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2011 Issue 2 - Frequently Asked Questions (FAQs)

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1. SERIES 2011 | ISSUE 2Non-Profit Finance:Fresh PerspectivesSUMMER 2011 Non-Profit Financing Frequently Asked Questions (FAQs)Inside This Issue As one of the country’s…
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  • 1. SERIES 2011 | ISSUE 2Non-Profit Finance:Fresh PerspectivesSUMMER 2011 Non-Profit Financing Frequently Asked Questions (FAQs)Inside This Issue As one of the country’s leading Financial Advisors to non-profit1 Bank-Based Financing for institutions seeking project debt financing, we routinely receive inquiries Non-Profit Organizations from clients and prospects on matters of financing eligibility, alternatives, cost and process. Here are some of the questions which we receive2 Financing Purposes, Cost most frequently and our responses: Effectiveness & Interest Rate 1. Are regular bank loans and tax-exempt financing for 501(c)3 Benefit organizations generally the only types of financing you see3 Interest Rate Swaps and for non-profits or are there other popular financing vehicles? General Advice for Non-Profit Bank-based financing is the most prevalent form of debt financing Borrowers for non-profit organizations. Usually, such financing is structured to be “tax-exempt” in order to secure a lower interest rate. Generally, the only times that such financings are done as conventional “taxable” loans are (1) if the financing amount is relatively small or (2) the costs to be financed are not eligible for tax-exempt obligations. Whether taxable or tax-exempt, such transactions are usually structured as variable rate financings, although banks have been more effective the past two years in offering a true fixed rate option (ie. not swap-based). Tax-exempt financings are also sold periodically in the capital markets as “publicly offered” bonds. For non-profit borrowers with any of the following objectives or constraints, a public offering of fixed rate bonds may be an Wye River Group is an appropriate alternative: independent financial advisory firm focused on  true fixed rate financing with a term of 15 years or longer, the financing and  amortization structure of up to 40 years,investment needs of non- profit organizations  more liberal financial covenants,  lower fixed rates than available from banks due to strong, investment grade rated, credit quality, or  bank loan to value (LTV) or other bank requirements or risk considerations that cannot be satisfied (ie. relatively large project and/or small equity contribution)
  • 2. Page 2 NON-PROFIT FINANCE | FRESH PERSPECTIVES2. Other than purchasing or refinancing a building, what other types of major financing purposes do you see? Under Federal tax law, tax-exempt financing can only be used for tangible assets such as equipment, land or buildings. Typically such financing is used for the acquisition, development, construction or renovation of facilities used by a non-profit in its mission. There are no eligibility constraints for taxable debt financing. Consequently, taxable financing is sometimes used by non-profit In order for a tax- borrowers for “tax-exempt financing ineligible” costs such as the following: exempt financing to be  working capital, “cost justifiable” in our experience, the  rental property, minimum borrowing  facilities in which religious services will occur or amounts should be at  facilities in which a commercial enterprise will be conducted least $2.5 million for a bank-based financing3. For 501(c)3 entities considering tax-exempt financing, what is generally the “cut-off” in terms of the minimum amount of the loan for cost effectiveness as far as transaction costs are concerned? The major advantage of tax-exempt financing is that the interest cost is lower than that of taxable debt financing. The relative interest cost advantage can range from 20 to 33% depending on the size and credit quality of the borrowing and the borrower. However, transaction costs for a tax-exempt financing are generally higher than those for a taxable financing. Consequently, in order for a tax-exempt financing to be “cost justifiable” in our experience, the minimum borrowing amounts should usually be at least $2.5 million for a bank-based financing and $5 million for a public offering.4. What kinds of interest rate benefit from traditional bank financing do you see for tax-exempt financings? Taking into effect the relative credit spreads and adjustments for the tax- exemption, we are seeing interest rate benefits on tax-exempt bank transactions (compared to taxable bank financings) ranging from 35-50 basis points for variable rate deals and up to 300 basis points for true fixed rate transactions. With respect to tax-exempt financing, there has been relatively The combination of little difference in cost between various variable rate financing alternatives changing tax laws, offered. changes in bank Banks provide financing to non-profits in one of two ways: (1) through a direct capital and loan or purchase of tax-exempt bonds or (2) by “lending their credit” through accounting a letter or line of credit. In the latter case, a letter of credit (“LC”) is used to secure the issuance of tax-exempt variable rate demand bonds (“VRDBs”) requirements and the which are sold primarily to institutional investors. Although the VRDB structure is currently low interest considerably more complicated than a direct bank financing, it has rate climate have had historically been the most popular financing alternative among non-profit the collective effect of borrowers. That has been the case largely for two reasons. First, absent a specific exemption under Federal tax law (for instance the “bank qualified” reducing the relative exemption or the “2 percent de-minimis exception”), banks are limited in their benefit to banks of LC ability to enjoy fully the “after tax” benefit of owning a tax-exempt obligation based VRDB financing (unlike individuals or other types of institutional investors). Second, until over direct financing recently, banks could “leverage” their capital much more with a LC than a direct loan, thereby securing a better return on the capital exposed in a financing. The combination of changing tax laws, changes in bank capital and accounting requirements and the currently low interest rate climate have had the collective effect of reducing the relative benefit to banks of LC based VRDB financing over direct financing.
  • 3. NON-PROFIT FINANCE | FRESH PERSPECTIVES Page 3 …..we have seen recent credit spreads that range from 85 to 250 basis points (generally over LIBOR) depending on such factors as the borrower’s credit quality, the borrower’s industry sector (ie. education, healthcare, association) and size and term of the financing….. Under current market conditions, we have not witnessed a meaningful difference in the “credit spreads” offered by banks for LCs and direct loans. Because LC spreads are not as advantageous, relatively speaking, as they once were, there has been increased participation in, and competition for, non-profit financings from community and regional banks which are not investment grade rated and do not have rated LC capability. That greater competition is good for non-profit borrowers and has served to bring credit spreads down from the horrendous levels that prevailed in late 2008 and 2009 as a result of the credit crisis. In general, through the regular competitive solicitations that we conduct for non-profit borrowers, we have seen recent credit spreads that range from 85 up to 250 basis points (generally over LIBOR) depending on such factors as the borrower’s credit quality, the borrower’s industry sector (ie. education, healthcare, association) and size of financing. 5. What are your thoughts and advice with respect to interest rate swaps? We approach interest rate swaps and similar derivatives based transactions with great care and skepticism. The problems with derivatives are several: complexity, accounting treatment and lack of pricing transparency. In general, if our client wants a fixed rate borrowing, we strive in our solicitation to secure “true” fixed rate financing proposals from the banks. However, many banks remain, by virtue of structure and strategy, “variable rate” lenders. Consequently, in our solicitations, we typically secure alternate bidding for the variable rate modality and then compute a “synthetic” fixed rate borrowing cost based on prevailing swap levels. When acquiring a swap for a client, we prefer to conduct a competitive bid process. Sometimes, because of transaction size or credit circumstances, that is not practical and so we “negotiate” the swap terms with the same bank that is providing the financing. In recent years, we have found the banks to be more cooperative in negotiating up front their “markup” in the swap so that our clients and we can be assured of market competitive pricing on the swap in advance of making a commitment. 6. What general advice would you have for a non-profit considering a financing? We think borrowers are very well served hiring an independent financial advisor such as our firm if they are considering or pursuing a debt financing. The capital markets are complex and bank pricing strategies and market conditions are sophisticated and constantly evolving. We specialize in this area and because of our regular involvement in financing solicitations, negotiations and implementations, are very current on prevailing rates, credit spread ranges and “market” terms and covenants. Consequently, a borrower would benefit appreciably from the type of analysis, market knowledge and stewardship that a firm like ours can provide in first determining what type and structure of financing is most appropriate to its need and then securing its preferred type of financing on the best combination of price and terms through a competitive solicitation process. We have developed a very time and cost efficient process using a combination of web-based tools and information dissemination techniques to solicit upwards of 25 pre-qualified financial institutions for each transaction. Our process insures the following:  the most market competitive pricing and terms,  the most cost efficient way to canvas the market for the best deal,  fairness among all of the competing banks and  informed decision-making, considerable time and cost savings, and peace of mind for the borrower. Wye River Group Independent Financial Advisors 522 Chesapeake Avenue | 2nd Floor | Annapolis, MD 21403 | 410.267.8811 4733 Bethesda Avenue | Suite 520 | Bethesda, MD 20814 | 240.383.1250 285 West Broadway | Suite 200 | New York, NY 10013 | 212.203.4179 www.wyeriver.net
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