Sell Side

Clint Eastwood and Floating Rates Pave Culture's Road to Bond Market

In a faltering economic environment where philanthropy often falls short, museums and galleries are turning to innovative bond structures and star-studded fundraising campaigns to finance their projects.

Cultural institutions like the D.C. Smithsonian Institution are finding ways to take advantage of historically low rates and raise capital for major projects without overleveraging. The deals, however, look much different than they would in a healthier economy. In one example, JP Morgan will lead a $100 million issue of taxable bonds for the Smithsonian this month, including $50 million of floating rate debt. With interest rates where they are and the need for financial maneuverability on ongoing projects, avoiding the oversight that comes with tax exemption was irresistible, according to Smithsonian and bank officials.

For another institution looking to avoid the financial troubles that have plagued cultural attractions nationwide, bonds will be coupled with a marketing campaign led by Hollywood A-listers Clint Eastwood and Vincent D'Onofrio. The National Law Enforcement Museum, a non-Smithsonian project that is in works at the nation's capital, has double-downed on philanthropy efforts to secure a large portion of the funds needed for construction, with big screen gun-slinger Eastwood as an honorary chair and Law & Order's D'Onofrio the museum's national spokesperson. The project will use bonds to finance an additional $99 million of costs.

"After the crisis, cultural institutions are trying to figure out how much leverage they are comfortable with," Chris Cowen, co-head of higher education within Goldman Sachs & Co.'s public sector and infrastructure group, said in an interview. "Issuers are considering how they can manage maintenance needs, but also how they can stay competitive in this tough environment."

In February, Goldman led $89 million of revenue bonds issued through New York City's Trust for Cultural Resources, a public benefit corporation authorized to issue debt on behalf of the Bronx Zoo and the New York Aquarium in Brooklyn.

Many cultural institutions are still reeling from low visitorship and untenable debt positions that came about with the collapse of financial markets in 2008. Without the revenue stream needed to make payments on potential bonds, small institutions became estranged from capital markets and landmark ones held back large projects.

In six out of the past seven years, the issuance of tax-exempt bonds for cultural facilities has ranged from $500 million to $1 billion annually, according to Rick Chisholm, co-head of Wells Fargo Securities' higher education and nonprofit investment banking group.

When museums, galleries and performing arts centers have entered capital markets recently, it's to restructure existing debt. Issuers are taking bonds out into the long-term fixed rate market or having a bank step in as a new swap counterparty after a downgrade, said Ila Afsharipour, director of US Bancorp's municipal securities group, which remarketed $83 million of Chicago Symphony Orchestra series 2008 bonds in October.

Cultural institutions are issuing fewer tax-exempt bonds than before the onset of the financial crisis and many have struggled to maintain strong credit ratings. In the past 14 months, nontraditional not-for-profit organizations such as museums and entertainment centers have had seven ratings downgrades and three upgrades, according to Standard & Poor's data.

In September, the Please Touch Museum, an interactive children's museum in Philadelphia, defaulted on almost $59 million in bonds. The rate of contribution pledges and cash collections became unsustainably low, and the museum crumbled under the weight of its debt, even as visitors packed the doors.

The Please Touch Museum's troubles aren't unique. Performing arts centers in Dallas, Texas and Orange County, Calif. have also met with credit downgrades since 2012. A year ago in Nebraska, a museum celebrating American pioneer history defaulted on $60 million of debt. With cultural entities, strong attendance is often not enough to keep institutions afloat, said Gavin Wilkinson, a senior vice president at UMB Bank.

"Philanthropic efforts have suffered substantially over the last several years," Wilkinson, who serves as successor trustee for distressed municipals, said in an interview. "If you're counting on good will and philanthropy, that's something that can change as people's lives and fortunes change."

As the economy drains the discretionary income of citizens, donors who originally committed to a project are free to change their mind, as there is seldom any legal binding to follow through on pledges.

"Civic institutions are often backed by charismatic leaders who have a vision, and convince taxpayers or others that it's worth putting investment into," Wilkinson said. "That vision has to connect with a broad group of people. If you build it, they may not come."

Vision is key for the D.C. Law Enforcement Museum, and the charismatic figures leading the police museum's fundraising efforts seem to be striking a chord with the public. So far, the museum's fund, affiliated with the existing National Law Enforcement Officers Memorial, has raised about $53 million in cash and pledges, according to Aaron Rulnick, a managing partner at HJ Sims, which will underwrite $99 million of bonds for the museum in the first quarter of 2014.

"We owe all these brave men and women a huge debt of gratitude," Eastwood, who famously played a loose cannon San Francisco detective in "Dirty Harry," says in a public service announcement for the museum. Eastwood helped secure a $1.75 million gift from Warner Bros. for the $125 million project.

Contributions only go so far though, and that's when institutions turn to the bond market.

"Bonds really provide a great vehicle to bridge the fundraising gap," Wells Fargo's Chisholm said. "It will take time for pledges to be raised and more time for those pledges to be converted into cash.

The Smithsonian, which has the unique position of being a partially government-funded endeavor, averaged $178 million per year in donor support from 2010 through 2012, Moody's Investors Service said in a report. The institution, comprised of 20 attractions in D.C. and New York, is set to complete the African American History and Culture Museum in 2015.

The $100 million taxable deal by JP Morgan will largely go to finishing that effort. Split into two series, $50 million of taxable 10-year fixed-rate bonds that were priced on Nov. 7, and $50 million of floating rate bonds set to price the week beginning Nov. 11, the Smithsonian said.

"In the past, institutions like ours probably wouldn't have even considered a taxable deal," Al Horvath, undersecretary for finance and administration at the Smithsonian, said in an interview. "But we're in this historically low rate environment where the spread between taxable and nontaxable is as narrow as it's ever been."

The varied nature of Smithsonian projects led the institute to look at alternatives from standard tax-exempt bonds, which come with heavier scrutiny, said Horvath and Diana Hoadley, managing director at JP Morgan's education and not-for-profit group.

"If they did a tax-exempt transaction, they'd have to track how every single dollar is spent," Hoadley said in an interview. "As non-profits look to enhance their revenues as the market gets tighter, they don't want to limit themselves in how they can actually use their facilities financed with in a tax-exempt deal."

The combination of longer-term fixed rate bonds with a variable rate component that gets reset every week made sense in the current rate environment, Horvath said. Spreads between taxable and tax-exempt bonds that are typically a few hundred basis points are now just 60-70 basis points in the 10-year range and virtually non-existent on the variable rate side, Horvath said.

The Smithsonian's deal may encourage battered cultural institutions to consider coming back to capital markets. The initial $50 million of fixed-rate bonds, rated AAA by S&P and Aaa by Moody's, were well-received in the market, Albert Lee, associate director for finance at the Smithsonian, said.

"We were over-subscribed," Lee said in an interview. "We heard feedback asking if there were more of those bonds coming."

The outlook for cultural institutions remains dubious. The pipeline of new projects isn't nearly as full as it was a decade ago, Hoadley said. If the municipal market, in its 24th straight week of mutual fund outflows, sees an influx of money, projects pushed to the side may be able to get financed, Rulnick and Afsharipour said.

"We're still in that place where few institutions are willing to take on massive capital campaigns," Afsharipour said. "We're starting to see some smaller scale projects in the $25-million range, and as the economy picks up we'll see more activity as institutions come back with larger projects."




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