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Swapping Debt

I last visited the topic of Cornell's debt a year ago, when I noted that despite a doubling in the University's debt load in recent years, Cornell has been successful at borrowing funds at a relatively cheap rate.

So now BusinessWeek reports that Cornell is going to borrow an additional $285 MM and that Moody's has placed the University's credit rating on a downgrade watch-list:

Cornell University, a member of the Ivy League, faces a credit-rating downgrade as it prepares to terminate interest-rate swaps tied to its debt, according to Moody’s Investors Service.

Cornell will end the contracts linked to at least $475 million of bonds, potentially costing it $39.9 million, Moody’s said in a report today. The New York-based rating company said it lowered the outlook on the university’s Aa1 ranking, its second-highest, to negative from stable, indicating it could be downgraded. Standard & Poor’s in March 2009 cut the school’s grade one level to AA, its third-highest.

The lower outlook reflects a “tightening of operating performance” and a possible cut in state aid, Moody’s analysts Kimberly Tuby and Dennis Gephardt wrote in the report. It also came amid a “decline in pledges and new gifts to the university, and financial resources providing a thinner cushion for a significant amount of debt and large expense base, as a result of investment losses and rapid pace of borrowing in recent years,” they wrote.

Cornell has $1.96 billion of debt, including $285 million it plans to borrow next month, Moody’s said. It lost 26 percent on its investments in the year to June 30, bringing its endowment down to $3.97 billion, according to the school. Simeon Moss, a university spokesman, said last month Cornell is trying to close a $45 million operating budget deficit this year. Cornell estimates the endowment is up 11 percent in the first half of fiscal 2010, Moody’s said.

"The university is borrowing $285 million to invest in biomedical research by constructing a new facility at our medical college in New York City," said Joanne DeStefano, Cornell's vice president for finance, in an e-mail.

"Given the current low interest rates, the university also feels it is prudent to restructure its overall debt portfolio by reducing variable rate debt and swap exposure risks by 50 percent and 30 percent, respectively," DeStefano said. "The cost of the swap terminations will be financed."

Interest-rate swaps are unregulated contracts to exchange payments linked to debt, often a floating-rate stream for a fixed one. Borrowers often use them in connection with bond issues in an attempt to lower their debt cost, sometimes taking the estimated savings as upfront payments from the bank.

The story is a bit difficult to follow, but here's the long and short of it: Cornell is borrowing more money to a) raise funds to build a new building in New York City, and b) help cover its operating deficit. On top of that, it's going to cancel financial contracts that had been in place to the cost of an additional $40 MM. That additional cost will be "financed" (read: paid with even more debt) as well.

Canceling the swap agreements may be advantageous to the University's financial position in the long-run. But another $40 MM in non-academic debt is tough to swallow, especially given some of the budget cuts that have taken place, particularly in the performing arts.

Matthew Nagowski | Posted on April 10, 2010 (#)

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