Managing Risk Around Capital Structure, Liquidity, and Mission

Managing Risk Around Capital Structure, Liquidity and Mission

Martha Bradley, Washington University in St. LouisJim Matteo, University of VirginiaCharlie Giffin, J.P. Morgan

2www.treasuryinstitute.orgwww.treasuryinstitute.org

Today’s panel

Charlie GiffinExecutive DirectorHead of Public Finance Debt Capital MarketsJ.P. Morgan

Jim MatteoAssistant Vice President for Treasury Operations and Fiscal PlanningUniversity of Virginia

Martha BradleyAssistant TreasurerWashington University in St. Louis

3www.treasuryinstitute.org

Agenda Developing a Comprehensive Risk Framework

Overview of Risk Approach for WashU and UVA

Today’s Big Issues: Liquidity and Debt Structure

Recent Risk Management Actions & Data Analysis

Summary Observations

Appendix: Industry risk study results


Managing risk in the new environment

Many institutions learned some tough lessons from the financial crisis

Several key risk factors came to light: Institutional exposure to fall in asset prices

Reliance on endowment for operating costs

Liquidity exposures in capital structure and investment activity

Swap MTM exposure in falling rate environment

Relationship of financial risks to implementation of the strategic plan


The risk management process is fairly established

Identify key risk areas Seek input across the institution

Quantify risks where possible Identify which risks could be considered “normal” vs. risks that are non-normal (“event risks”) Do appropriate stress testing

Determine appropriate risk tolerance Seek input across the institution

Build the concept of Financial Enterprise Risk Management


Building an enterprise-wide framework (flows)

Endowment

Treasury

Operations

Capital / Commitments

Other Support

Maximize long-term return

Make annual distributions

State revenues Federal grants, other

Net tuition & fees Auxiliary net revenues

Building, acquisition Institutional

commitments

Debt

Expected periodic fund flows

Funding Debt service


Building an enterprise-wide framework (risks)

Endowment

Treasury

Operations


Other Support

Potential payment holiday

Potential cuts Shift in demand statistics

Unforeseen expenditures

Reduction in expenditures

Debt

Potential Disruptions / Recourses

Access to capital risk Taxable borrowing

capacity Bank risk


Determining exposure to certain risk factors

Endowment

Treasury

Operations


Other Support

Debt

Investments Domestic equities, international equities, domestic fixed income, international fixed income, treasuries, short-term rates

Debt Short-term interest rates, long-term interest rates, bank support

Operating environment Student demand, net tuition & fees

Other Inflation, construction costs, bank credit support, state/federal support, student loans, annual giving


Summary of key overall risk topics

Investment performance continues to drive overall risk exposures Which is more important: risk in net assets or risk in the annual budget?

Risk is highly inter-related across the institution between investments, funding and operations, requiring an integrated management approach

Liquidity is the key metric of risk between these different exposures and should be actively managed

Rigorous stress testing must become a more routine part of risk management – assumptions will always be wrong in some way


Integrated risks require integrated management

Risks across the institution are increasingly inter-related, though management is sometimes de-centralized Endowment, Investments, Treasury, Debt, Strategy, Advancement, Admissions

Many schools have bridged these divides through new management structures Coordination of investment, financing, strategy at the board/committee level

Elevation of risk officers and Enterprise Risk Management professionals

Management committees across multiple disciplines








12www.treasuryinstitute.org 12www.treasuryinstitute.org

WashU overview Key stats (as of June 30,2010)

Number of Students Approx. 12,300

Investments $ 5.525 billion

Debt Outstanding $1.254 billion

Debt Structure 22% Variable / 78% Fixed

Swaps$90.5 million SIFMA variable to fixed$9.98 million LIBOR variable to fixed

Endowment distribution % of operations:

11%

Liquidity 35% - 40%, one-month

Credit Rating Moody’s – Aaa , S&P – AAA

Academic Ranking(US News 2011 Rankings)

Undergraduate 13th

School of Medicine 4th


WashU overviewRisk governance structure – Board of Trustees Committees

University Finance Committee Reviews and approves the broadest range of financial matters including

budgets, debt, liquidity, insurance, and tuition rates Asset Management Committee

Reviews endowment return estimates and approves payout projections Reviews investments of operating funds

Audit Committee Reviews broad range of compliance matters in addition to financial audit;

Chief compliance officer reports to this committee WU Investments Management Committee – Separate from BOT

Oversees all matters related to endowment performance Executive Committee

Final approval on financial matters

Chief Financial Officer responsible for financial risk oversight through these Committees


UVa overview Key stats (as of June 30,2010)

Number of Students Approx. 21,000

Investments (excl. foundations) Approx. $3.6 billion

Debt Outstanding $992 million

Debt Structure 14% Variable / 86% Fixed

Swaps $100 million SIFMA fixed payer

Endowment distribution % of operations:

6%

Liquidity 212.8 annual days cash on hand (FYE 2009)

Credit Rating Moody’s – Aaa , S&P – AAA, Fitch - AAA

Academic Ranking(US News 2011 Rankings)

Undergraduate - Overall 25th (tied)

Undergraduate – Publics 2nd


UVa overviewRisk governance structure

University Finance Committee responsible in all matters relating to the University's financial affairs and

business operations Audit & Compliance Committee

responsible for all matters relating to financial accounting and reporting and has direct access to internal and external auditors to assess their performance, the scope of audit activities and the adequacy of the system of internal accounting controls

UVIMCO Board of Directors Oversees all matters related to endowment performance

ERM Initiative Lead by CFO Currently being reviewed with new President for assignment of Strategic,

Operational, and Compliance risks.









Big issue #1: Sizing liquidity What is the “optimal level of liquidity”

Difficult to answer because of the number of different factors involved What are the different potential uses of liquidity? What are the potential sources of liquidity and how likely is it that the institution will have access to different sources of liquidity?

Developing a liquidity framework Distinguish between committed sources of liquidity (cash) and uncommitted sources of liquidity (CP draws, bank lines) Establish liquidity needs in “normal” environments and in a variety of stressed environments

“Liquidity is like the air in this room, you don’t really notice it until its gone”

Segmenting optimal cash balances

The above chart is shown for illustrative purposes only.

ConsiderationsSegment optimal cash balance by liquidity needs

Segment optimal cash balance by liquidity needs

Operating Cash(Horizon-Daily)

Strategic Cash (Horizon—Longer-term)

Reserve Cash(Horizon—Daily / Monthly)

70

40

60

90

0

10

20

30

50

80

Op

era

tin

g

Forecasted excess balances for a particular near-term or cyclical purposeR

eserv

eS

trate

gic

Restricted Cash(Horizon—Longer-term)

Restr

icte

d

4S T

R A

T E

G I

C

L I Q

U I

D I

T Y

M

A N

A G

E M

E N

T

Funds daily operating needs which may be subject to unforeseen volatility

Held in restricted account or as collateral for certain credit agreements

No short-term forecasted use; investment horizon usually one year or longer


WashU - Developing a Liquidity Framework

Committed sources

Cash (same day availability), Short term investments (2 day-2 week availability) Committed lines of credit

Established liquidity needs in a “normal” environment

Operating swings: $100 million drawn or excess in any given day over course of 1 month

Policy to keep no less than $50 million immediately available cash

Stressed liquidity with potential worst case scenarios



UVa - Developing a Liquidity Framework

Current Approach Determine liquidity needs by:

Identifying cash flow cycle troughs Identifying max consecutive day needs Rating agency reviews Holding enough buffer to be comfortable

Developing Approach Identifying risk profile (sources, uses, drivers)

Identifying risk tolerance

Consolidate Modeling efforts

Stress test scenarios

Determine a cost of liquidity



Big issue #1: Sizing liquidity($MM) Normal Stress Environment

1 Week 6 Months 12 Months 1 Week 6 Months 12 Months

Liquidity Sources

Tier 1 Cash 200 200 200 200 200 198

Tier 2 Cash 100 100 100 100 99 98

Treasury Investments 200 200 200 190 188 184

Total Committed Liquidity 500 500 500 490 487 480

Uncommitted Sources

Endowment Distribution/Loan 250 250 250 - - -

Bank SBPA 300 300 300 300 300 300

Bank Operating Lines 500 500 500 475 375 200

Debt Capacity (CP or Bonds) 250 250 250 - 200 150

Total Liquidity Sources 1,800 1,800 1,800 1,265 1,362 1,130

Liquidity Uses

Uncommitted Funding (VRDBs, etc.) 300 300 300 300 300 300

Endowment Payout Holiday - - - - 350 350

Operational Contingency 50 300 500 100 500 500

University Commitments 50 200 250 50 200 250

Total Liquidity Uses 400 800 1,050 450 1,350 1,400

Committed Liquidity Ratio 1.25 0.63 0.48 1.09 0.36 0.34

Uncommitted Liquidity Ratio 4.50 2.25 1.71 2.81 1.01 0.81

S

ourc

esU

ses


Big issue #2: Debt structure

Understand the relationship between capital structure and liquidity Short-term funding and rolling debt has an effect on liquidity Liquidity related to investment activity should relate to the choice of debt structure (fixed vs. floating, committed vs. uncommitted)

The “right” amount of uncommitted funding relates to excess liquidity Choices of interest rate mix are a second order decision that can be managed with certain derivative solutions where warranted









WashU key management risk factors & recent actions Management Risk Factors

Debt policy is conservative – no changes required after financial crisis Endowment asset allocation – little change

Recent Actions Bi-weekly meetings with endowment director of risk management More frequent monitoring on financial health of banks, insurers and other

counterparties Increased committed operating lines of credit Reviewed overall asset allocation of operating funds Diversified SBPA providers; moved from 364-day to multi-year facilities

Other Actions Developed crisis management team Committee formed to review how the University handles Enterprise Risk

Management


WashU risk dashboardMetric WashU Peer Avg*

Ratings Aaa/AAA Aaa-A3

Net Assets ($mm) $5,680 $5,221

Total Cash and Investments $4,953 $5,039

Total Volatility ($mm) $427 $474

Total Volatility (%) 7.52% 8.14%

95% Worst Net Assets ($mm) $4,843 $4,292

Operating Margin Volatility (%) 0.57% 2.03%

Investment Portfolio Volatility (%) 8.50% 8.38%

Operating Revenue from Investments (%) 15.0% 20.3%

Balance Sheet Leverage 1.33 1.58

Annual Liquidity to Total Volatility 5.12 4.89

Annual Liquidity to Operating Risk 6.76 6.12

Annual Liquidity to Puttable Debt 6.28 4.50

* Private institutions, definitions summarized in the appendix. Source: Moody’s Municipal Financial Ratio Analysis & J.P. Morgan, additional information available upon request.


UVa key management risk factors & recent actions

Risk Factors Risks assessed in a vacuum

Cash flow, liquidity, debt capacity, debt ratios, ERM scenarios

Inputs are unique to each analysis

Recent Actions Exploring a financial model to create a data warehouse.

Model would be used to change variables and financial statement impact

Data could be used for risk analysis and measurement


UVa risk dashboardMetric UVA Peer Avg*

Ratings Aaa/AAA Aaa-Aa3

Net Assets ($mm) $4,803 $5,535

Total Cash and Investments $3,569 $3,569

Total Volatility ($mm) $396 $442

Total Volatility (%) 8.24% 5.98%

95% Worst Net Assets ($mm) $4,027 $4,668

Operating Margin Volatility (%) 0.52% 1.53%

Investment Portfolio Volatility (%) 7.78% 6.38%

Operating Revenue from Investments (%) 9.20% 5.33%

Balance Sheet Leverage 1.31 1.66

Annual Liquidity to Total Volatility 2.91 7.67

Annual Liquidity to Operating Risk 5.27 6.76

Annual Liquidity to Puttable Debt 7.20 5.63

* Public institutions, definitions summarized in the appendix. Source: Moody’s Municipal Financial Ratio Analysis & J.P. Morgan, additional information available upon request.


UVa Central Bank risk profileSummary Pro Forma Risk Exposure Map1Summary Pro Forma Risk Exposure Map1

Exposure

2011 Pro Forma Annual Return (%)

Pro Forma Annual

Volatility (%)

Pro Forma Balance

6/ 30/ 2010

Pro Forma Annual

Return FY 2011 ($)

Pro Forma Annual

Volatility FY 2011 ($)

Cash and Cash Equivalents 1.25% 0.5% 12.8 0.16 0.1

Investments - Short Term 1.25% 0.5% 213.7 2.67 1.1

Investments - Long Term 8.00% 12.0% 522.4 41.8 67.7

Investments - Restricted CRP 8.00% 12.0% 120.4 9.6 24.7

Internal Loans Receivable - CRP 4.75% 0.0% 903.4 46.8 0.0

Internal Loans Receivable - Working Capital 4.75% 0.0% 2.5 0.1 0.0

Direct Loans Receivable (VCBA & State Issued) 4.50% 0.0% 73.6 3.3 0.0

Investments - Restricted Debt Proceeds 3.50% 0.5% 115.0 4.0 0.6

Total Assets 1,964.0 108.5 93.1

Long-Term Debt -3.09% 0.16% 938.1 (29.0) 1.5

Swap MtM 15.68% 9.2 0.0 15.1

Commercial Paper -1.00% 0.00% 55.6 (0.6) 0.1

Internal Investment Program Deposits -1.00% 0.00% 354.4 (3.5) 0.0

Due to Construction Projects 0.00% 0.00% 231.2 0.0

Due to Departments 0.00% 0.00% 344.1 0.0

Other Liabilities (6.5)

Total Liabilities 0.74% 1,926.0 (33.1) 13.8

Subtotal 75.4 110.3

Benefit of Diversification (28.1)

Total 75.4 82.2









WashU beyond the numbers

What keeps you up at night? What have we failed to recognize as a risk? Concern that we are too conservative

What makes you sleep well? Knowing that we are conservative


UVa beyond the numbers

What keeps you up at night? Collateral risks

The lack of good risk management data tools

Missed opportunities

What makes you sleep well? Conservative nature of University

Internal and external vetting of position

32www.treasuryinstitute.orgwww.treasuryinstitute.org

We welcome your questions









Study Results

Source: Moody’s Municipal Financial Ratio Analysis & J.P. Morgan, additional information available upon request.

Private Institutions Public InstitutionsMetric Average Min Max Average Min MaxTotal Assets ($mm) 7,635 766 45,004 9,321 1,291 42,057Expendable Financial Resources ($mm) 3,377 -19 23,574 2,451 263 10,070Total Cash & Investments ($mm) 5,039 231 32,193 3,569 201 13,954Net Assets ($mm) 5,221 437 30,140 5,535 752 24,025Total Volatility ($mm) 474 21 3,017 442 12 4,500Total Volatility (%) 8.14% 4.89% 13.26% 5.98% 1.59% 22.64%Operating Margin Volatility (%) 2.03% 0.57% 4.42% 1.53% 0.52% 4.33%Operating Revenue from State (%) 0.29% 0.00% 8.00% 19.27% 7.30% 34.70%Operating Revenue from Investments (%) 20.32% 4.00% 53.00% 5.33% 1.30% 14.60%Equities and Alternatives as (%) of Invested Assets 78.19% 54.10% 95.90% 50.70% 0.00% 94.59%Investment Portfolio Volatility (%) 8.38% 5.47% 13.71% 6.38% 3.13% 10.41%Total Revenues ($mm) 1,799 154 5,462 4,159 809 18,927Balance Sheet Leverage (x) 1.58 1.18 2.78 1.66 1.31 2.48"Total" Leverage 1.72 1.23 3.36 1.91 1.33 4.33Debt to Cap. (x) 0.24 0.10 0.56 0.24 0.15 0.44Cash to Debt (x) 3.76 0.48 9.16 2.00 0.40 4.70D/S to Operations (%) 4.88% 2.10% 28.90% 3.26% 1.00% 7.00%Annual Liquidity to Puttable Debt (x) 4.50 0.43 27.13 5.63 0.98 24.65Annual Liquidity to Operating Risk (x) 6.12 1.96 10.88 6.76 2.51 12.02Annual Liquidity to Total Volatility (x) 4.89 1.33 9.81 7.67 1.71 17.84Expendable Resources to Debt (x) 2.47 -0.02 7.49 1.45 0.39 2.87Expendable Resources to Ops (x) 2.59 -0.02 9.25 0.64 0.22 1.59


Study Institutions

Public Institutions:California State UniversityIndiana UniversityMichigan State UniversityThe Ohio State UniversityPennsylvania State UniversityPurdue UniversityRutgersTexas A&M SystemUniversity of ArizonaUniversity of CaliforniaUniversity of MichiganUniversity of MinnesotaUniversity of Missouri SystemUniversity of North Carolina at Chapel HillUniversity of PittsburghUniversity of Texas SystemUniversity of VirginiaUniversity of WashingtonWest Virginia University

Private Institutions:American UniversityAmherst CollegeBoston UniversityBrandeis UniversityBrown UniversityCollege of the Holy CrossColumbia UniversityCornell UniversityDartmouth CollegeDuke UniversityEmory UniversityGeorge Washington UniversityGeorgetown UniversityHarvard UniversityJohns Hopkins UniversityLehigh UniversityMassachusetts Institute of TechnologyNew York UniversityPrinceton University

Quinnipiac UniversityRensselaer Polytechnic InstituteRice UniversitySmith CollegeStanford UniversityTufts UniversityUniversity of ChicagoUniversity of PennsylvaniaUniversity of RichmondVanderbilt UniversityVassar CollegeWake Forest UniversityWashington UniversityWilliams CollegeYale University


Key Definitions Volatility is a key measure of annual risk that is approximated with a standard deviation Net Asset Total Volatility (%) = Annual Enterprise Dollar Volatility ($) / Net Assets ($) Operating Margin Volatility (%) = Calculated volatility over past 5 years from Moody’s Balance Sheet Leverage = Total Assets / Net Assets “Total” Leverage = (Total Assets + Pension Assets + Swap Notional) / Net Assets Annual Liquidity to Total Volatility = Moody’s Annual Liquidity / Calculated total Enterprise

Volatility Annual Liquidity to Operating Risk = Moody’s Annual Liquidity / (Operating Margin Volatility

($) + Operating Revenue from Investments ($)) Annual Liquidity to Puttable Debt = Moody’s Annual Liquidity / Puttable Debt

Puttable debt: Debt subject to short-term refinancing risk, including VRDBs, CP, etc. Expendable Resources to Operations = Moody’s Expendable Resources / Total Operations Expendable Resources to Debt = Moody’s Expendable Resources / Total Debt Debt Service to Operations = Peak Debt Service / Total Operations

Economy & Finance

Managing Risk Around Capital Structure, Liquidity, and Mission