (4.0) Municipal Bond Fund Flows YTD 2015 net inflows are $3.7 billion (5.0) Jan-13 Apr-13 Jul-13 Nov-13 Feb-14 Jun-14 Sep-14 Jan-15 Source: Bond Buyer: A Decade of Municipal Bond Finance, as of January 2, 2015. *Represents long-term issuance; excludes short-term notes and remarketings Source: Lipper, A Thomson Reuters Company, as of January 30, 2015. Represents only funds that report weekly.
Positioning University Cash Portfolios Curve steepening in the current environment is causing investors to look at their strategic cash allocations to see if there are opportunities to extend or introduce new asset classes into their investments. Segmentation of the Corporate/ Public Cash Portfolio (for illustrative purposes only) Liquidity, Stability of Principal Liquidity, stability of principal Operating Cash (Horizon - daily) Reserve Cash (Horizon - Quarterly) Restricted Cash (Horizon - longer-term) Strategic Cash (Horizon - longer-term) Less liquidity, higher yields, more price volatility Less liquidity, higher yields, more price volatility Q1 Q2 Q3 Q4 Source: ICI, Wells Fargo Securities, LLC
Changes in the Short-Term Investment Environment 1. A good investment policy will: Be kept up to date Be flexible Include a broad set of short-term asset classes Establish clear limits on credit risk, duration risk, and individual issuer and asset class concentrations 2. Successful cash managers have: A clear picture of cash flows over multiple investment horizons based on individual business needs (i.e. daily, weekly, monthly and longer-term horizons) Those cash flow forecasts can be used to separate true day-to-day operational cash needs from longer-horizon reserve and/or strategic cash needs An investment strategy consisting of a current market-based and cash flow-based view of cash needs and the investments that best match those needs in the current market environment Appropriately aligned the current investment strategy with the parameters of the investment policy
Change in Payment Types Creates Opportunities for Change Are You Ready? 2013 Fed Study Non-Cash Payments Estimated number of noncash payments, excluding wire transfers, was 122.4 billion Debit Card = 47B Credit Card = 26B ACH = 22B Debit, credit, and prepaid card trends include general-purpose and private-label payments Source: Federal Reserve 2013 Payments Study
Change in Payment Types Creates Opportunities for Change Are You Ready? Inflection point Fewer checks than electronic payments, but many processes still built around paper IT infrastructure, including workflow, must be in place Is your workforce set up to think in the automated process? Will it be mandated?
How Consumers are Paying Bills Online increasing Mobile/Phone ramping up Mail decreasing ACH stable Debit card outpacing credit card Avg ACH payment: $2,186 Avg check payment: $1,420 Source: Aite Group
Biggest Opportunities for Higher Education Need for automation, especially of reconciliation process Use of third party solutions, including standard data capture, to bridge IT gaps Reimagining processes and workforce, eliminating paper and manual intervention Improving the customer experience for the student demographic Align decentralized decision making and revenue models to a more efficient treasury function Technology in the workplace is not as strong as the technology at home