Floating A Bond, Not Passing The HatRichard A. Melcher
In late May, construction equipment began rolling onto the grounds of the Norton Gallery and School of Art, tearing out a street and bulldozing a small building at the museum in tony West Palm Beach, Fla. Housing a collection of Impressionist and 20th-century American art, the Norton is commencing a major expansion. Although it boasts a respected array of philanthropic and corporate board members, it's no more flush with cash than most other cultural institutions these days.
So, to finance the Norton's $16.7 million expansion and renovation, directors organized a fund-raising campaign. But they also turned to a source of funding long tapped by cities, universities, and health-care institutions--tax-exempt bonds. The projected savings on the 30-year deal: a handsome $1.2 million in interest costs over a traditional bank loan. The debt will be serviced with income from a bolstered endowment.
Caught between reduced funding from federal and local governments as well as overburdened private sector sources and the need to spruce up old buildings or construct new ones, a wide array of not-for-profit organizations like the Norton are raising tax-exempt money at a sharp clip (chart). From the Western Washington Fair Assn., which runs a state fair, and the Father Flanagan's Boys' Homes in Nebraska to the Art Institute of Chicago and the Phillips Academy prep school in Massachusetts, financial executives are discovering the special allure of the tax exempt-market: It allows them to shave as much as 300 basis points from their borrowing costs. "It's kind of a gift to public institutions, a much-needed one right now," says John D. Cartland, who heads the not-for-profit practice at Arthur Andersen & Co.
Found money, though, often contains hidden or unexpected costs. Cheap credit has caused some less-than-financially-astute institutions to get in over their heads and some bankers warn of further problems ahead. "There is an infinite number of causes and a finite amount of donor money," cautions Mark E. McCarthy, senior vice-president at Chicago's LaSalle National Bank, which has provided letters of credit to nonprofits. "The more people who add debt to the equation, the closer you will get to the breaking point, and the greater the risk some will fail."
NUANCES. Most of the bonds, which are underwritten by such investment banks, are placed with mutual funds, insurance companies, and other institutional buyers. But some small issues are sold to unsophisticated retail investors. "You don't want widows and orphans holding on to them," says Kenneth A. Kerzner, managing director of First Chicago Capital Markets, one of the most active not-for-profit underwriters. "There's no way you can explain the nuances to them."
Nuance, indeed, abounds in scrutinizing not-for-profit bonds. The financial performance of many issuers can be very volatile, for instance. And collateral such as art collections is usually off limits. Investors thus usually demand that deals receive a credit agency rating, insurance, or letters of credit. "These issues require special analysis," says Paul C. Williams, head of investment strategies and research at John Nuveen & Co., a major tax-exempt investor.
Consider what rating agencies and banks look at when assessing the risks of not-for-profits. For museums and symphony orchestras, it's everything from local competition to the composition of the board of trustees, which, in a pinch, might be called upon to rustle up more endowment money. Standard & Poor's, which rated the Art Institute of Chicago's $25.5 million issue in February A/A-1, offset its concerns about a stream of operating deficits and mounting debt with the comfort of a $222 million endowment. Professional organizations, including such recent issuers as the Association of American Medical Colleges, are scrutinized for the stability of their memberships. MBIA Inc., the largest insurer of municipal bonds, which has backed deals from the New York Public Libary and the Choate Rosemary Hall School in Connecticut, won't even consider a bond unless there are unrestricted funds on the balance sheet greater than the total debt level.
The major mistake not-for-profits make is to get "seduced" by cheap financing, as First Chicago's Kerzner puts it, and overbuild. Take the Fernbank Museum of Natural History in Atlanta. Though it lacked an endowment or a permanent collection, it was able to raise $20 million in tax-exempts in 1990 to put up a new building. But it badly overestimated admission revenues. On May 1, Fernbank missed an interest payment of $1.3 million and is now trying to restructure its debt and raise contributions.
SECONDARY EFFECT. The venerable Boston Museum of Fine Art is finding that the interest burden from $33 million in bonds issued in the 1980s for renovation and new construction is compounding the institute's operating problems; it's now five years in the red. "When you issue debt, you have to be very cautious and remember you need a plan to pay it back," notes Thomas W. Fitzgerald, director of finance. The MFA, which had simply hoped to repay the interest out of operating income, is cutting staff and programs.
Fortunately, not-for-profits are finding that shiny new bond-financed buildings beget scads of new contributions. Take Chicago's Museum of Contemporary Art, whose headquarters just off Michigan Avenue was constructed with a $50 million tax-exempt bond issued last year. The new building, five times the size of its old facility, was a big spur toward a $55 million endowment campaign, most of it now pledged, says Kathleen A.
Hechinger, finance manager for the project. To pay off the debt, the museum plans to use income from the endowment. Hechinger says the process of planning the bond issue imposed a useful financial discipline on the museum. What about the risks? "I would be concerned if the curators were running the museum, which they aren't," she adds.
For not-for-profits that can hew to such financial discipline, tax-free bonds can be a useful tool to meet mounting budgetary pressures. For those that can't, tax-free bonds could be a bargain with the debt devil.