Faculty of Arts and Sciences’ Debt Deal

The dean’s annual report provides financial details on House renewal, the faculty census, and a new inequality initiative.

Click right arrow for full chartData courtesy of FAS Office for Faculty Affairs

Faculty of Arts and Sciences (FAS) dean Michael D. Smith used his annual report to colleagues for the 2016-2017 academic year, being released today, to highlight an academic initiative focused on inequality in America; update data on the faculty’s makeup; and outline striking details about FAS’s capital spending on House renewal and other projects—and the resulting strain on its finances.

Inequality in America

Claudine Gay
Photograph by Stephanie Mitchell/Harvard Public Affairs & Communications

Dean of social science Claudine Gay has worked with a 10-member steering committee of faculty members from diverse social-sciences disciplines to define this new initiative. Gay, who is Cowett professor of government and of African and African American studies, has ranged widely as a scholar, examining the influence of neighborhood environments on black Americans’ racial and political attitudes;  housing mobility and political participation; and the effects of low-income housing tax credits. The inequality initiative, to be unveiled in an inaugural symposium on October 13, encompasses the following issues of particular importance to the challenges facing the United States today (which fall into areas where Harvard scholars are particularly active):

  • work, family, and opportunity;
  • governance, citizenship, and social justice;
  • migration and mobility;
  • American inequality, globally; and
  • science, technology, education, and health.

“Inequality isn’t one problem,” Gay said in the annual report narrative. “It is a constellation of problems that are intricate and interconnected.” For instance, she noted, black children are three times as likely as white children to attend a school where than fewer than 60 percent of teachers meet certification requirements.

The modus operandi will parallel that of the recently announced University data-sciences initiative: symposiums, postdoctoral fellowships, grants for early-stage research, and resources for course development. “The ambition,” she said in the report, “is to position Harvard as a leading voice in the public discourse…and as a central resource for students, scholars, and policymakers committed to addressing the issue.”

The faculty

The annual update on the composition of the faculty shows a fairly steady state (see the graph above). As of fall 2017, the ladder faculty numbered 738 members—up a total of six from the prior year, but within the bounds established immediately after the financial crisis and recession (between 720 and 725 ladder faculty members from 2008 to 2011; then a decline to 712 in 2012; and modest accretion since).

The distribution of professors by academic division, provided separately by the office for faculty affairs, is consistent with figures reported last year (see “Here Come the Quants!”). The arts and humanities division had 201 ladder members this year, up from 197 (27 percent); social sciences, 243 members, down one position (33 percent); and sciences and engineering, 294 positions, up from 291 (40 percent), as the engineering and applied sciences cohort rose by four, to 89, and the life and physical sciences declined by one member, to 205. The major shift from the middle of the prior decade, before engineering and applied sciences was elevated from a division to a school within FAS (in the fall of 2007), is the relative growth in the new school’s ranks.

The faculty’s finances

FAS’s office for administration and finance disclosed that the faculty had reported a surplus for the first time in several years on a cash basis (its “management” system of accounting), and a smaller deficit than budgeted, based on its “modified GAAP” system of accounting. (The latter is more nearly aligned with generally accepted accounting principles, which reflect depreciation costs and defer much of the debt-service costs associated with long-term capital projects and spreading them over the life of the associated facilities and equipment; these accounts are more closely comparable to the University’s annual financial statement, which is presented on a GAAP basis.)

Importantly, those gains versus prior expectations reflect an unusual development: a decision late in fiscal year 2017 (ended June 30) to restructure the debt FAS is scheduled to pay the University for past and current capital projects. As reported, FAS has been struggling to carry out the House Renewal project and invest in academic priorities at a time when the long-term performance of the endowment has lagged budget expectations. (Distributions from the endowment fund about half of FAS’s operating budget each year.)

FAS leadership signaled that it had exhausted its appetite for decapitalizing its endowment—taking extra distributions of principal—to fund House renewal. It had also more or less exhausted its unrestricted cash reserves, and so would resort to additional debt financing. No doubt, FAS would love to access current low market interest rates for that additional debt, but it doesn’t work that way: schools pay the blended Harvard borrowing rate, since the University issues debt on a consolidated basis, and its aggregate interest cost is about 4.6 percent. The debt restructuring, described in the financial narrative as emanating from a University proposal and agreed to in May 2017, looks like the outcome of a negotiation between FAS and the University: a way for the central administration and/or Corporation to signal support for pursuing House Renewal as a major priority, while recognizing that FAS cannot operate responsibly, nor invest in academic initiatives, without unrestricted cash reserves.

According to the report, the transaction improved fiscal 2017 results, and increased reserves, by some $32 million. The downside, of course, is that “the short-term relief it affords will give way to higher costs in time as the FAS compensates the University for reduced payments in the early years.” Other disclosures related to or driven by House renewal include:

  • The Corporation has authorized FAS to spend $873.9 million on the project, as of last June 3; the complicated Adams House project (with its many separate buildings) is yet to come, as are the large, expensive renewals of Eliot and Kirkland.
  • FAS’s debt obligations rose to $1.03 billion at the end of fiscal 2017—up more than $151 million (17 percent) from the prior year, reflecting the shift to debt financing for House Renewal, and the accelerated pace of work as Winthrop House was completed for occupancy this past August, and Lowell House construction ramped up after Commencement. As previously reported, FAS had worked diligently to reduce long-term debt from $1.08 billion at the end of fiscal 2009—in part to create capacity to borrow anew for House Renewal, once it was clearer how capital-campaign fundraising for the project was going, and the actual costs of construction came in. The inflection point has not occurred, and FAS’s financial obligations to the future are increasing.
  • Overall, FAS invested an extraordinary amount in capital projects, facilities, and equipment in fiscal 2017: more than $300 million.

In other financial highlights:

  • Fiscal 2017 results reflect a healthy increase in endowment funds distributed for operations, up 4.7 percent ($32.1 million) to $718 million—almost exactly half of FAS’s $1.43 billion in revenues. But the guidance for fiscal 2018 (reflecting the endowment investment loss in fiscal 2016, which affects operating budgets with a lag) is for no increase in the distribution—perhaps pushing FAS back into a deficit this year. (Looking further ahead, the Corporation recently decided to use a “collar” to determine endowment distributions in fiscal years 2019 through 2021. Under its smoothing formula, described here, the fiscal 2019 distribution per unit of endowment would rise a nominal amount, perhaps 1 percent, reflecting the recent weak investment returns–squeezing the schools two years in a row. [Distributions also grow as gifts or other transfers increase the number of units each school owns.] Under the collar arrangement, the Corporation has told schools to plan for per-unit distributions to rise between 2.5 percent and 4.5 percent annually in those three fiscal years, beginning with 2.5 percent for 2019. That would afford some breathing room, while remaining relatively conservative during Harvard’s presidential transition, in an uncertain domestic and global economic environment, and in light of Harvard Management Company’s protracted restructuring and adoption of new investment strategies. Any such guidance, of course, is subject to further revision if investment results turn out to be unexpectedly good, or dire.)
  • The School of Engineering and Applied Sciences continues to operate at a deficit—raising questions about how the ownership or leasing costs, depreciation, and operating expenses associated with its more than 500,000 square feet of new facilities in Allston, scheduled for occupancy in the fall of 2020, will be handled. (The University, not FAS, is assuming the cost of financing and building the complex.)
  • The FAS capital campaign had raised $2.84 billion in gifts and pledges as of June 30, exceeding its nominal $2.5-billion goal.
  • But it is late in the campaign, and gifts for current use declined in fiscal 2017.
  • FAS’s endowment is now $15.9 billion—still below the $16.7-billion peak value at the end of fiscal 2008. And those are nominal figures; FAS estimates that the endowment would have to be worth $19.7 billion, adjusted for inflation, to have purchasing power equivalent to the 2008 corpus.
  • Financial-aid spending increased $12.3 million, or 5 percent, in fiscal 2017—but that was driven by growth in continuing education (up more than 10 percent) and graduate-student aid excluding fellowships (up more than 6 percent). The undergraduate aid budget rose slightly less than 4 percent, to $180 million.
  • Salaries and wages increased 3.7 percent, driven by 3.0 percent annual merit increases and modest expansion in the number of FAS personnel (led by the sciences, where sponsored funding rose, and by continuing education). Costs for employee benefits increased just 1.6 percent.

Looking ahead, FAS appears likely to exit the campaign with many of its facilities renovated; a faculty of roughly the same size, although not the same disciplinary distribution, it had a decade ago; substantially more endowment assets dedicated to funding financial aid; and, alas, continuing constraints relative to its ambitions, at least until it completes the largest building program in its history and defrays the associated costs of servicing its enlarged debt. 

Read more articles by: John S. Rosenberg

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