January 20-21, 2005
Montana State University
Series J 2005 Revenue Bonds
History of Evaluation and Consideration of Innovative Financing Techniques
- Series G 2003 Bonds
- Purpose– refund a portion of Series A 1993 Bonds to reduce annual debt service for Bozeman and Northern campuses.
- Innovative Approach Employed – use of multi-modal variable rate bonds to maximize interest rate savings; selected 35 day auction rate securities structured with quarterly variable rate debt management committee oversight process.
- Result to Date – the debt service savings using this process has equaled more than $580,000 over the past nearly year and a half.
- Request for Proposals for Underwriting Services – Spring/Summer 2004 – MSU conducted a comprehensive search for lead underwriting firms during the early part of 2004; during this process a variety of innovative financing approaches were presented by the various offerors and discussed by the MSU team:
- MSU Requested in Scope of Work Section 3.2 of RFP – the “identification and explanation of creative and innovative financing techniques which could benefit MSU”;
i. over half of the respondents outlined the use of interest rate swaps, specifically synthetic fixed rate swaps, as a means of reducing MSU’s borrowing costs and benefiting students.
- MSU Requested in Offeror Information Request Section 4.1.2.c –“explanation of the offeror’s experience in higher education bond financing using derivative products with examples of such used by which universities”:
i. All but two of the 8 respondents to the RFP wrote extensively about their use of interest rate swaps, synthetic fixed rate structures and other derivative financings for other universities and provided specific examples of the benefits for such with these universities.
- During Personal Interviews – the MSU team had extensive question and answer sessions with four underwriting firms, all of whom described using interest rate swaps for their clients:
i. AG Edwards, ultimately selected the winner of the RFP search process, specifically described and modeled a forward starting swap as a means of capturing currently low rates in a rising rate environment.
- Series H 2004 Bonds Preparation – during the months leading up to the issuance of the Chemistry/Bio-chemistry research building financing, the MSU administration and their financial advisor and underwriter reviewed a range of innovative financing options:
- These options included both the synthetic fixed rate structure using a BMA index and a 70% of LIBOR index approach;
- These two synthetic rate structures with also both examined in a forward starting mode on a variety of assumptions;
- The MSU team spent a number of meetings and conference calls reviewing the intricacies and risks associated with these options; and,
- In the end, it was determined that a traditional fixed rate approach best matched with the primary source of funding – indirect cost recovery revenues.
- Series J 2005 Bonds Preparation – the Admin & Finance VP brought together a team to evaluate the financing approaches available for the Student Facilities Enhancement Project, specifically addressing the following challenges:
- To explore means of capturing the low interest rate market available for a financing that was best not implemented prior to Summer 2005 while most economists continue projecting that interest rates will continue rising;
- The new student fee supporting much of the Project financing is scheduled not to start until Fall Semester 2005; and,
- The design and construction bidding would not be completed until Summer 2005 and the reinvestment rates on traditional fixed rate bond proceeds still is approximately 2% below the borrowing rate creating negative arbitrage.
- Proposed Forward Starting Interest Rate Swap – the result of seven meetings and substantial analysis by the Student Enhancement Project financing team is the proposed Board Item 126-2005-R0105:
- MSU is recommending this approach and expansion of the variable rate debt oversight committee process to achieve a lower cost of borrowing for the Project;
- Risks associated with the proposed approach are believed to be mitigated by:
i. Employing the BMA index swap approach that minimizes “basis risk” and closely tracks MSU experience with the Series G Bonds;
ii. Allowing only swap counter parties to bid on the proposed swap who have at least double-A category ratings from both Moody’s and S&P;
iii. Requiring in the swap agreement that collateral be posted in the event of a rating downgrade of the swap county party;
iv. Carefully reviewing a matrix of potential swap termination outcomes under all expected future market scenarios; and,
v. Expanding the role of the Variable Rate Debt Oversight Committee put in place with the Series G Bonds to add quarterly monitoring of the proposed interest rate swap, its value, any change in risk profile and recommend any actions relative to swap termination or change of mode in the underlying variable rate bonds.