No Surprises

The Harvard University Financial Report for the fiscal year ended last June 30 appears to fulfill administrators’ hopes: it conveys essentially no surprises. In this, the mid-October report contrasts sharply with the fiscal 2009 version, which disclosed nearly $3 billion of previously unreported losses sustained from investing Harvard’s cash reserves alongside the endowment and from unwinding interest-rate swaps intended to buttress financing for future campus construction in Allston. (The swaps backfired badly, given the recession and record-low interest rates; see “Further Financial Fallout,” January-February 2010, page 45.)

Nonetheless, the 2010 report outlines a new state of University financial affairs. Operating revenue declined to $3.72 billion, down from $3.81 billion in 2009, and operating expenses were modestly lower, too: $3.73 billion, down from $3.76 billion. During the five fiscal years from 2005 to 2009, revenues had risen by more than a billion dollars (from $2.80 billion to $3.81 billion), and spending had kept pace (climbing from $2.76 billion to $3.76 billion). The days of an 8 percent compound annual growth rate in spending--of $200-million increases in annual outlays--are over.

Fiscal 2010’s 2.2 percent decrease in revenue is a surprisingly good result. The Corporation had directed an 8 percent reduction in the endowment funds distributed for operations during the year--the source of 38 percent of operating revenues in fiscal 2009. The fiscal 2010 report indicates that the actual reduction came in at 7 percent ($1.32 billion, down from $1.42 billion); the slight difference reflects the buffering effect of distributions on new gifts to the endowment. “Decapitalizations” of endowment principal remained nearly level, at $237.4 million in fiscal 2010; the “administrative assessment”--formerly called the “strategic infrastructure fund,” a half-percent annual levy on the endowment for University expenses associated with Allston campus development--apparently declined to about $130 million from fiscal 2009’s $176 million. But there were offsetting pockets of strength: tuition income from graduate- and professional-degree programs rose a robust $23 million, and nearly $15 million from continuing-education and executive programs; and federal support for sponsored research--augmented by national stimulus appropriations--soared 11 percent, increasing almost $62 million.

The report breaks out expenses in a new way. The 1 percent decline in total spending reflects the 8 percent increase in direct sponsored spending and a 2 percent decline in “non-sponsored outlays.” In their section of the report, vice president for finance Daniel S. Shore (Harvard’s chief financial officer), and University treasurer James F. Rothenberg characterize the latter as “more squarely within the University’s control, and…demonstrat[ing] progress made in planned cost reductions.” Excluding “certain costs that tend to be fixed in the near term (i.e., tenured faculty compensation, financial aid, depreciation, and interest)” and adjusting for one-time items in both fiscal years ($59 million of fiscal 2009 expenses for retirement incentives and severance and benefits costs associated with layoffs; and a $52-million item in fiscal 2010, discussed below), Harvard’s “controllable non-sponsored operating expenses decreased by 6 percent,” from $2.30 billion to $2.17 billion. In other words, expense reductions valued at $130 million were realized during the year--not an easy feat after routine increases in spending. Among the salient details:

• Given workforce reductions and a fiscal 2010 salary freeze for faculty and nonunion staff members, non-sponsored salaries and wages declined 3 percent, or $31 million.

• Sharp savings were effected in discretionary expenses, with non-sponsored costs for supplies and equipment, utilities and building maintenance, travel, and purchased services reduced by $88 million. The University did most of its budget dieting here, rather than in permanent changes in the workforce. Accordingly, it is now notably more challenging to add employees or to fill vacancies (the term of art is “position control”).

But other expenses rose. Total interest expense increased 26 percent, to $265 million (accounting for more than 7 percent of the University’s spending in the year). Total indebtedness, $2.85 billion in fiscal 2005, climbed steadily in subsequent years before ballooning to $5.98 billion in fiscal 2009, when Harvard placed $2.5 billion of new debt issues to restore its impaired liquidity, refinance variable-rate debt, and unwind some of the costly interest-rate swaps. Interest expenses not associated with specific capital projects rose to $89.4 million in fiscal 2010, up from $56.6 million in the prior year (and just $13.3 million in fiscal 2008), reflecting the burden of servicing these new University-level obligations. Bonds and notes payable at the end of fiscal 2010 increased modestly, to a total of $6.28 billion, reflecting new issues, principally to pay for construction projects such as the Law School’s Northwest Corner building.

During the year, capital spending was essentially cut in half, to $324 million. Although work continues at the Law School and on renovations of the Fogg Art Museum and the Fairchild Biochemistry Building (to outfit it for stem-cell researchers), the $1.4-billion Allston science complex has been suspended. For the foreseeable future, these projects and renovation of the physical plant seem likely to be the major capital initiatives. A new capital-planning process, overseen by executive vice president Katie Lapp and meant to provide a University-wide, five-year building program, will shape future commitments Harvard will make; there will surely be pressure to restrict new debt financing, despite current low interest rates (see “Back to the Bond Market,” below).

Kris Snibbe/Harvard News Office

Mark R. Johnson

(To manage the process, Mark R. Johnson has been appointed vice president for capital planning and project management. His planning responsibilities span Cambridge, the Longwood Medical Area, and Allston, and he will direct the resulting construction projects--all within Harvard’s financial resources. Johnson has worked at Harvard since 2002, managing in turn the Business School’s Baker Library/Bloomberg Center project and now the Northwest Corner building under construction at the Law School, where he has also led campus master planning and a five-year capital plan.)

Among other items of interest, during fiscal 2010, the University entered into $695.5 million of additional swap agreements, all designed to offset existing swaps and so to reduce further long-term risk of loss if interest rates stay low or decline even more. It did so without laying out additional cash, by agreeing to new contracts that offset the terms of the original ones--but giving up the opportunity to recover past losses should rates increase over the life of the original contracts. To the extent possible, the University is getting out of the business of bearing interest-rate risk for those past contracts.

Continuing the emphasis on enhancing liquidity that was announced last year, the General Operating Account (GOA)--Harvard’s cash and operating funds--is now relatively less heavily invested alongside the endowment. Of its current net asset value of $3.75 billion, liquid assets held outside the University’s General Investment Account have risen to approximately $1 billion; two years ago, when the GOA totaled $6.57 billion, the cash portion was $300 million. The “de-risking,” as it is called, will continue: gaining liquidity, at the cost of lower potential returns.

Finally, a review of the “fair value” of investment assets in the footnotes suggests that the portfolio as a whole (for endowment and other holdings) is more oriented to liquid holdings. At the same time, the portfolio managers are redeploying funds into certain areas that they deem attractive--notably certain kinds of new real estate, commodities, and natural-resources holdings.


In all, said Shore in a conversation, fiscal 2010 was “a good year.” Harvard set out to make progress in addressing controllable expenses, and did so, relatively quickly. He also pointed to the improved risk profile of financial resources, especially in light of the University’s debt load. And the growth in tuition and sponsored-funding revenues demonstrated, he said, that Harvard is “quite resilient” in its core operations, teaching and research.

The current year poses new challenges. Employee benefit costs are still rising, the salary and wage freeze has ended, and a further reduction in endowment distributions for operations will subtract $130 million or more from revenues.

Two factors will offset about half that apparent gap. First, fiscal 2010 expenses are inflated by a one-time $52-million charge associated with restructuring the Broad Institute, a genomics-research center, into an independent entity. Second, the sponsored-funding awards under the federal stimulus program should provide an additional $20 million in revenue this year. 

Dealing with the rest, Shore suggested, requires further “administrative aggregations” of functions (from human resources and communications to information technology) to effect longer-term expense savings. Savings in fiscal 2009 and 2010 were realized principally within each school and unit; the current opportunities, he suggested, lie in identifying better ways to work between and among those autonomous units and the central administration. Realizing such savings will take time; the Faculty of Arts and Sciences, he noted, is on a two-year path to eliminate its remaining budget deficit, using reserves to fund the work in the interim. (Retirements may help; see “Retiring from the Ranks.”)

For the foreseeable future, Shore said, there is too much uncertainty about all sources of revenue--tuition net of financial aid, endowment investment income, and federal research funding--to relax any efforts to identify and pursue efficiencies. That is the University’s financial outlook, and priority, for the next few years.

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