Managing Risks in the Internal Lending Program, Lecture notes of Investment Management and Portfolio Theory

Download Managing Risks in the Internal Lending Program and more Lecture notes Investment Management and Portfolio Theory in PDF only on Docsity! F–11 F–11/207-11 7/21/11 VII. STANDING COMMITTEES B. Finance, Audit and Facilities Committee Internal Lending Program Risk Management INFORMATION: This will be an oral report for information only. The attached slides will be used during the presentation. They are provided here so that those who want to review them ahead of time have an opportunity to do so. Attachment Managing Risks in the Internal Lending Program MANAGING RISKS IN THE INTERNAL LENDING PROGRAM UW Board of Regents Finance, Audit and Facilities Committee July 21, 2011 F-11.1/207-11 7/21/11 Page 1 of 17 Overview: ILP Goals & Decision Making 4 Program Goals • Achieve lowest risk-adjusted cost of capital for the institution • Provide stable and predictable rate for internal borrowers Decision Making Debt 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 F-11.1/207-11 7/21/11 Page 4 of 17 Overview: ILP Structure 5 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 F-11.1/207-11 7/21/11 Page 5 of 17 6 Overview: Historical Borrowing Decisions $30M in CP; rate to date 0.75% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 UW Long Term Borrowing Rate UW Short Term Borrowing Rate Build America Bonds Rate $213M in tax-exempt at 3.88% $150M in tax-exempt/ BABs at 3.22% $78M in BABs at 3.63%$76M in BABs at 3.97% $165M in taxable/BABs at 3.97% ILP APPROVED BY REGENTS 7/1/2008 $75M in CP; rate to date 0.25% F-11.1/207-11 7/21/11 Page 6 of 17 Portfolio Management: Future Borrowing Rate Sensitivity 9 • Expected Borrowing in FY 2012 = $287 million • Weighted Average Cost of Funds on current portfolio (including June 2011 Bonds) = 3.9% • External interest rates would have to increase to nearly 7% in 2012 to increase the weighted average cost of funds to 5% Under this scenario, the Rate Stabilization Account would still be funded • External interest rates would have to increase to 8.5% in 2012 to increase the weighted average cost of funds to 5.5% Under this scenario, there would be no ongoing funding for the Rate Stabilization Account, but existing balances would remain intact F-11.1/207-11 7/21/11 Page 9 of 17 Proposed Change To Debt Management Policy 10 • Proposal Amend Debt Policy to set maximum variable rate debt exposure to 20% of debt portfolio (currently no limit on variable rate debt) • Risk-reward trade-off Variable rate debt has lower cost than fixed rate debt, but introduces rate and liquidity risks • Rationale for 20% limit Rating agencies impose higher scrutiny for issuers with more than 20% variable rate debt exposure University’s available liquidity support estimated at 25% of market value of cash and liquidity pools (currently $250 million available) Peer institutions with variable rate debt exposure typically allocate 20% - 25% of debt portfolio to variable rate debt F-11.1/207-11 7/21/11 Page 10 of 17 11 0% 2% 4% 6% 8% 10% 12% 14% 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 Year Fixed Rate Avg 6.3% St Dev 1.97% Variable Rate Avg 3.78% St Dev 2.03% Since 1975, fixed rates have been higher than variable rates with an average spread of 2.50%. Portfolio Management: The Role of Variable Rate Debt in Lowering the Overall Cost of Debt Historical Interest Rates: 1975 - 2011 F-11.1/207-11 7/21/11 Page 11 of 17 Managing Borrower Risk 14 Monitoring Reporting Description 1. Construction progress Regents Monitor project schedule and budget, ILP construction draws. 2. Financial updates Regents Periodic updates (not less frequently than annual reports). 3. Key financial metrics Regents Specific borrower financial data required by ILP financing agreements. 4. Proforma variance Internal Annual variance review of proforma-vs.-actual financial performance. 5. Minimum reserves Internal Semi-annual review of borrower reserves. ILP borrower’s financial performance is compared to projections to detect potential loan repayment problems F-11.1/207-11 7/21/11 Page 14 of 17 Portfolio Management: Borrower Impairment 15 (1) Monitoring • Borrower is required to report key data annually. • For major borrower, Treasury requires “early warning” quarterly or semi-annual reporting. (2) Mitigation • Borrower is required to use internal resources to resolve financial issues. • Internal resources include reserves, cost reductions, operating changes, revenue enhancements. (3) Intervention • If borrower is unable to fully mitigate problem, Provost will provide temporary bridge loan. • Provost will require borrower’s fullest internal mitigation efforts before providing assistance. (4) Restructure • If borrower is unable to return to normal financial condition, operational and budgetary actions will be imposed. F-11.1/207-11 7/21/11 Page 15 of 17 Institutional Support 16 • ILP financing agreements identify institutional backstop if borrowers are unable to make debt service payments. • Borrowers are required to take internal mitigation action before Provost provides loan backstop. • Institutional backstop is a temporary bridge loan until normal financial condition is restored. Internal borrower mitigation is undertaken before institutional resources are available F-11.1/207-11 7/21/11 Page 16 of 17