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NewsvineWith the recent U.S. economic decline, scores of colleges and universities across the nation have been facing a sharp rise in interest payments on their large debts. According to the 2007 Annual Report, Stanford currently has approximately $1.5 billion of debt outstanding.
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Randy Livingston, vice president for business affairs and the University’s chief financial officer, explained that Stanford issues debt primarily to finance facility capital projects, such as new building projects or the addition, renovation and repairs of existing buildings, services and equipment. These debts are described as debt instruments and usually come in the form of loans from banks, bonds, certificates, mortgages, leases or other such agreements.
“Although we receive many generous gifts to fund new facilities, the gifts are rarely sufficient to pay the entire cost of a new building,” he said. “The gap is funded either with University debt or unrestricted cash reserves when available.”
He added that the University also uses the debt to fund major building renovations and certain major equipment purchases as well as to provide mortgages to faculty to assist them in purchasing homes.
Variable-interest demand notes and auction-rate securities are two popular methods colleges use to finance their long-term debt. Variable-interest demand notes are loans for which the rate of interest is subject to change. When such a change occurs, the monthly payment is adjusted to reflect the new interest rate. Auction-rate securities are loans for which the banks hold weekly or monthly auctions to set the interest rates and give holders the option of selling the securities. In February, a number of these auctions failed and the banks also refused to support the auctions.
The collapse of the auction-rate debt market forced universities to restructure millions of dollars of debt, as the interest payments doubled or in some cases tripled beyond what officials had budgeted. Stanford, too, was impacted by the collapse of the auction-rate debt market in February. According to Livingston, the University had approximately $318 million of auction-rate securities outstanding.
“One of our debt instruments went from approximately three percent interest rate to eight percent within a week,” he said. The change in interest cost the University nearly $180,000.
Stanford takes out a mix of fixed-rate and variable-rate debt. Variable-rate debt generally carries a lower interest rate, but the rate is subject to volatility as general market interest rates change. Livingston pointed out that the best method was to seek a balance between the two.
“In deciding on the mix of debt instruments, we’re seeking to balance the benefit of lower rates that comes from variable rate debt with the benefit of interest rate stability that comes from fixed rate debt,” he said. “Although the debt we borrow has a range of interest rates, we pool all of the debt together and charge internal projects a blended average rate. This year that rate is 5.70 percent.”
Not all universities have been as fortunate. According to the Moody’s Investors Service, which provides research data and analytic tools for assessing credit risk, Simmons College had nearly $100 million of variable-rate debt, compared with $51.6 million of unrestricted resources, which are funds received by an institution that have no limitations or stipulations placed on them by external agencies or donors. That relatively small amount of operating cash compared to its debt made it difficult for the college to weather a market downturn. Even though the school managed to convert $49.6 million of the college’s debt to fixed-rate bonds, officials still had to deal with higher interest rates. Furthermore, Moody noted that a third of the nearly 300 private institutions are financing over half of their debts with variable-rate bonds. From their rating, private colleges alone have an estimated $7 billion of auction-rate debt.
Stanford has been able to refinance all of its auction rate debt over the past 3 months.
“Although we paid a higher interest rate for a few months, it will not have a material impact on our blended interest cost for the year or on the University’s overall financial health,” Livingston said.