John Lynch and Justin Baumgardner work with independent K-12 schools and institutions of higher education to deliver the power of Truist's Business Lifecycle Advisory approach and help them anticipate challenges and seize opportunities on their path to success.
Financial executives at higher education institutions live under constant pressure. They must balance direction from the president, the finance committee, and the board while juggling the complex balance of tuition and fees, endowment draws, and educational offerings.
Higher education has now faced two years of intense headwinds. Climbing interest rates and an inverted yield curve, unpredictable enrollment, and shifts to remote learning have disrupted cash flows, operations and virtually every aspect of financial management in this already challenging sector. In some cases, capital projects were put on hold due to the cost of financing, labor, and materials. In other cases, project and loan approvals were paused altogether until the educational environment stabilized. With increased staffing costs, broad inflationary pressures, and unpredictability of economic conditions that continue to plague institutions, budgets created just a few months ago may already be out of date as conditions continue to change rapidly.
Amidst all this financial turmoil, the rise in interest rates has also saddled many organizations with variable rate debt, while stripping away the most straightforward options for reducing the cost of capital.
The path forward is not a clear one. How long will these conditions last? What will normal look like? Where should you be focusing your attention? What capital moves can you make to lower your costs while providing the access to capital that your institution needs? Now more than ever, higher education institutions are grappling with these questions.
What you should be evaluating right now.
These pressures are particularly acute for small and midsized institutions, even those that receive state support. Leaner finance teams and those who don't have a dedicated debt manager with expertise in public-market debt will have a tougher time actively managing capital sources. For institutions with fewer financial resources, the current economic environment is particularly concerning.
Whether you’re feeling pressured or relatively comfortable, a couple years of a fluid operating environment for educational institutions combined with volatile economic conditions that many haven’t seen in their lifetimes all require you to look at your capital structure and evaluate your sources and costs of debt financing. What do you have? What will you need? How will you secure critical funding? By working closely with your financial advisors and by thinking about the seven considerations below, higher education executives at small and midsized institutions can move forward with clarity and confidence despite the continued volatility.
7 considerations as you rethink your capital structure.
Lesson 1: Explore all capital sources, especially the public markets. If your institution is struggling, traditional sources of lending simply may not be an attractive option. But there are still investors who may be very interested in lending to you. Start educating yourself on the public markets and start conversations with your stakeholders and your financial advisory teams. Public markets may not be as restrictive as banks in terms of covenants, such as deposit requirements, and can allow institutions to lock in rates for longer terms relative to bank-issued loans, which can reset as often as every three to five years. Public issues can also give you greater flexibility in areas such as retiring the debt before or after their traditional 10-year par call. Consider dual tracking bank loans and public financing to get a good comparison of the two sources.
Don’t overlook non-debt sources. Fundraising could be a potential path to close any cash flow gaps. Another might be use of cash on hand if your short-term investments have been performing well.
Lesson 2: Understand the quantitative and qualitative components of your institution’s scorecard with ratings agencies. If you decide to seek a public rating, agencies are going to look at both the quantitative and qualitative dimensions of your institution. In addition to your financials, they’ll examine board governance, the quality of your leadership, and how well you're delivering on your strategy. Increasingly, they want to review your environmental, social, and governance approach and the actions you’re taking to meet your goals. Be sure you know what will be scrutinized so you can prepare now and have a plan to address any issues prior to seeking a rating. Substance matters here, but it’s also all about a cohesive story—you don’t want to just check the boxes in providing information to ratings agencies. Bring your “A game” in communicating your vision and the work you’re doing to get there.
Lesson 3: Have a debt policy before you need to borrow. You may not have needed a debt policy in the past, but it will inevitably come up with ratings agencies and investors. Many smaller institutions don’t have formal policies that cover debt, and you don’t want to be scrambling to put one together when the time comes for you to borrow. With a policy, banks will be more comfortable with additional indebtedness that could be secured on parity with existing bonds or loans. Your policy should cover facets such as allowable fixed rate versus floating rate debt ratios and clear metric thresholds for refunding debt should you want to make a strategic play to free up cash. A policy will also typically cover items such as selection of financial professionals, how bond proceeds may be used, and others. If you aren’t sure what should be included in your debt policy, your lender or other financial advisors should be able to offer an objective framework and specific suggestions for what to include.
Lesson 4: Don’t lose sight of the real end game when it comes to your rate versus your rating. If you’re considering public issues and the financing possibilities it may open for you, you’re probably thinking about the rating process. Ratings can be daunting, particularly if you’re not assured of a top rating, and may be dreading the optics of a less-than-stellar result.
But ratings are not the end-all be-all—securing lending at a compelling rate and with a structure that fits your organization’s needs is what you’re after. If you get what seems like a less-than-ideal rating but find access to financing sources that are a strategic fit, you’ve met your goal. You may still need to educate your board on the pros and cons of ratings, including the costs of ongoing annual reviews and of updating necessary disclosures.
Lesson 5: Start planning now for a normalized rate environment. Right now, the yield curve is inverted, volatility continues to reign, and the borrowers have been quiet. But at some point, it will return to normal, and when it does, many issuers who have been sitting on the sidelines as the Federal Reserve hikes rates, will be ready to issue, increasing the supply of debt. You can position yourself to take advantage of a more normal rate environment by understanding your options now and creating a path to move into lower rate debt and still ride out your longer term amortization in a way that gives you more flexibility. The right steps now can help you avoid prepayment penalties and give you more room to maneuver in the future to lower your interest expense and improve cash flows.
Lesson 6: Step back and look at the complete picture. Higher education has been forced to focus virtually all energy, capital, and management attention on responding to the challenges brought on by the pandemic. Now is your chance to step back and look at everything—operations, offerings, tuition, and critical capital projects that need to be planned or taken off hold—so that you can be ready to move forward decisively and strategically. As your priorities shift, you should refine your capital structure to reflect those changes.
Lesson 7: Get reacquainted with the details of your current capital structure. To assess your next moves and ensure you’re ready to engage with advisors or potential borrowers, look closely at your current capital structure from top to bottom. How much debt do you have outstanding currently? Who holds the debt? What projects did it finance? What are the prepayment provisions? Do you need any debt service relief over the next five years, for instance for a particular department?
After taking stock of your current capital situation, you can consider bundling and refinancing your debt, restructuring it, or evaluating other courses of action. You may be able to change your debt mix in a way that lets you shift some of your cash flows to other expenses that need attention. Regardless, you need to have a handle on the details so that your advisors can give you the most useful advice and help you effectively grade your options relative to your variable versus fixed expense mix and your short-term liquidity goals.
Get your capital structure ready for what’s next.
Higher education institutions have been through a lot over the past two years—talk to your Truist relationship manager about how our Business Lifecycle Advisory approach builds on our understanding of your organization to bring the expertise you need. Truist can help you objectively reassess your capital structure and your financing opportunities now, so that you can be ready for whatever comes next.