December 5, 2013
This June, Hamilton College issued $103 million worth of “century bonds,” bonds that will reach maturity in 2113. These bonds represent a new strategy for structuring Hamilton’s debt. A bond is effectively selling a promise of future repayment to someone. The bond issuer promises to pay back the owner of this bond at its initial price and interest to compensate for inflation.
Corporations and governments are common issuers of bonds, but they tend to have shorter maturities, ranging from several days to 30 years. In the late 1990s, some corporations (Disney and Coca-Cola, among others) issued century bonds, and higher education institutions have recently issued them, taking advantage of low interest rates in a weak economy: MIT, University of Pennsylvania, OSU, and, in the NESCAC, Bowdoin and Tufts. Hamilton’s century bonds have an interest rate of 4.75 percent, only slightly higher than Bowdoin’s 4.69 percent, but still lower than Tufts’ 5.017 percent. Hamilton’s bonds were also issued a year after Bowdoin’s bonds, in a stronger economy.
Vice President for Administration and Finance Karen Leach explained that the bonds were issued now for two primary reasons: “the very low interest rate environment and the desire to lower the long-term cost of capital.”
Hamilton’s century bonds are also “bullet” bonds, wherein the entire principal is due in 2113, though the College retains the option to repurchase the bonds sooner. This leaves the college to pay approximately. $4.8 million in interest annually, until the $103 million payoff in 2113. The trustees also established a “Tricentennial Fund,” alongside the century bonds, designed to grow and cover the cost of the $103 million payoff.
Leach explained that the College “plans to use all of the century bond proceeds (almost $99 million) to retire existing 2002 and 2007 bonds.We can’t retire the 2002 and 2007 bonds right now because they are not callable for about four years. In the meantime the century bond proceeds are invested in a way that seeks to earn at least the payments we are making on the associated debt.” Thus, the bonds help to ensure that the College remains stable and has the money needed to operate for the next century.
They also help stabilize the College’s funds against demographic and economic trends. With the Millennial boom ending, college applications will soon start to decline. While this will barely affect Hamilton, as a college that receives a high volume of applications every year, it still allows us to weather this shock, as well as future demographic shocks. Additionally, with the economy recovering, inflation is expected to rise. If inflation increases past the 4.75 percent interest rate on the century bonds, the College will effectively be paying a negative interest rate, in inflation-adjusted dollars. And if banks begin to quickly use the money the Federal Reserve is supplying them through Quantitative Easing, then an inflation spike may occur, strengthening the value of these bonds to the College.
However, these bonds do have some drawbacks. In the short-run (the next four to five years), the College will hold a significant amount of debt on its balance sheets relative to revenue, putting the College at greater risk if something negative happens to revenue or to the endowment. This risk decreases significantly once the bonds from the early 2000s are repurchased, but that action is dependent on the successful investment of the century bonds and a stable economy for successful investment. Leach added that “the financials are also a corresponding asset that is invested, so there is little impact on the bottom line.” Over time, however, as inflation rises and the College repurchases older bonds and invests the money from the bonds, the bonds will strengthen the College’s financial position and reduce its interest payments, assuming that Hamilton’s strong position in higher education continues to hold.
These bonds come with short-term risk, but they will help the College remain solvent, stable and growing over the next century.