Today's leaders in education have their work cut out for them. The combination of decreased funding, tighter budgets and limited resources has created a complex environment for finance leaders. Most spend an increasing amount of time looking for new ways to bend the cost curve. By evaluating different financial product options available for capital projects, you can determine the best fit for your needs and generate significant savings for your school.
Schools across the country have looked to debt markets as an attractive source of long-term, fixed-rate financing. However, there are several downsides to issuing bonds. First, they come with material issuance costs and can be administratively burdensome. Time is also a limitation, as it can take anywhere from three months to two years depending on the amount and structure.
Bond financing is generally not a good source for short-term projects or equipment that may have a useful life less than seven years. Putting short-term assets on long-term debt is akin to rolling your groceries into your mortgage. Issuing long-term debt to finance short-lived assets is a costly strategy, even at low rates.
Consider the example in Figure 1, comparing a 20-year bond for $5 million with a fixed interest rate of 3% to a 5-year equipment financing agreement for the same amount with a rate of 4%. The interest costs on the 20-year bond total more than $1.6 million. Despite the equipment financing agreement's higher rate, its total interest cost is less than a third of the total interest cost for the bond.
Another significant negative issue with debt is the restrictive covenants and blanket liens that limit future flexibility. The uncertainty surrounding funding available means schools should be prepared to be nimble and adapt quickly to changes.
First American Education Finance
Like bond financing, the low-rate environment has fueled equipment leasing and finance products. Education leaders have strategically used this source of capital to help prepare for the uncertainty that lies ahead.
Lease financing products are intended for specific equipment or projects that have a useful life of seven years or less, as shown in Figure 2. Organizations are able to take advantage of the low, fixed rates without the issuance burdens or costs typical of bond debt. The lead-time is measured in days, not months or years.
The shorter term allows organizations to strategically fund projects and equipment with a financial product that is closely aligned with the useful life and with the same low-if not, lower-all-in rates as the bond market.
Since leases are collateralized by the equipment being financed, these products do not come with blanket liens or debt covenants that restrict an organization's flexibility. Each project can be evaluated independently for appropriate term and structure. These products also provide schools with the option to use off-balance sheet financing. This can help increase efficiency metrics such as ROA, but more importantly, navigate around existing covenants the school may have due to prior debt insurances. For a more in-dept comparison between the features of equipment financing through First American and bonds, reference Table 1.
Why First American?
Utilizing leas financing as part of a school's capital structure can be a strategic, cost-effective and timely source of capital, especially for short-term assets like IT and network equipment, furniture, and fitness equipment. Schools seeking flexibility and stability in the coming years should look to these products as a complement to their existing capital structures.
We understand that this is a major decision for your school and would be happy to walk you through the details of how we compare to traditional vendor financing options. Contact us today to learn more.