F4C

Office of the President

TO MEMBERS OF THE FINANCE AND CAPITAL STRATEGIES COMMITTEE:

ACTION ITEM - CONSENT

For Meeting of November 13, 2019

AUTHORIZATION OF MEDICAL CENTER POOLED REVENUE BONDS TAXABLE EXTERNAL FINANCING

EXECUTIVE SUMMARY

This item requests authorization for the President of the University to issue a long-dated taxable with a final maturity not to exceed 100 years and in an amount not to exceed $2 billion plus financing costs. The bond will be structured as interest only with a bullet maturity in the final year. The proceeds will fund strategic, high-priority capital needs at the medical centers, including projects necessary to comply with seismic requirements, for which long-dated taxable financing matches the longer-term assets being financed. The medical centers participating in this issuance would be Davis, Irvine, Los Angeles, San Diego, and San Francisco.

The financing, including amount and final maturity, will depend on market conditions at the time of issuance. Current market conditions are favorable and would allow the medical centers to take advantage of low financing rates. The 30-year taxable Treasury yield, the pricing benchmark for long-dated bonds, reached all-time lows in August 2019 and credit spreads are also historically narrow. The University has previously used long-dated taxable as a part of its capital financing strategy, including issuing two century bonds for the campuses. In February 2012, the University issued an $860 million century bond at an interest rate of 4.858 percent and, in April 2015, issued a $500 million century bond at an interest rate of 4.767 percent.

RECOMMENDATION

The President of the University recommends that the Finance and Capital Strategies Committee recommend that the Regents authorize the President to:

A. Issue a taxable borrowing with a final maturity not to exceed 100 years and in an aggregate principal amount not to exceed $2 billion plus financing costs to be issued under the University’s Medical Center Pooled Revenue Bond indenture. As long as the bonds are outstanding, the medical centers receiving such proceeds shall satisfy the following requirements:

(1) The medical centers receiving proceeds, Davis, Irvine, Los Angeles, San Diego, and San Francisco (the “Medical Centers”) shall maintain revenues in amounts

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sufficient to pay the debt service and to meet the related requirements of the authorized financing.

(2) The general credit of the Regents shall not be pledged.

B. Take all necessary actions related to the action approved above, including, but not limited to, approval, execution, and delivery of all necessary or appropriate financing documents.

BACKGROUND

The transaction is part of a strategy that Capital Asset Strategies and Finance and the Medical Centers developed to finance capital projects and seismic improvements at the medical centers over the next decade. If the current, low interest rate environment continues into early 2020, when the transaction is expected to occur, the medical centers would be able to take advantage of favorable market conditions to issue long-dated taxable debt as a part of their long-term capital strategy. The advantages of this bond structure compared to a 30-year -exempt borrowing include: a) long-term funding at historically low rates that will provide a cost-effective hedge against inflation, potentially illiquid markets and rising interest rates;

b) the flexibility of taxable financing, which avoids tax-exempt financing restrictions; and

c) diversifying the debt portfolio with a longer liability that matches the longer-term assets that are anticipated to be financed.

Long-dated Taxable Bond Issuance. The University has a successful track record of issuing long-dated bonds. In March 2012, the University issued $860 million of 100-year bonds at an interest rate of 4.858 percent and, in April 2015, $500 million was issued at an interest rate of 4.767 percent. In the past five years, a number of other higher education institutions as well as several have also accessed the century . In 2015, The New York and Presbyterian issued a $750 million century bond at an interest rate of 4.024 percent. In 2014, The Cleveland Clinic issued a $400 million century bond at an interest rate of 4.858 percent. Corporations and sovereigns have also been active users of the century bond structure.

Current Market Conditions and Investor Appetite. Long-dated taxable bonds continue to provide issuers with access to long-term capital at attractive rates. The 30-year taxable Treasury yield, the pricing benchmark, reached all-time historical lows in August 2019 and, at 2.07 percent as of October 9, 2019, remains within 15 basis points of those levels. In today’s environment, the medical centers could expect favorable rates as compared to the University’s previous transactions. The actual rate of the bond will depend on market conditions at the time of issuance. Investors continue to be attracted to longer-dated debt, including century bonds, due to the incremental yield in today’s low-rate environment. At the same time, longer-dated debt provides an ideal match for investors with long-dated liabilities, such as insurance companies.

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Future Project Review and Approval Required. The authorization of the item by the Regents at the November 2019 meeting would only constitute approval for the financing. It would not constitute approval for the use of the bond proceeds. The use of proceeds will otherwise comply with all applicable University policies with respect to capital projects, including, without limitation, environmental review.

Guidelines for Long-Dated Debt. The anticipated issuance of a long-dated taxable bond will be an integral part of the medical centers’ capital structure and will require oversight and management. It is expected that the bond proceeds will be spent in a timely manner, with a goal of fully expending all proceeds by FY 2026.

The medical centers will also set aside proceeds for the principal repayment of the bond at maturity. The set-aside amounts represent the present value of the bond principal, discounted at the rate of the Total Return Investment Pool (TRIP) or the General Endowment Pool (GEP). The set-asides will be set up as Funds Functioning as Endowments in GEP. The Medical Centers and the Office of the President will monitor the set-asides to ensure that anticipated earnings are being realized, and if not, whether additional investment is required over time.

Financial Feasibility. As of June 30, 2019, the Medical Centers had a 6.0 percent net income margin (adjusted for pension and Other Post-Employment Benefit expenses as permitted by the debt policy), 4.0x debt service coverage, and 115 days’ cash on hand, in compliance with the University’s Debt Policy for external financing.