Cleveland Orchestra deal allows exit from variable-rate debt

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The Cleveland Orchestra is turning to the bond market to raise some new money and shed interest rate risk.

The orchestra is pricing $30 million of tax-exempt bonds the week of May 20 through Cuyahoga County. Proceeds will refund auction rate securities, shifting them to a fixed-term structure, with $7 million going to finance updates to Severance Hall, the orchestra’s primary residence in downtown Cleveland.


“The rationale for the refunding is to eliminate short-term interest rate risk and to take advantage of low long-term fixed rates,” said Bethany Pugh, a managing director at PFM Financial Advisors, the orchestra’s financial advisor.

The bonds are secured by loan payments under a loan agreement between the county and the orchestra, which essentially represents a general obligation pledge of the orchestra.

Morgan Stanley is the senior manager. KeyBanc Capital Markets and PNC Capital Markets LLC are the co-managers.

S&P Global Ratings has assigned a first time credit rating of A to the orchestra. The outlook is stable. After the bond sale, the orchestra will have roughly $38 million in outstanding debt. The orchestra has no additional borrowing plans.

The rating agency said the new bonds will eliminate interest rate risks tied to the variable-rate auction-rate securities, which together with increased funding of its $73.5 million pension liabilities should serve to improve the orchestra’s balance sheet.

In the last three years, the orchestra has reported deficits on a cash basis largely due to pension liabilities, slight increases in the interest paid on the variable rate debt and lower gifts and contributions, according to S&P.

“Management is committed to improving financial performance and expects to return to cash surpluses in the next few years,” S&P said. “The pension expense is expected to decline with the addition of funds provided by the board, and there will be no more interest rate risk once the variable rate debt is fixed out. Substantial efforts are also being made to increase the endowment so that the endowment draw to operations can be a greater percentage of revenue.”

S&P analyst Stephanie Wang said that with the support of the orchestra’s 71-member board of trustees, the orchestra has been able to raise $12.5 million over the course of a few years to fund pension liabilities, helping it go to 77% funded from 57%.

“The board realized that if pensions continued to go unfunded it would be a strain for the orchestra so they stepped in and relieved them of some of those pressures,” Wang said. “There is ongoing fundraising, along with other things, for the pension and I think the hope is that the pension expenses won’t be such a burden on the orchestra going forward.”

Wang said that while pensions aren’t fully funded, the expense is now more manageable and won’t be as large of a strain on operations and is likely to result in cash surplus.

“To be clear the pension alone was not the drive of the orchestra’s deficit,” said Charlene Butterfield, an S&P analyst. “Similar to most cultural institutions, Cleveland Orchestra does not fund depreciation as part of their budget in full and that is really the underlying cause of why you might see a deficit. It wasn’t necessarily one for one, they have pension issue so that is why they were running a deficit.”

The orchestra funds depreciation from fundraising. In fiscal 2018, it raised over $24 million from trustees, corporations, foundations, governments and various events. Over the longer term growth, the board has placed greater emphasis on planned giving and $82 million of known commitments have been made so far.

Cleveland Orchestra derives a portion of its annual revenues from the investment of its endowment and funds. As of June 30, 2018, the orchestra's endowment fund had a market value of $191.5 million.

The orchestra is over 100 years old and consists of 104 full-time members. It divides its time each year between two venues: Severance Hall and Blossom Music Center, an outdoor venue in Cuyahoga Falls, Ohio, that seats 15,000 people. The orchestra also performs in concerts across Northeast Ohio as well as New York, Europe, and Asia. It also does an annual residency in Miami.

Total attendance has been healthy with over 260,000 paid attendees in the 2018 fiscal year.

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Primary bond market Variable-rate bonds Refunding bonds Public pensions Cuyahoga County Ohio
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