S&P - Public Finance Criteria (2007). - The Global Clearinghouse

Education And Non-Traditional Not-For-Profitsand provides a measure of an entity’s ability tofund operations if operating revenues decrease.Different organizations require different cushionlevels. For the most part, the level of working capitalrequired is a function of the organization’scash flow. An entity that receives a steady streamof income throughout the year can operate onthinner reserves than one that receives most of itsrevenue once or twice a year. An exempt organizationthat can quickly and easily reduce expendituresat midyear can operate with thinner reservesthan one that must commit funds well in advance.Most not-for-profit corporations rated byStandard & Poor’s have a good sense of their coststructure—what portion of their operating expensesare fixed and what portion, or components, arevariable. Some organizations indicate that a substantialportion of their salaries and benefits couldbe considered to be variable in nature, while facilitiescosts, insurance, and legal fees are not.Generally, institutions with unrestricted resources(measured in cash and liquid investments) below25% of their annual operating budget have a limitedfinancial cushion.In addition to operating revenues, many nonprofitsrely on annual voluntary contributions. A longhistory of successful fundraising managed by a professionalstaff can offset concerns about the cyclicalityof this revenue source. However, thesestrengths would not be enough to offset the risksassociated with an organization totally dependenton contributed revenues.Debt and capital structureIn addition to reviewing specific debt ratios asnoted above, Standard & Poor’s considers security,the project being financed, and future capital plansin its assessment of debt. Organizations that arecapital, or facilities-intensive, should have debt policiesin place. Debt policies should include the typesof allowable debt, directions about when derivativescan be used, and how an appropriate level ofdebt is determined. Other long-term liabilities, suchas postretirement obligations, may need to be consideredin addition to any long-term bonded indebtedness.The level of debt that is manageable is verymuch specific to the type of institution being rated.Cultural facilities, which are more place-intensive,tend to have higher debt burdens than other typesof nonprofit corporations.Security. Most not-for-profit corporations’ bondissues are secured by an unsecured corporate, GOpledge of the obligor institution. WhileStandard & Poor’s will consider a narrowerpledge, such as membership fees at a museum orindirect cost recoveries of a research laboratory, itis unlikely that such a structure will receive ashigh a rating as a GO pledge. As additional security,a fully funded debt service reserve is prudentunless the issuer has substantial liquidity. Mostissuers also include legal covenants, such as ratecovenants, asset-to-liability tests, and restrictionson the issuance of additional debt. The ratingimpact of such covenants depends on the nature ofthe entity and each covenant’s relative strength ordegree of restriction. Some covenants are so looselywritten that they do not provide any real protectionfor bondholders. Stronger legal covenantsgenerally do not result in a higher general obligationrating. Endowed foundations present a specialcase for bondholders. While they look for someindication that a pool of assets will not be spentdown, nonprofit corporations issuing tax-exemptdebt are subject to arbitrage restrictions, whichwould be a strong disincentive to pledging anykind of “reserves”. However, restrictive covenantsand policies remain a protection that bondholderswouldn’t otherwise have, and a gauge of willingnessto meet the needs of investors.Project. An analysis of the project to be financedincorporates several factors. Standard & Poor’s initiallywill examine the need for and scope of theproject, and how it fits into the organization’s overallactivities. Many of the nonprofit project financingsrated by Standard & Poor’s involve theconstruction of new headquarters buildings and theconsolidation of operations in one location, and areconsidered fairly essential. Standard & Poor’s alsoanalyzes the degree of self support assumed for theproject, compares debt maturity with project life,and evaluates other sources of funding. Undertakinga project that does not help meet an organization’smission, that takes it in new untested directions, orthat is likely to require considerable financialresources in the future even when an organizationhas debt capacity, could be considered a negativerating factor. Most of the project financings ratedinvestment grade are projects being undertaken byexisting exempt organizations. Start-up projects bynew organizations without a track record, or byentities without any financial resources, may find itdifficult to achieve investment-grade ratings.Capital improvement program. A review of thesize, sources of funding, and timing of future capitalplans provide important insight into an organization’sneeds and goals for expansion. Standard &Poor’s also is interested in determining whetherthese plans will significantly change an organization’sscope or mission. Some organizations, such asaquariums or other attendance-driven cultural institutions,must constantly plan for new attraction andupdates of their facilities. A failure to consider newexhibits or changing exhibits could be of concern.202 Standard & Poor’s Public Finance Criteria 2007