Credit crisis gives OU a scare involving big apartment complex
By Jim Phillips
October 6, 2008
By the time Congress passed its massive rescue/bailout of the financial industry last week, Ohio University had already begun feeling the dire effects of the nationwide credit implosion.
At their meeting Thursday and Friday, OU Trustees learned that returns on investment are dropping for both the university’s working capital and its foundation endowment.
In an even more stomach-churning revelation, the Trustees were informed Friday that OU had been required briefly to take back most of a multi-million-dollar bond issue, floated in 2000 to build the University Courtyard apartments.
This remarkable development occurred when two institutional investors recently decided not to renew their purchase of holdings in the Courtyard bond issue, and turned them back to Housing for Ohio, the non-profit created by the OU Foundation to own Courtyard. These holding represented well over $20 million, according to Decatur.
The Foundation managed to re-place the bonds with investors. But it underwent some nervous moments while it sought to unload the hot potato, and was only able to find buyers by substantially increasing the interest rate the bonds will pay.
The payoff money for the bonds comes out of revenues earned by the student apartment complex, which sits on OU land above Richland Avenue and the Hocking River.
“It’s been wild times,” admitted Bill Decatur, OU’s senior vice president for finance and administration, Friday.
Decatur said it’s a stunning development for a company related to a public university to have to agree to buy back most of a bond issue that has been performing without problems.
“This is unheard of,” he declared. “It’s another manifestation of the times we’re in.”
With credit markets going down in flames, there is a massive “flight to quality” going on among investors – i.e., they’re bailing out of anything that seems the slightest bit risky and heading for the safest investment waters they can find.
Under normal circumstances, a student housing bond such as the one that financed Courtyard would be considered fairly safe – not as solid as a municipal bond, or one backed by OU as a state institution, but quite reliable.
In the current panic mode of the investment community, however, a solidly performing variable-rate bond, paying around 2.5 to 3 percent, and backed only by the revenues and assets of Housing for Ohio, apparently looked too risky for the two big investors who unloaded their holdings.
The original tax-exempt bond issue was for close to $32 million, and the bonds were “non-recourse,” meaning that neither OU, nor the Athens County Port Authority, through which they were issued, was at risk of losing money if they didn’t perform.
The two investors who turned back their holdings in the Courtyard bonds — Decatur said he could not recall their identities Friday — were holding between them the majority of the bonds, he said.
Last week, the OU official reported, the Foundation found new investors to take the bonds. To do so, however, he added, required agreeing to an initial 6.5 percent interest rate – which requires a much bigger payout to the bondholders.
“The price of money just doubled,” Decatur noted grimly.
HFO does have a letter of credit with a bank, which in the worst-case scenario, could have been invoked to require the bank to buy the bonds. This luckily wasn’t necessary, Decatur said — as this recourse probably would have knocked the interest rate on the bonds up closer to 7 percent.
Even the new 6.5-percent interest rate will mean serious money troubles for HFO if the markets don’t stabilize and bring the rate down, Decatur warned.
“At that interest rate long-term, it’s very problematic,” he acknowledged.
Last year, Decatur said, after paying off bondholders and other financial obligations, HFO cleared about $300,000 on Courtyard, which was a public/private partnership between OU and a private developer.
Given numbers like this, Decatur suggested, any interest rate on the Courtyard bonds above about 4.5 percent is going to mean HFO is losing money long-term. Obviously, he said, if the markets don’t calm down soon, the OU Foundation will have to start considering other options, though not many are available.
One possibility would be for the Foundation to assume ownership of the apartment complex and find alternative financing for it. Another would be selling the apartment complex – though in today’s market, Decatur admitted, the prospects for doing that may be slim.
DURING A MEETING of the Board of Trustees’ University Resources Committee Thursday, members learned that investment returns to OU and the Foundation are dropping sharply.
Laura Brege, chair of the OU Foundation’s Investment Committee, noted dryly that “we’re clearly in historic times” as far as the investment climate, with enormous volatility in the markets.
Three years ago, she recalled, OU and Foundation investments were heavy on equities such as stocks – a situation that has had to change as the markets got “very very ugly, very very fast.”
By cutting back on equity investments and also moving into private equity, Brege said, the investment committee has been able to shore up its investments against market developments somewhat.
“Fundamentally we are in a position of weathering the storms,” she said.
She acknowledged, however, that investment returns are going to take a hit. “It’s not pretty,” Brege said. “There’s no question that in the first quarter, we’re going to see a decline.”
Decatur confirmed Friday that from earnings on OU’s working capital that were up above 4 percent last spring, earnings have now dropped to around 0.25 percent.
“It’s almost effectively zero,” he said, noting that these earnings are used for the university’s operating budget.
This could mean that OU’s budget will be short by some $5 million it expected to get from investment returns – a number that had already been revised downward from an earlier, more optimistic forecast.
One piece of good news, Decatur told the Trustees, is that OU doesn’t have any major exposure with financial firms that have gone belly-up.
The university does have some $9 million in a long-term investment in a hedge fund, which will be inaccessible while Lehman Brothers goes through bankruptcy proceedings. Luckily, he said, the university won’t have any pressing need to get at that money in the immediate future.
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