Past Session:

Proceedings of the Standing Senate Committee on
National Finance

Issue 18 - Evidence

OTTAWA, Wednesday, September 19, 2001

The Standing Senate Committee on National Finance met this day at 5:47 p.m. to examine the role of government in the financing of deferred maintenance costs in Canada's post-secondary institutions.

Senator Lowell Murray (Chairman) in the Chair.

[English]

The Chairman: Colleagues, this is our second meeting on the reference we have been sent by the Senate to study, the role of government in the financing of deferred maintenance costs in Canada's post secondary institutions.

Let me welcome Senator Wiebe, who is with us tonight, replacing Senator Banks.

Our first witness is Mr. Cliff Inskip, who is with the Canadian Imperial Bank of Commerce. Mr. Inskip was involved, on behalf of CIBC, in the University of Toronto's bond issue earlier this year. I believe we circulated a copy of a National Post article on that subject.

Mr. Inskip has an opening statement to make. He will be using a document that he has prepared. The document is available to you, but it is in English only. It is his right as a citizen to address the committee in the official language of his choice. If you are interested in having a copy of the document as an "aide-mémoire" during his presentation, the pages will distribute it to you.

Welcome, Mr. Inskip. Please proceed.

Mr. Cliff Inskip, Managing Director, Debt Capital Market, Canadian Imperial Bank of Commerce: Mr. Chairman, honourable senators, ladies and gentlemen, I appreciate the opportunity to be here and I look forward to discussing a challenging topic. I prepared a brief presentation. I shall skim through it quickly, to ensure that we have plenty of time to answer questions.

The purpose of my initial remarks is to provide an overview of some of the key issues associated with financing universities in Canada and then to briefly summarize the University of Toronto $160-million-bond offering, a transaction on which I spent many months leading our team.

Traditionally, borrowings by universities have been focused on bank borrowings, for two particular reasons: one is short-term timing differences between receipt of cash and required expenditures; the second is for various capital projects. Those capital projects tended to have been projects that generate revenue - for example, residences, parking lots, food service facilities, things like that.

The Canadian debt capital markets, which is a group of institutional investors, insurance companies, mutual funds, pension funds, et cetera, is a market outside the bank, and certainly university financings can be seen as attractive and provide a viable alternative. As I mentioned, the University of Toronto is the largest broadly distributed university financing in Canada to date.

I will make a few comments on the financial operations of a university and some of the constraints. There are various sources of income - most of them are well known to all of you. There are grants, user fees, donations, debt; on the bottom of this page, in the blue, there are operating costs, capital expenditures and debt servicing costs. Most universities have reasonably diversified revenue sources, and that is useful because when one source is not available others potentially are.

There are a number of limitations on funding flexibility for universities. Operating grants typically operate by formulas, depending on the province. They may be capped; with enrolment growth, the operating grants may not increase. Tuition fees are typically regulated, so there is an inability to increase those beyond the regulated limit.

In addition, there are a number of restrictions on how funds that are actually received are used. In certain provinces, provincial grants cannot be used to pay principal and interest on debt used for capital purposes. In Ontario, a certain portion of tuition fees must be used for student aid. Research grants and endowments have various restrictions on their use. As a result, universities typically operate different funds. There is an operating fund, a capital fund, ancillary operations, and restricted funds.

The operating fund is for operating purposes. In general terms, the operating fund is typically managed on an approximate break-even basis. When governments cut funding in the 1990s, universities were forced to cut operating expenses or to increase tuition fees.

The second fund is the capital fund, which is to build non-academic buildings. It is usually project-specific and funded from government capital grants and donations.

The ancillary services fund covers all of those things that are non-academic in nature: residences, parking lots, food services, bookstores. That fund is typically operated on a full cost-recovery basis. The costs, therefore, are recovered from the users with no surplus and no deficit over the long period.

Finally, the restricted funds are various kinds of donations, grants or endowments, and those funds can be used only for the purposes specified.

In summary, universities have a diverse source of revenue, but there are numerous constraints on how those funds can be used. Universities have limited abilities to increase their funding - which is based on formulas or received through fundraising. Much focus in recent years has been placed on fundraising to augment other sources of funds.

Universities have demonstrated a capacity to borrow both in the bank and the capital markets. Borrowings have been limited by their ability to repay. In other words, universities have only borrowed where there has been a repayment source to repay the debt. They have not accessed the markets generally to fund accumulated deferred maintenance because there is no specific repayment source on which to service that debt.

The next thing I would like to address is the University of Toronto transaction. The amount there was $160 million. These were 30-year debentures, so interest only for 30 years and repaid in full in 2031. The interest rate is 6.78 per cent, payable semi-annually.

When we met with the University of Toronto - and this whole process took six months - we analyzed a number of options. We looked at bank debt as an alternative, we looked at a traditional private placement placed with a limited number of life insurance companies, and then we looked at a public-style debt issue.

I will summarize the transaction. The issuer was the University of Toronto - $160 million unsecured debentures. No security was provided. The term was coupon 6.78 per cent, which was 65 basis points, or .65 per cent above the Government of Canada 30-year benchmark bond. Repayment is by interest on a semi-annual basis, with principal in full at the end. Use of proceeds was to finance capital projects, primarily residences, but a small amount for a parking facility and potentially a small amount for academic buildings.

Repayment will be from the ancillary revenues generated from those facilities. Repayment is internally allocated to the divisions within the university making use of the proceeds. If money was provided to a specific residence, the users of that residence would pay a residence fee and those monies would be paid to central treasury. Central treasury use those monies to pay interest and to invest the portion of principal set aside, which we manage, so that at the end of 30 years the university will have the full $160 mil lion to repay the loan.

Typically, loans have covenants or restrictions. The only covenant of any magnitude was a negative pledge, which is a covenant that says that they will not give security to other lenders. If these lenders are lending on an unsecured basis, they want other lenders to lend on an unsecured basis as well so they are on an even basis.

The credit ratings obtained were one notch higher than the province of Ontario, which was an AA-2 by Moody's and an AA-plus by Standard & Poor's, which are extremely high credit ratings.

I have provided you with some of the criteria and factors that a rating agency looks at, which include financial, demand, general and management factors. I would be happy to answer questions on those, but the rating agencies went through an analysis process looking at all those factors to determine their rating.

The University of Toronto is an outstanding university. We have outlined some of the key things that are worthy of note and ones that the rating agencies and investors looked at, but, clearly, in terms of going to the bond market, an institution like the University of Toronto was very simple because of the quality of its credit.

With regard to market reception, the issue was, as I mentioned, the first widely distributed university debt financing in the Canadian market. Quebec universities have issued small amounts in the retail market. The debt service in those cases is paid by the Quebec government. The U of T issue was extremely well received by investors. It was well over-subscribed, meaning that there were more buyers than there were bonds to place. The pricing was tight. The pricing was 65 basis points over a Canada bond. No other non-government issuer has achieved a spread lower for a similar maturity bond, so it was tightly priced. The buyers were evenly balanced between three groups - insurance companies, investment managers and pension funds.

In summary, we believe that there are significant opportunities for Canadian universities to raise funds in the debt capital markets. The University of Toronto certainly demonstrated that. In the Financial Post, Barry Critchley wrote in July that the U of T issue and, more important, what may follow, has got the market excited.

Investors are looking to diversify their portfolios. Universities are generally seen as strong credits, and it is a credit they are interested in buying.

The key issues for universities in terms of issuing in the market are to identify what funds are required and what is the source of refinancing. To finance a significant amount of infrastructure renewal generally will require an incremental source of revenue that can be used to repay the debt.

In the case of school boards, the market has raised over $1 billion for school boards in the last two years. They have a funding formula for additional schools and also for facilities renewal where you have a specific dedicated stream that must be set aside into a segregated account and used only for specific capital purposes. Something like that would certainly facilitate the accumulated deferred maintenance issue. The key issue from a university's perspective in terms of capacity to borrow is to identify the source of repayment. If there is an identified source, universities will have access to the market.

Mr. Chair, that is the end of my formal comments.

The Chairman: Thank you very much and thank you for giving us a copy of your presentation.

Before I open the floor for questioning, I should say for the record that what gave rise to this study that we are doing was Senator Moore's concern about the extent of deferred maintenance at Canadian universities. I hope that I am not putting it unfairly, but it would appear that over the past number of years universities, under financial constraints, have allowed the physical plant to deteriorate considerably, to the extent that the Canadian Association of University Business Officers has done a study that suggests that the bill for all of this will amount to approximate ly $3.6 billion. I suppose the issue cannot be divorced at all from the overall question of financing of universities, which is why we were so anxious to have you here and are so happy to have had such a thorough presentation from you.

Senator Moore: Thank you, Mr. Inskip, for being here and for your presentation. We were all tweaked to what your company was doing by the newspaper article of May 16 to which our chair referred.

Were you involved from the outset in this financing?

Mr. Inskip: Yes, I was.

Senator Moore: U of T has a very healthy endowment. It is the largest in the country. It exceeds $1 billion, I believe.

When you analyze the borrower to see whether there would be appeal to the market to invest in that borrower, what weight is given to the endowment? I am interested to note that there was no security given.

Mr. Inskip: The endowment by itself is not a large factor, and one reason for that is that the endowment is restricted. The uses to which those funds can be put are fairly heavily restricted. The endowment itself is intended to be permanent; is only the investment income can be spent. We would look at the endowment in terms of size. In the case of the University of Toronto, it is approximately $1.2 billion, as you mentioned. Those funds are not actually used. They are preserved and the investment income is used. The question is what that investment income can be used for.

To the extent that there are uses that are unrestricted, that provides value to an investor because there are unrestricted funds. To the extent that the funds are restricted, they become less useful. To the extent that you could take restricted-use funds from the endowment and free up moneys from the operating fund, then they provide real value.

That is only one factor. There are certainly many other universities across the country that have borrowed in the bank market. Many universities have been around longer than this country has, so endowment is only one factor.

On page 13 of my presentation I tried to outline a number of the factors. Financial factors include revenue flexibility, which is everything from whether tuition fees can be increased or whether they are capped by government regulation, to student demand. If demand goes down generally because of economic conditions, which universities will students come to? Financial factors also include ability to raise funds through donations. On the other side is expenditure flexibility, which includes what percentage of the professorship is tenured, where expenses can be cut, et cetera. There are a number of factors. Endowment is one, but it is not a huge factor in the process.

Senator Moore: You mentioned no security. What legally secures the obligation to repay the funds that you have arranged from the marketplace?

Mr. Inskip: There is a trust indenture between the university and the trustee, and the trustee acts on behalf of all the bondholders. The trust indenture is nothing more than a loan agreement, an IOU, a promise to pay. There are a number of other things in there, but basically it says that the university is borrowing a certain amount and promises to pay interest at a certain rate on a semi-annual basis and to pay it all back at maturity.

There are a couple of things they promise not to do, and those are what I refer to as covenants. They promise not to give security to other lenders, because those lenders would be secured while these lenders are unsecured. There are a number of circumstances under which they could give security, but they are limited.

Senator Moore: Does the undertaking not to give security apply just to the properties that are subject to this borrowing, or is it to any properties on campus?

Mr. Inskip: If you lent money for a specific asset and you took security on that asset, then you would not have a negative pledge. They could do whatever they wished with their other assets because the lender has security on this residence or this facility. In this case, the lender said, "Here is the money for the residence and parking lot," but it has no right to any of those revenues. Therefore, the lender is saying that it wants to lend on the same basis as any other lender, which is not having security on any asset. That is easier for most borrowers because it means that they do not have to bear the cost or spend the time to actually put a mortgage on a building. The lenders do not have to worry about access to the building, if they were to repossess it; also, if the building were in the middle of campus, they do not have to concern themselves with subdivision issues. Those issues are avoided by doing it on an unsecured basis.

Senator Bolduc: You mentioned as a source of repayment ancillary generated residence and parking facilities. Do you have any other possible areas for repayment, for example, an arena?

Mr. Inskip: This is an unsecured loan; therefore, U of T can choose to repay from whichever sources it wishes. The university is not obligated to take revenues from a residence or a parking lot. The university's intention is to build a residence and charge residence fees. Those residences fees will go to the central treasury for management. U of T is free to do whatever it wants. There is no legal obligation to use any revenue sources to repay these bonds. If they are not paid, the bondholders, in theory, could sue the university and demand payment from whatever resources the university has; however, the bondholders have no right to any particular asset or any particular cash flow. Anybody else could lend on an unsecured basis, and they would have equal rights to the revenues created by the assets built from this funding.

The other option is to lend on a secured basis - the lender lends the money, U of T builds a residence, the lender has security on that residence and the cash flow stream from it. If things got tough, in theory, you could take those assets and cash flows and use them to repay the loan. The constraint there is putting on mortgages. It is costly and there are a number of other issues. If you do not need to give security, from an issuer's point of view, sometimes it is easier to say all of its lending is unsecured.

The documentation is simpler.

Senator Bolduc: How do you compare the interest rate that you charge on that project with some of the types of capital developments?

Mr. Inskip: This interest rate was 6.78.

Senator Bolduc: Fixed rate for 30 years?

Mr. Inskip: Yes, for the next 30 years. One of the attractions of going to the bond rate is being able to get a fixed rate for the full term. The university knows when pricing its residence fees exactly what the capital costs are. The university built the resident, knows what it cost, and knows what the borrowing is. U of T can predict over the next 30 years some margin for operating cost variation. As far as capital costs, the university knows exactly what they are.

Senator Bolduc: It is about 65 basis points over the Government of Canada benchmark bond.

Mr. Inskip: That was the tightest spread in the market for that term for a non-government issuer. The other comparable, for example, would be NAV Canada, very similar pricing, and it has a monopoly, runs the air space. If you look at GTAA, it was closer to the high 90s basis points. This rate was very attractive. There was no non-government issuer that achieved a tighter spread over a 30-year term than this issue.

Senator Bolduc: Is there any Ontario Hydro financing on a 30-year basis?

Mr. Inskip: There is. The old Ontario Hydro debt, which was guaranteed by the province, had provincial rates - because the province guaranteed it. With respect to Hydro One, for example, I believe it was certainly higher. It was less than 100 basis points but definitely higher than the 65 basis points.

Senator Bolduc: This is not guaranteed by the government?

Mr. Inskip: That is correct.

Senator Bolduc: In the Province of Quebec, if memory serves me, the government is involved, I believe.

Mr. Inskip: My understanding is that in Quebec the debt service is paid by the government. In the example before us, there is no government guarantee. Obviously, however, the government has seats on the board.

Senator Bolduc: The University of Toronto issue that is before us is a free market operation.

Mr. Inskip: This is stand-alone financing for the University of Toronto, no guarantees. There is government support in terms of board representation, government grants, but this is a separate obligation of the University of Toronto only, and there is no guarantee from the province.

The Chairman: The situation in Quebec is that the government actually pays the debt servicing costs.

Senator Bolduc: I do not think they have the right to -

The Chairman: Go it alone. Why would they?

Mr. Inskip: This is the first widely distributed government bond for a university on its own credit. There are numerous universities that have gone to the bank markets for capital projects, because the projects were smaller and perhaps the money was for a shorter term.

Senator Bolduc: You say that there is a possibility for diversifying the portfolio. Do you see it as a possibility for various universities in Canada to do that?

Mr. Inskip: Absolutely.

Senator Bolduc: There is a market for that?

Mr. Inskip: There is a market. Investors are looking to diversify their portfolios. We have talked to a number of universities across Canada who are exploring it, and who, we are confident, could access the market.

Senator Bolduc: In the case of residences and the parking facilities, I cannot understand that. Are there other possibilities - except maybe in the sports area?

Mr. Inskip: Obviously, we are in the business of placing debt. We will explore every opportunity to place debt, and where there is a willing buyer and seller we will put them together. It is relatively easy to go to a university that needs to borrow money to produce an asset that will generate a cash flow, and take that cash flow to service the debt, good business principles. Residences, parking lots, food services, bookstores, any of those kinds of things are fine. With respect to academic buildings, presumably, it can be paid off by grant revenue.

In Ontario, for example, the operating grants cannot be used to pay debt related to capital. Those are not available. The endowment funds are not available. If you cannot find a repayment source, it becomes difficult. Even if the university has lots of assets, you do not want to rely on them selling off buildings to pay off the loan. That revenue source could be user fees, or it could be government grants.

In the case of school boards, the $1 billion I referred to, the governments have said, "Here is one grant for new pupil places, for new facilities to generate additional places in school," or "Here is a grant for facilities renewal." Both of those grants have to go into a segregated account. These school boards have raised over $1 billion, and for the next 25 years they are getting grants that have to go into the segregated accounts, and they can be used to repay the debt. In the school board case, there are no user fees, but an identified source that is segregated can be used to service the debt.

Senator Bolduc: I give money to Laval University every year, and I always stipulate that it is for the library. Many people are doing the same, so we have specialized endowment funds. Would you go so far as to say that you would be ready to look at it from the point of view of financing a library?

Mr. Inskip: We would look at any assets where there is an identified repayment source. If a university came to us and said that they had a particular grant we could use for this, or an endowment fund, and the intention is that so much can be segregated, you must consider the legalities. Can you pledge these funds or can they be used? The source would need to be identified and we would be happy to explore the possibility.

Senator Bolduc: How is it that in 2001 this bright idea of market financing has come about?

Mr. Inskip: Basically, for a couple of reasons. One is that there has not been the need on the part of universities. For the most part, in terms of capital facility, governments have funded those academic buildings, or it is has been a combination of governments and donations. The only ones where the universities have needed to borrow in past are ones that governments did not fund, which were typically things like residences. If you do one residence at a time, the borrowings are relatively small. If you want to borrow $25 million you can go to the bank and arrange the financing. If you want a fixed rate you might go to the swap markets and lock in your interest rate. For the size of the transactions, that has been an appropriate way to proceed.

When we are looking at significant growth in enrolment - in Ontario we are looking at the elimination of grade 13, which means we have more students - all of a sudden you are looking at significant amounts of capital requirements.

Senator Bolduc: CMHC used to be the source of residence financing on the universities campuses.

Mr. Inskip: CMHC was involved in many of them. In the U.S., they have used capital markets for many years where they had large needs. The second reason is that in the Canadian market, 10 years ago, there was not a developed corporate market. The governments issued a large amount of debt, as we know, and interest rates were high so it crowded out the non-government issuers. It has only been the last five or six years where we have had school boards, airports, universities, therefore, a broader corporate involvement in the market.

Senator Bolduc: The bond market is going down, too.

Mr. Inskip: The yields have come down significantly. Five years ago, you were looking at close to 10 per cent, whereas today you are looking at between 5 and 6 per cent for 10-to 30-year money.

[Translation]

Senator Ferretti Barth: Mr. Inskip, after Italian, French is the language I speak best, better than I do English.

I would like to know how many years the University of Toronto has used your services to secure loans, namely, for how long has the University of Toronto been needing the services of the Canadian Imperial Bank of Commerce?

Has this been going on for a long time or did the university only begin using your loans services last year, in addition to organizing fund raising in order to resolve many of their problems?

[English]

Mr. Inskip: I cannot answer how long. We deal with the University of Toronto on a banking relationship. In terms of the particular bond issue, the process started with a request for proposals to a number of different financial institutions, and that process was done in the fourth quarter of 2000. We started the advisory work in January 2001, at which point we talked about what was required to issue a bond, what the credit ratings were, the legal document, the kind of covenants, and then we started that process. From the time we actually were awarded the mandate to help them go to the markets, it was early January of this year. It actually went to market in July, so it was about six and a half months.

[Translation]

Senator Ferretti Barth: I would like to know what problem the University of Toronto was facing when it informed the bank that it needed to borrow money in order to resolve some very important issues.

Can you tell me what the problem was? Was it the residences, infrastructure maintenance or maintenance required for other sectors in the university? What was the main problem facing the university that required that it borrow money?

[English]

Mr. Inskip: I do not think it was much a problem, as I would think of deferred maintenance as a problem. It was that the university currently has residence facilities for roughly 14 per cent of its students. It wanted to expand residence capacity over a period of time to something closer to 25 per cent of their students. More than half of this money will be used for building new residences. They wanted to expand a number of residences, particularly with the elimination of grade 13 and two years graduating at once - but even for their current enrolment they wanted to expand residences. They wanted to build a parking facility, and they may have a small need for augmenting their academic buildings. Primarily, it was motivated by a need for additional residences.

[Translation]

Senator Ferretti Barth: Did you begin providing this service to the university in 2000? Did you inform other universities in Canada that you were able to assist them?

You know, Quebec universities are in good shape. The way that they operate provides some stability, even for resolving infrastructure problems. But for the other universities that require money for research or building maintenance, did you advertise the fact that you were there to help the universities?

The Toronto example must be very positive, and there may be a lot of universities that will call upon your services. You could subsequently reduce the interest rates!

[English]

Mr. Inskip: I appreciate the opportunity for you to look after our interests. We certainly have met with some universities, some on the West Coast and the East Coast, in Quebec, Ontario. We have not met with the majority.

We met with selected ones. Obviously it takes time, but our intention is to meet with many universities across Canada. We obviously want to look at ones that have a need that is of a size that is appropriate for the bond market. We have told a number of them that we have done this transaction and would be happy to talk to them about how it went. I have met with several universities across the country and have presentations planned with others. We have met with one in Quebec and have plans for others there as well.

It is an ongoing process. This was done in July. Summer intervened and we are now just starting up again. The markets are a little unsettled at the moment, but we will be out talking to more universities.

Senator Stratton: With regard to payback on the bonds, I realize we are talking about payback from general revenue, even though there was revenue achieved from the student residence and the parking fees. Did the university base the payback of the interest on the income derived from the residence and the parking? Is that how you arrived at the amount, or did they top it off with other revenue sources?

Mr. Inskip: They will allocate the funds to the particular users. I think that, in the case of the University of Toronto, they said that they would provide a small subsidy for a time-limited basis. In that sense, I do not know the exact amount. The intention is to subsidize residence rates by a small amount for a certain period of time, reflecting the difficult market conditions in terms of high housing costs.

Absent that, generally the costs of the financing would be passed on on a full cost-recovery basis. Therefore, in the long term, full cost recovery but a temporary period of subsidy.

Senator Stratton: I would hope that they would have a gradual escalation of residence fees rather than a sudden increase.

You talk about funding of a size appropriate for a bond market. What is an appropriate size for the bond market?

Mr. Inskip: As I outlined in my presentation, there are two ways of approaching the bond markets. One is the traditional private placement. That is where you would go to a number of insurance companies and negotiate a fixed- rate, long-term transaction with those providers of money. The minimum is in the range of $25 million to $100 million. For a public-style issue, the amount is probably $100 million.

Therefore, in terms of the capital markets, it will be at least $25 million; otherwise, you are in the bank market. If it is under $100 million, you will do a traditional private placement where you negotiate with individual investors. If it is over $100 million, it will be more of a public style, where it is fully negotiated and underwritten by an underwriting group.

Senator Stratton: A small university building, a residence and a parkade would, in many cases, have to go the private route?

Mr. Inskip: Yes. We are talking to a couple of universities that have requirements of less than $100 million. In those circum stances, it is just a different approach to go to market. In many cases, we are talking about the same investors; some will be different. You will not be going to mutual funds and others that require more liquidity. The process is different, but the trust indenture and the other things could be very similar.

Senator Stratton: Is the rate higher because of that?

Mr. Inskip: The rate is higher because of the lack of liquidity. Liquidity is the ability to resell. When investors get nervous and want to see their mutual funds, they have to be able to sell what is in their portfolio. These are less liquid, and typically they have a premium on the spread.

Senator Stratton: How many basis points?

Mr. Inskip: It depends on the circumstances. An insurance company would say 25 basis points. Sometimes we can squeeze that down, depending on who the issuer is. If it is heavily structured, it will be more than that.

Senator Bolduc: When it is in a private placement, you can do it as a major undertaker and then sell it to other of your friends, I suppose?

Mr. Inskip: You might have a lead investor, where you do more negotiating, but typically if we were doing a $50-million private placement we would work with the university. We may or may not get it rated. We would draft up term sheets, go through the details, prepare a presentation, and go with the university to half a dozen investors and make the presentation. They would each say how much they want. We want fill up the book, and we would negotiate the documentation. It might be three or four insurance companies, as opposed to a bank transaction where you might have a bank underwrite the whole thing and then sell off pieces after. In the private-placement market, you would typically try to place the whole thing first.

Senator Tunney: Can you imagine a situation where a university would go into receivership if they defaulted on interest payments, for instance? How could a university go bankrupt? I expect I know what you would do if they were in serious financial trouble.

I am sure this will not happen, but supposing it were 1929 and the economy went into a serious depression. Of course, there would be thousands of these cases in serious trouble, but what coverage have you got for risk, if there is risk? I have not yet heard you say whether there really is a risk.

Mr. Inskip: My view is that there is risk in anything. Some risks are very small and some are very big. In the case of the University of Toronto, the credit ratings are a notch higher than those of the Province of Ontario. The Province of Ontario has unlimited taxing power. The university has assets with an insured value of $4.8 billion, it has a large amount of land in downtown Toronto and it has an endowment fund of $1.2 billion. It has a lot of assets and high demand for its services. The risk theoretically exists but is infinitesimally small. Investors have the same view. They said the spread they will charge is extremely low. It sold very quickly and is heavily over-subscribed. That is the University of Toronto.

Looking at universities across the country, there are others that are located in less favourable locations. In the case of the University of Toronto, if they got into difficulty, they have some very valuable assets in terms of lands and the things you could do with those assets. In the cases of some other universities located in small town, if it were not a university it is not clear for what other purpose those assets could be used, so there you have a higher risk.

Investors will look to see which universities in a province are the flagship universities. They will take the view that no provincial government would let its major university get into difficulty, so those ones become fairly easy.

It is when you have four, five or six universities in a province, some of them small, and there is a 1929 situation, that there might be real risk where one would ask whether the province needs five universities. The expectation of investors and underwriters in those circumstances would be that there would probably be consolidation. In the hospital sector, numerous hospitals were merged. There was a reduction in the number of facilities, but the merged entities took over responsibility. Does the risk exist? Yes. Can I imagine a university going bankrupt? It is hard to imagine. A more likely scenario is some kind of restructuring to reduce the number of universities or merge them, so you would have multiple campuses.

Senator Tunney: I may not have explained my concern well enough. For instance, in a 1929 situation, the university would not stop operating but tuition fees might have to be substantially reduced, maybe enrolment would be reduced, and many things that keep the university flowing now might not be there. There might be problems with the capital amount, if not with the interest charges. Maybe that could be extended over a time.

I admire the promptness with which you were able to put all this together. You mentioned late 2000, and it is still not late 2001 and this whole deal is in place.

Mr. Inskip: It took six months. We started January 6 and were done in July. We could have done it a couple of months quicker, but we wanted to go through all the different options. If the university knew which option it wanted, it could have been done more quickly.

A private placement or a bond offering for a first time issuer could be done in three months. For a university or any issuer that is looking at doing it this way instead of a bank offering, a tax deal or a securitization, an analysis needs to be done. Therefore, six months is a reasonable time.

Senator Tunney: I like the interest rate. I am a farmer, and I know I could not get that, nor probably could I get a loan put through in the short time you were able to do this, but I do not deal with the Canadian Imperial Bank of Commerce.

The Chairman: Notwithstanding that the senator does not deal with the bank, I hope you will appreciate this exercise as a rehearsal for the next shareholder's meeting.

Senator Wiebe: Like Senator Stratton, I am not a banker or a bond issuer, so could you explain to me what kind of assurances there are. You mentioned that the revenue to pay the interest would be generated from the residences or the parking lot or any other source of income, and a certain portion of that would be set aside each year to pay for the capital, to pay the $160 million back in 30 years.

What kind of assurances are there that the university is handling the capital payback portion properly? You mentioned that the university could invest that. Does that mean investment in another building and another way to generate some money? What kind of assurances do I, as a bondholder, have that that $160 mil lion will be there 30 years from now?

Mr. Inskip: I will answer generally and then specifically, in the case of University of Toronto.

In some cases, there is a formal sinking fund. For example, the school boards have issued debt. They are, under the Education Act in Ontario, required to either pay off the capital portion on an annual basis, like a mortgage, or they have to set it aside in a formal sinking fund. By law, it has to be audited. Many of them have independent fund managers that manage that account. There is a formal sinking fund, which is a legal requirement of the trust indenture, and if it is not done, there is a breach. The bondholders can say that they want all their money back today and take legal action.

In the case of the University of Toronto, there is no legal requirement for a sinking fund. Many companies that issue debt do not have any legal requirement for a sinking fund; therefore, you are relying on the company's management, on its financial prudence to put that money aside. In the case of University of Toronto, it has outlined it intentions in its document, but no legal requirement forces it to have a certain amount of money on a certain date. As a bondholder, you are reliant on good management, the strength of the credit, and the promise to pay.

Senator Wiebe: Will there be any indication on a yearly basis with an annual return by the university that there is some good prudence being done? To find out in 28 years that in two years from they will not be able to come up with the money - will there be something on an annual basis that allows some comfort?

Mr. Inskip: The university publishes an annual report, which is audited, the same way it has an endowment fund. They have $1.2 billion. It has an independent company that manages these funds. I do not know what will be in its annual report next year about money that has been set aside, whether it is specifically identified. It is probably relatively small; perhaps not.

If you think in the context of its operation, $160 million is small. No prudent financial manager is going to say it has assets that are ensured at 4.8 billion. Those are just the physical assets, and there is an endowment. In terms of their operation, $160 mil lion is a small portion. No prudent financial manager, let alone a governing council consisting of one-third government appointees, alumnae and others, is going to risk the credibility of an institution like that when it is a small proportion of their whole business. In the end, if it does not pay, investors can sue. No one ever wants to be in a situation of defaulting. It will do everything it can, like any other borrower, to make sure they meet any covenant obligation, any reporting obligations, and, obviously, in due course, the final payment obligation.

At the end of the day, the bondholder has to assess the risk. If there is not a formal fund, the bondholder has to determine the risk he is prepared to take, whether he is he willing to buy the bond and at what price? It is a risk he weighs. For a borrower that has a lower credit quality, bondholders might want a formal sinking fund or to get their money back on an annual basis.

Senator Wiebe: It went on the market on July 1. Have they all been sold?

Mr. Inskip: They were sold within the same day. Everything was sold the same day.

Senator Mahovlich: University of Toronto has been around since 1827. How many students would they have today?

Mr. Inskip: The university has 55,000 students.

Senator Mahovlich: Their alumnae must be in the hundreds of thousands.

Mr. Inskip: I do not know the number, but it has a very large group of alumnae.

Senator Mahovlich: Would not they be purchasing these things, and if they are as old as Senator Wiebe, in 30 years they will not be around?

Senator Wiebe: I am going to surprise you, Senator Mahovlich.

Mr. Inskip: We encourage the university to send something out, and suggest that rather than accepting an interest payment they donate the interest payment to the university. That way they would not need to actually pay anything.

These were technically a private placement. There are various securities laws. A public issue can be sold retail, but that requires all kinds of reporting obligations on the university. We recommended they did not go that route, so it was done technically as a private placement, which meant the minimum purchase amount was $150,000. Therefore, virtually all of it was sold to retail as opposed to alumni. If an alumnus wanted to buy $150,000 or more, they could have.

Senator Mahovlich: This is large to me but it is small to you. Do you mind me asking what your commission was on this transaction?

Mr. Inskip: It is a small percentage of the annual average hockey player's salary.

The Chairman: I presume it is public knowledge, Mr. Inskip. In addition to this indebtedness, what does the overall debt load of the University of Toronto look like?

Mr. Inskip: I will actually answer that question, and Senator Mahovlich's question too, which is a matter of public record. The underwriters received a fee of seven-tenths of 1 per cent, which was distributed among the underwriters.

The second question concerned the University of Toronto's debt load. Their current debt load is something in the order of $60 million plus the $160 million they have just borrowed.

The Chairman: We are accustomed in this sector to reckon the debt, as you well know, as a proportion of sometimes GDP, sometimes of government revenues, and so forth. Given the assets of the University of Toronto that you have referred to, a debt load of approximately $220 million, the vast majority of it quite long term, is not much of a burden, is it?

Mr. Inskip: It is not, and that is one of the reasons for their high credit rating. When credit rating agencies look at it, they will look at the debt service as a percentage of their operating revenue. Their plan is potentially to borrow $300 million - the $160 million now and, if they need it, an amount that would get to $300 million. At that point, their debt service obligations as a percentage of their annual operating revenues is about 3 per cent. That is still very small.

The Chairman: Did Standard & Poor's and Moody's rate the University of Toronto in connection with this issue, or do they routinely rate the universities?

Mr. Inskip: They can do either. They can do what they call an issuer rating. If a university phoned up and asked for a general rating, they can get that. In the case of University of Toronto, they technically have two ratings: one is a general issuer rating and the other is the rating on the specific bond. They happen to be identical. They are identical because the bond is a general obligation bond, it is unsecured, and it is not limited to only residence revenues or only tuition. It is a general obligation of the whole university, and there is no one in front. If there were another lender that had security on all the assets, then this bond might be rated lower. They do not have that, so the ratings of the university and the bond are identical.

The Chairman: Do you know how many other universities have been rated by the agencies?

Mr. Inskip: In Canada, the University of Toronto has two ratings; the University of British Columbia has one rating from Moody's; and Brock University has one rating from Standard & Poor's. There are no other public ratings.

The Chairman: You have told us that you have been in touch with a number of universities with a view to discussing the possibility of bond issues of this kind. You have told us that you have not seen the majority of the universities in Canada; however, I presume you have seen a fair cross-section of the universities from the point of view of size, financial capacity, location and so forth.

Mr. Inskip: To be honest, we focused more on the larger universities, or the ones we thought had the largest need, and less so on the smaller ones; however, we have spoken to a couple of smaller ones.

The Chairman: How many of those do you think might qualify for the kind of rating that the University of Toronto received?

Mr. Inskip: Brock University is rated A low. There are ratings of A low, A mid, A high, double A low, double A mid, double A high. The University of Toronto is double A high by one rating agency and double A mid by another. UBC is double A low, so you have six notches in between. Brock is a smaller university. UBC is the largest in B.C., and one of the larger, so it is probably fair to say that most of the universities would get a rating in the A category.

The Chairman: Would that be most of the ones to whom you have been talking?

Mr. Inskip: There will be some in the double A category, such as UBC, U of T, so there would be a limited number in that category, and then there would be a large portion in generally the A category. All of those are acceptable to the market. Those are good investment grade ratings. They will have different prices attached to each one, but they are all still good ratings.

Senator Bolduc: Do you mean that there is a 25-basis-point difference, or more than that?

Mr. Inskip: No, the 25 basis points was the premium that you would pay for going the traditional private placement versus a public route.

For the actual spread, you look at the university and you question where its funding is coming from. In Ontario, investors look at the Province of Ontario and they build a spread that way. If we are talking about a university in another province, an investor would look at the spread for that province, the appropriate spread for that university given its credit rating, and the other spreads available in the market at the time. Spreads move up and down.

Senator Bolduc: It is a bit like the school boards.

Mr. Inskip: The school boards are different, in that if you look at the school boards in Ontario they all have the same legislation. They are all governed by the Education Act, as opposed to universities all having their own legislation. They all have the same funding formula. They are not a competitive business. Universities compete. School boards will all have similar ratings.

Senator Bolduc: They have municipal taxation.

Mr. Inskip: In Ontario, they have taken that away. School boards will have similar ratings; therefore, the credit spreads will be fairly similar for a similar size bond issue. If you do a large one, you will get a tighter spread than a small one, which is the same for universities.

The Chairman: To come back to the problem that preoccupies Senator Moore, you say here that for universities to finance significant levels of accumulated deferred maintenance an incremental revenue source is required to repay the additional borrowings. I believe you said something about that earlier but I would like you to elaborate.

Mr. Inskip: Earlier, when referring to a university's operations, I mentioned four funds. The operating fund is the day-to-day operating requirements. It has specific source of revenues. There are operating grants, student fees, et cetera. Those typically operate on a break-even basis, and they work hard to break-even. Then you look at the capital account, and those are typically project by project. You get government money and donations and you build a building. The ancillary services are the residences and parking lots. Those are typically full cost but break-even. Then you have restricted funds, which are your endowments and your donations, and they can only be used for specific purposes. When you go through each of the accounts and you look at where the money comes from, how it is used, there is no extra source of money. You can look at how it can be increased. If we go to sources, such as government operating capital grants, if that is increased that is an incremental source that can be used but governments may say no.

Research grants and contracts are all for specific purposes, so you cannot use that. In many cases, student tuition and fees are regulated. Some universities, by nature of their reputation, could, in theory, raise their tuition fees and students would still come. Others could not. Most fees are regulated, not all; but if you raise them above the regulated rate, the government reduces the grant so you do not get any new revenues. Therefore, you cannot raise money there.

Investment income may be dedicated to a specific source, and it is a function of what assets you have that actually earn return. Sales and ancillary operations refer to parking lots, residences and so on. The only way to raise money on those is to charge more than they cost and use the excess to subsidize the building, but the philosophy of most universities is not to cross-subsidize.

Then there are donations. Usually people who donate designate where their donations are to go, so that money is not available for refurbishing buildings.

In all those sources, there is no obvious source of money that you could use for accumulated depreciation.

The Chairman: You are not encouraging us to think that a bond issue is the way to tackle Senator Moore's problem.

Mr. Inskip: A bond issue is really nothing more than a financial instrument to bridge timing differences. If I want to get a mortgage on my house, the bank will give me money today in the expectation that I will earn money over the next 25 years to pay it back. It is really just a timing difference. The key issue in terms of deferred maintenance is that if you could identify a source of money to come in in the future you could borrow today. That would not be a problem, or you could give cash today. If that source could be donations or government grants, you could take the cash and build it. If those sources were not there but you wanted to promise it for the next 25 years, like school boards did, under that scenario you could borrow.

The Chairman: You, the Canadian Imperial Bank of Commerce and, I suppose, other institutions are getting ready to move into this field. It is clear to you that there is a need and there is a market?

You have been analyzing the financing and the administration of our universities. Feel free to make whatever comments you like about that. In particular, I wonder whether you have come to any conclusion about the regulatory framework in the sense of the kind of conditionality you were talking about earlier where governments insist that a certain percentage of tuition fees go to a particular purpose or whatever. Have you come to any con clusions about the wisdom of the constraints upon the budgeting process of universities?

Mr. Inskip: I do not think so. I suspect they vary across the provinces. I do understand the need to have certain restrictions. Governments want to ensure that money designated for a certain purpose is used for that purpose. If the objective is to educate students, you want to ensure that the money is used for the appropriate reasons. School boards have money for classroom purposes, money for building new facilities and money for repair and maintenance. That works well because a lender knows that there are restrictions. They cannot take all the money from the capital envelope and grant a 15 per cent salary increase while being unable to pay their debt.

There is definitely value in restrictions from a bondholder's point of view and probably from the public's point of view, but I cannot comment on whether the existing restrictions are the most appropriate ones or not.

Senator Moore: Mr. Inskip, in response to Senator Stratton's questions about the interest rates that might be payable and the type of financing that would be available, you indicated that the minimum appropriate sum would probably be $100 million to do a public bond offering such as your company did. Less than that you thought would be a private placement situation, at least 25 basis points above that?

Mr. Inskip: The spread over Canada would be a reflection of the credit risk, the liquidity and the size of the offering. In the case of the University of Toronto, we are talking about 65 basis points. For another university, the appropriate spread may be 100, if it were a similar size issue. If that university is lower rated, their spread is 100 and they only wanted to do $25 million, you might add 25 on top of that to reflect the fact that it is an non-liquid offering, which is difficult to sell and you are selling to selected universities. In that case, the spread might be 125.

It is a function of what the appropriate credit spread is for a large liquid offering for that university, and then there would be a premium for a smaller transaction.

Senator Moore: In the area of 25 to 100 would happen through a conventional bank loan?

Mr. Inskip: On page 1, I outline the three. You could do a bank loan as one option. I mentioned that between $25 million and $100 million, you could do a private placement. Not all investment dealers will apply the same size criteria. One investment dealer might say that if it is under $50 million it is too small.

Senator Moore: What would be the range of interest rates on something like that?

Mr. Inskip: It depends on the issuer and on whether it is secured or unsecured. The University of Toronto is at 65. That is the tightest you will get for any Canadian university. It will go up beyond that. A 10-year deal is different than a 30-year deal. There are many variables.

Senator Moore: It is certainly going to be a lot or more expensive.

Mr. Inskip: I do not know whether it is a lot more expensive. If, broadly speaking, it is in the 7 to 8 per cent range, is that really expensive? I do not know. There is no question that any university offering in Canada will have a higher spread than the University of Toronto.

Senator Moore: With respect to financing the accumulated deferred maintenance, you have indicated that it is not something that would be attractive in the bond market. Where would you see that? If you were running a university with a $50-million need, where would you try to find that money, given what you have told us about the parameters and the considerations?

Mr. Inskip: The lack of attractiveness is not specific to the bond market. Any lender, whether a bank or an individual institution, will want to know how it is going to be repaid. If you have an accumulated depreciation, borrowing is not a magic solution. Borrowing the money and fixing it up may not create additional revenue, because you have just maintained the assets in the condition that they should have been. You now have exactly the same revenues as you had before, but you also have a debt service obligation. You are going to have to say, "How am I going to pay that?"

There are two possibilities. One possibility is that one has more revenue coming in. I would look at all my revenue sources. I would lobby the governments to see if I can get more government money.

Ideally, one would lobby the government for it to fund 100 per cent; then one would say, "If I come up with a dollar, will the government come up with a dollar on a joint kind of basis?" That may be done through fundraising. The other portion may be achieved through any operating cost savings. There is probably not a lot of operating cost savings in the system because funding has generally decreased in the 1990s. Everybody has already gone through and said, "What can we cut?" They have already done that process. It probably means some combination of government grant and donations. However, that is tough. Everybody likes to cut ribbons. They do not like to fund deferred maintenance.

There are people who give on an unrestricted basis. Using unrestricted donations, combined with some kind of a government support, might be a combination that works.

Senator Moore: You have mentioned the word "government" several times in your response. No one is going to write a $3.6 billion cheque, but there may be ways that donors can be encouraged to donate with tax breaks. It is a huge problem. I am from Nova Scotia. I know the universities in Nova Scotia and in the other Atlantic provinces. I know the situation, from the report mentioned by our chairman. Some of the universities in Quebec and Ontario have needs in the hundreds of millions. The immediate need identified is $1 billion, apparently for things that must be done yesterday. I am struggling with how we do that.

I sit on the board of St. Mary's University and all the things you have covered here are things we look at. How can these situations be handled? The universities have faced cutbacks in funding. They have had increased demand from their students. Research monies do not beget new facilities.

The committee is hoping for some jewels of wisdom, so that we can pass them on to the powers that be.

Mr. Inskip: Unfortunately, the bond market does not provide any jewels of wisdom. Instead of writing a $3.6 billion cheque, you could say, "I am willing to write a bunch of smaller cheques so the bond market can lend." You write a cheque this year and next year and the year after; therefore, you are writing smaller cheques. This is just a timing difference. Reducing the size of the cheque that you have to write in any given year is one solution. However, it does not reduce the accumulated size of the cheque. In fact, the size of the cheque might be bigger because you have interest that accumulates over time.

Presumably, there may be opportunity for cooperative effort with the university. With my son, I always say, "If you do this, I will do this." Obviously, the simple answer is for universities to turn to governments and say, "We need all this money." Frankly, they probably do need a lot of the money and there is probably limited opportunity for them to contribute, but maybe there is some combination of fundraising.

Senator Moore: It still comes back to identifying the source of repayment.

Mr. Inskip: Absolutely. All the bond market will do is to grant you funds on a timing differential basis. If you need the money now and want to pay next year, that is okay, but you need to identify what that source is.

The Chairman: In your travels, did you come across evidence of serious accumulated deferred maintenance at institutions that you visited or with whom you were in contact?

Mr. Inskip: Not physically, although had I looked around I am sure that might have been the case. Certainly, in speaking with the universities, several of them had said, "We have X-hundred million of accumulated depreciation and it is a concern to us. We cannot borrow - how would we repay the funds?" It is an issue, as you all know, for universities. That has really been the extent of our involvement, to acknowledge that that is a concern they have.

The Chairman: Do you think it was a management problem at the universities?

Mr. Inskip: In terms of the accumulated -

The Chairman: Yes.

Mr. Inskip: I am not qualified to answer that.

The Chairman: We all know the universities have been under serious financial constraints for quite a few years.

We will have an opportunity to discuss it with them.

I thank Mr. Inskip for his attendance this evening.

The committee adjourned.

National Finance

Proceedings of the Standing Senate Committee on National Finance

Issue 18 - Evidence

Proceedings of the Standing Senate Committee on
National Finance