Economy & Finance

2011 Issue 1 - Bright Future Non Profit Financing

1. SERIES 2011 | ISSUE 1Non-Profit Finance:Fresh PerspectivesJUNE 2011 A Bright Future For Non-Profit Financing? The past three years have witnessed dramatic developments…
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  • 1. SERIES 2011 | ISSUE 1Non-Profit Finance:Fresh PerspectivesJUNE 2011 A Bright Future For Non-Profit Financing? The past three years have witnessed dramatic developments in theInside This Issue capital markets resulting in a fundamentally changed, still evolving, and,2 The Rise and Fall of VRDBs in many respects, significantly improved financing climate. Both access to capital and the breadth of financing alternatives have expanded2 BQ Bonds… First to the Rescue, Then off to the while interest rates have remained low and relatively stable. The causes Sunset of this more hospitable environment are several, and the benefits to non-profit borrowers are many:3 And Now… The “NBQ” Bond!  Structurally simpler and sounder “bank bought” transactions are3 To What End a Public eclipsing the traditional variable rate demand bond (VRDB) Offering? structure.5 The Blessings of Competition and Price  Long the province of large investment-grade-rated banks, the Transparency non-profit market is witnessing the emergence of well capitalized regional and community banks as competitive sources of financing. The increasing number of banks active in the non-profit sector is creating greater competition in the lending community resulting in lower capital cost for non-profit Wye River Group is an borrowers. independent financial advisory firm focused on  In response to the growing reluctance of borrowers to use the financing and interest rate swaps, traditional “variable rate” lenders are nowinvestment needs of non- offering “true fixed rate” options for periods up to 10 years and profit organizations. amortizations of up to 30 years. How did all of this happen and what does it mean for non-profits pursuing financings or refinancings?
  • 2. Page 2 NON-PROFIT FINANCE | FRESH PERSPECTIVES The Rise and Fall of VRDBs VRDBs have long been the most popular tax-exempt financing vehicle for non-profit organizations. Over the past 10 and 20 years, VRDB borrowers have enjoyed average borrowing costs of 1.80% and 2.60% respectively (excluding the cost of remarketing services and the letter of “The vulnerabilities of financing structures credit (LC)). Since the early 2000s, borrowers have been sold on the involving VRDBs and idea of fixing “synthetically” their variable rate borrowing cost by companion swaps were purchasing an interest rate swap. The vulnerabilities of financing fully exposed during the structures involving VRDBs and companion swaps were fully exposed credit crisis of 2008-09.” during the credit crisis of 2008-09:  LC bank credit rating downgrades resulted in increased VRDB rates and in some instances, the collapse of the market for such bonds.  Borrowers discovered the meaning of “basis risk” as their interest rate swaps failed to hedge increases in VRDB interest cost.  Mark-to-market losses on swaps, often combined with significant erosion in investment portfolio values and radically increased debt service cost, triggered financial covenant violations with an array of negative consequences. BQ Bonds… First to the Rescue, Then off to the Sunset Many non-profit borrowers struggling with “broken” VRDB financings found salvation in a refinancing with “Bank Qualified” (BQ) Bonds. Under the stimulus-motivated American Recovery and Reinvestment Act of 2009, the new, but temporary, BQ exemption for non-profits was not only a timely solution for the restructuring of troubled bond issues, but a radically new financing alternative that challenged banks to offer less expensive and structurally simpler direct loans with features non-profit Bank Qualified Bonds borrowers wanted most:  a variable rate option with an interest rate that is indexed rather than market driven,  no “basis risk” for those inclined to synthetically fix their variable rate financings, and  better yet, for borrowers desiring predictable borrowing cost without a hedge, “true fixed rate” options.
  • 3. NON-PROFIT FINANCE | FRESH PERSPECTIVES Page 3Between 2009 and 2010, it is estimated that approximately $70 billionof non-profit BQ financings were completed. During the same period, VRDB vs. BQ Issuance ($ in millions)new issuance of VRDBs declined by nearly half, with a significant 120,000 100,000amount of outstanding VRDBs redeemed or refunded with BQ Bonds. 80,000Unfortunately, the tenure for the special BQ exemption was brief. It 60,000expired on December 31, 2010. Legislation has been introduced to 40,000reauthorize the exemption, but the prognosis for its passage is dim. But 20,000 0even if the special BQ exemption never returns, it has had a profoundly 2006 2007 2008 2009 2010beneficial impact on the non-profit community, with banks continuing VRDBs BQ Bondstoday to offer “BQ-like” financing alternatives. Source: The Bond Buyer Figures are based on issues maturing in 13 months or longerAnd Now… The “NBQ” Bond!“Non Bank Qualified” (NBQ) financing is rapidly achieving prominenceas the successor to BQ financing. Here is what we are seeing in themost recent (2011) financing solicitations conducted for our non-profitclients:  Despite the loss of the BQ exemption, a significant number of banks are still offering “bank purchased” alternatives to LC- backed VRDBs.  Banks are not only offering both variable and true fixed rate “For most non-profit options, but pricing is reasonably in line with last year’s BQ borrowers, it is hard to levels. Typical variable rate options are being priced at 67 to justify a public offering of 77% of LIBOR plus a “spread” and true fixed rates for good fixed rate bonds…” credits have ranged from 2.50% for a 3-year term to up to 4.00% for a 10-year term.  For variable rate financings, banks are offering swaps whose pricing is calibrated to the related bond rate index to assure effective hedging.To What End a Public Offering?In light of the expanded financing repertoire of banks, that is a goodquestion. For most non-profit borrowers, it is hard to justify a publicoffering of fixed rate bonds unless the borrower is either:  an “AA” or better rated credit with a relatively large borrowing requirement ($30 million plus) and a strong desire to secure a fixed rate for the full term of the debt, or
  • 4. Page 4 NON-PROFIT FINANCE | FRESH PERSPECTIVES  at the other end of the credit spectrum, a non-rated credit with a financing requirement that cannot satisfy the lending criteria of banks (for instance a high “loan to value” need or a significant dependency on future growth in revenues to support debt service). In general, the disadvantages of a public offering relative to a bank- based financing are significant:  transaction costs that can be twice as high or more,ABC Non-Profit  the interest rate is not fixed until all financing documents areFixed Rate Financing Options completed and the bonds are sold, which can take months Year NBQ Public Offering from the start of the transaction, exposing the borrower to 1 --- 1.95% potentially higher than planned rates, 5 --- 3.80% 7 --- ---  there is usually a debt service reserve fund requirement equal to 10 4.25% 5.35% 10% of the borrowing amount, exacerbated by a significantly 15 --- 6.00% 20 --- 6.20% negative carrying cost under current market conditions, 30 --- 6.50% All-In Cost 4.37% 6.55%  the initial and ongoing annual public disclosure requirements Source: The Bond Buyer can be burdensome, WRG Managed Transactions Key Assumptions:  there is an early repayment limitation, usually in the form of a 10-  BBB Credit Quality  $10 Million Borrowing; 30 Year Term year redemption prohibition, and  NBQ Callable in Year 10  the interest cost will be 150 to 250 basis points higher than that of a 10-year, bank-purchased alternative under current market conditions. Moreover, as a practical matter, relatively few long-term, fixed rate bond issues ever even run full term. Interest cost saving opportunities, new borrowing requirements and other changes in circumstances inevitably prompt the refinancing or early repayment of a significant number of such issues. Consequently, if a non-profit can borrow under current market conditions at an all-in fixed cost of 4.00% for 10 years, it may be hard-pressed to justify the public offering alternative at appreciably higher interest rates.
  • 5. NON-PROFIT FINANCE | FRESH PERSPECTIVES Page 5The Blessings of Competition andPrice TransparencyToday, borrowers have the opportunity to reap the benefits of (1)increasing competition among a growing number of capital sourcesand (2) mechanisms that can harness competition to their maximumadvantage. In our experience, competitive solicitations directed to alllogical financing candidates consistently produce better pricing andterms than one-on-one negotiation or “price shopping”. At our firm,we have developed web-based solutions to streamline solicitation,information dissemination and proposal analysis. The result is a highlycompressed and cost-effective process that enables a broad basedmarket solicitation of 25 or more financial institutions, the selection of apreferred lender, negotiation of a commitment letter and transactiondocuments within 90 to 120 days. This compares to the more “In our experience,cumbersome and expensive process for VRDBs or public offerings that competitive solicitationscan typically span 180 to 270 days. consistently produce better pricing and termsFor non-profit borrowers, debt financings will almost always be “mission than one-on-one negotiation or “pricecritical” and great care should be taken to assure that the financing shopping”.”serves the mission. Non-profits owe it to themselves and theirstakeholders to secure financings on the most economical and cost-efficient basis with reasonably contained transaction costs. Bank-based financing offers non-profits those opportunities. The challengefacing each non-profit borrower in these transactions will bemanaging the planning, solicitation, evaluation and implementationphases of the financing process to the best economic advantage.The assistance of a knowledgeable and motivated independentfinancial advisor can help assure that result.For More Information: Wye River Group Independent Financial Advisors 522 Chesapeake Avenue | Annapolis, MD 21403 |
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