Team Meeting Reviewing Financials

When it’s time to make decisions about borrowing funds for your organization’s projects, this process can help you arrive at the best financing vehicle.

Impacts of financial decisions

Three Steps to Structuring Debt for Higher Ed and Nonprofit Organizations

  • 12/14/2016

As leaders at higher education and nonprofit institutions, you have a variety of debt structures to choose from when funding projects and shaping the makeup of your debt portfolios. It’s not always easy to know which option is best when it comes time to make decisions about borrowing, but a three-step approach can help you narrow down your choices and select the best financing vehicle for your organization and project.

  1. Establish a desired capital structure.
  2. Understand the characteristics and risks of various borrowing vehicles.
  3. Select the optimal borrowing vehicle for the immediate need — while keeping the future in mind.

Establish a desired capital structure

First, you should establish goals and guidelines for the capital structure, and it is sound policy to create a written debt plan. To get started, begin with (and then elaborate on) basic goals, such as:

  • “We will maintain an investment grade debt rating.”
  • “We will borrow on a long-term, fixed-rate basis to fund long-lived assets that generate revenue.”
  • “We will maintain no more than 20 percent of our capital structure in variable rate debt.”

When you have clear goals, your decisions will be easier to make. For example, if your organization wants to maintain a particular debt rating, you’ll know you should rule against an ambitious debt-funded project that will likely result in a ratings downgrade.

Know the risks and benefits of various borrowing vehicles

A brief overview of the borrowing vehicles at your disposal can get you started on more thorough research to help make informed decisions about debt financing.

Fixed-rate, tax-exempt, long-term bonds

These are traditional core financing structures for assets with long useful lives, particularly revenue generators such as student housing. Generally, the pros include debt service certainty, long amortization (30 years), and looser covenants than bank loans. With some exceptions, the cons include higher upfront costs to issue, higher interest costs than most alternatives, the requirement to maintain a public debt rating, continuing disclosure requirements, and the restriction of a 10-year call.

Fixed rate tax-exempt bank loans

These are similar to bonds with a few notable differences. It is rare to see a fixed interest rate and amortization for 30 years from a bank. Some banks will offer 20-year set amortization, and some will contain a rate reset, commonly at the seven-year mark. An advantage of working with a bank is that borrowers can often negotiate favorable terms if there is a relationship. Covenants can be customized to suit a borrower’s needs but often are tighter than with public debt (banks have staff to monitor financial performance). In lieu of a 10-year non-call period, banks will often use a make-whole provision, which can economically restrict borrowers from calling debt earlier. And individual banks will have limits on the amount of credit they will issue a single borrower.

Floating rate debt (bonds or bank loans)

Variable rate debt has historically afforded borrowers the lowest cost of capital along with repayment flexibility, at the cost of volatility. Borrowers should consider maintaining a certain percentage or dollar amount of debt as variable rate in order to blend down the average cost of capital. To avoid surprises, decision makers should conduct sensitivity analyses on future rate increases. One structuring strategy is to match the amount of floating debt with floating-rate investments that are accessible to the operating budget, because as rates increase, the higher interest cost will be offset by increased earnings on investments.

A significant benefit of variable rate debt is repayment flexibility. This flexibility can be particularly important to borrowers that are raising funds for a project and may be uncertain about the project’s eventual cost and/or the amount of fundraising dollars that will be received. With this vehicle, you could retain the flexibility to pay off debt as funds come in.

Taxable borrowings (fixed or variable rate bank loans in particular)

These should be kept under consideration at all times because of their ease and lower cost of issuance and flexible use of proceeds. Tax-exempt borrowings are expensive and cumbersome to put into place but generally make economic sense for larger, long-term issues. It is advisable to conduct a break-even analysis between taxable and tax-exempt structures for borrowings under roughly $7 million. (One might be surprised at the result, particularly with shorter repayment periods.)

Tax-exempt borrowings are also restricted as to use of proceeds. However, taxable debt can be used for mixed-use real estate, sponsored research facilities, and other similar projects.


Derivatives are independent obligations that require additional administration and can create balance sheet liabilities, depending on market conditions. They are extremely flexible tools that can be used to:

  • Hedge some or all interest rate risk on a floating rate loan or bond (floating to fixed swap).
  • Create variable rate exposure on a fixed-rate debt structure (fixed to floating swap).
  • Lock in fixed-rate protection at a future date, such as at the end of a construction period or fundraising campaign (forward starting swap).
  • Set up non-traditional call dates to match pledge forecasts or other milestone dates (flexible call provisions).

Select the optimal vehicle for the immediate need (while planning for the future)

Long-term strategic planning is a difficult balancing act. As you manage the here-and-now, you can also keep an eye on the future by considering these debt structuring factors:

  • Be honest about future prospects for the organization as they relate to ability to meet debt covenants.
  • Make sure that fund raising campaigns and goals are in synch with debt amortization and debt repayment provisions.
  • Run various scenarios that incorporate interest rate sensitivity, cost and revenue assumptions, and covenant compliance.
  • Contemplate how future projects will be impacted by current borrowing plans.

How we can help

CLA’s higher education and nonprofit industry professionals understand how debt impacts your organization, and we can help with the difficult decisions surrounding debt financing.