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Harvard Finances: Strengths and Warning Signs

10.26.17

Courtesy of Harvard University Financial Administration


Courtesy of Harvard University Financial Administration

The University’s financial report for the fiscal year ended June 30, 2017, released this morning, was full of the sorts of results that make budget officers happy:

  • Revenue increased $222 million to nearly $5 billion (growth of 4.6 percent)—largely consistent with the quarter-billion-dollar growth (5.5 percent) in fiscal 2016.
  • Expenses rose, too, by $185 million to $4.9 billion (3.9 percent), a more moderate pace than in the prior year (when expenses rose 5.3 percent).
  • In combination, that yielded a surplus of $114 million, up from $77 million in fiscal 2016—the fourth consecutive annual surplus, and by far the largest.

In her letter introducing the report, President Drew Faust celebrated

great progress toward our educational and research goals. Advances in scholarship and discovery helped to confront some of society’s greatest challenges; increases in financial aid ensured that talented students could pursue their highest aspirations regardless of their means; and the renovation and expansion of Harvard’s physical spaces enhanced our teaching, learning, and research environments.


Thomas J. Hollister, vice president for finance
Photograph by Paige Brown/Courtesy Tufts Medical Center 

Even amid the bounty, though, Harvard’s senior financial officers—Thomas J. Hollister, vice president for finance (the University’s chief financial officer), and Paul J. Finnegan, treasurer—focused on the cautions and concerns that come naturally to their species. Their overview stressed that the operating surplus “may represent a high-water mark for the foreseeable future…due to the broad and ongoing revenue pressures in higher education” (discussed further below). Repeating a recent theme, they maintained that “the business model of higher education is under enormous pressure,” and amplify thus:

Since the 1950s, higher education in the United States has been a growth industry, and has enjoyed demographic increases in student populations, generally steady economic expansion, increases in federal research funding, and robust investment markets. This picture has changed. Higher education has matured as an industry and revenues are under pressure as student numbers have plateaued, tuition costs reach limits of affordability, federal research support is threatened, and expectations for returns in the investment markets are muted. The industry is showing financial strain, even in these comparatively healthy economic times….

Those benign external conditions, they noted, have been complemented by (and have contributed to) “the extraordinary success of The Capital Campaign”—and notably in the fiscal 2017 results. So it is striking that despite the campaign’s largess (Harvard has reported receiving more than $8 billion in pledges and receipts), Hollister and Finnegan emphasized that

Our deans and administrative staff are first focused on mission excellence, but they are also increasingly focused 
on cost containment and newer sources of mission-related revenues.…We raise this not as a matter of discouragement, but simply to signal to 
the University’s many friends, supporters, alumni, faculty, students, and staff that the University, and 
its schools and units, will need to further adjust to 
the environment, change, and embrace new ways of extending Harvard’s excellence in the future.

The Year in Review

Revenue. Operating revenue increased nearly 5 percent to almost $5.0 billion. The report cites gains in

  • the annual distribution from the endowment (up $81 million, to nearly $1.8 billion);
  • gifts for current use (up $29 million, to $450 million); and
  • sponsored-research funding (up $40 million, to $886 million).

It does not specifically highlight other engines of revenue growth: net tuition and fees (up $56 million, to $1.05 billion); and robust gains in funds distributed from the University’s general operating account, separate from the endowment, which rose more than $31 million (24 percent) during the year—apparently, a one-time gain reflecting the level of cash in Harvard’s treasury account in prior years. Offsetting these gains to a modest extent was a decline in the line item aggregating miscellaneous other income (down $17 million, or 3 percent—again reflecting a one-time factor in the prior year, when Harvard made an agreement for the use of some intellectual property).

Putting these figures in context,

  • the endowment distribution contributed 36 percent of Harvard’s operating revenue;
  • student income (tuition and fees) 21 percent; and
  • gifts for current use 9 percent—all unchanged from fiscal 2016.

Sponsored support, at 18 percent, gained a percentage point as a share of revenue from the prior year, and other income decreased a percentage point, to 16 percent.

In that light, the endowment distribution is particularly consequential. From fiscal 2012, when the fundraising campaign was still in its quiet phase, through the most recent year, the annual distribution has risen $370 million (26 percent), outpacing the 22 percent rise in consolidated revenues. So deans will feel particularly squeezed during the current fiscal year, when the distribution per endowment unit will be held level with fiscal 2017, reflecting poor investment returns in prior periods (fiscal 2017 reported here, with links to those prior years). For units like the Faculty of Arts and Sciences, which derived 52 percent of its revenue from the endowment distribution in fiscal 2017, the pressure is particularly acute.

The challenges facing Harvard Management Company (HMC), and the sweeping restructuring under way there, have been previously reported (and updated last month). The annual financial report makes clear how much the endowment has been bolstered by the capital campaign: gifts for endowment totaled $551 million in fiscal 2017, nearly $60 million more than in the prior year. For perspective, gifts for endowment realized during the quiet phase of fundraising, in fiscal 2012, were $226 million—and for the period from fiscal 2012 through 2017 totaled $2.3 billion.

The annual report also spells out the endowment managers’ investment gains during the year—$2.9 billion for the general investment account, which encompasses the endowment and other assets—and that $1.8-billion distribution. These figures align closely with the estimates provided when HMC reported in September. (The footnotes also suggest changes in HMC’s portfolio, providing details the management company no longer discloses. Among them: natural-resources assets were written down by about $1 billion, in line with estimates; and secondary-market sales of private-equity and real-estate assets appear to be about $600 million and $1.8 billion, respectively, in line with earlier reports in the financial news media. There is new news, too: significant additional parts of the private-equity, natural-resources, and real-estate portfolios had been designated for sale, or were in the process of being sold, after the June 30, 2017, close of the financial year: assets valued at more than $3 billion.)

The robust level of current-use giving—important flexible funding for the president’s and deans’ highest immediate priorities—also reflects the power of the campaign. Including the $450 million received in the current year, such gifts since fiscal 2012 have totaled $2.4 billion.

Hence the import of Hollister and Finnegan’s comment on the most recent fiscal year as the “high-water mark.” Although the capital campaign may well finish with a bang next June, the annual report notes that both current-use and endowment pledges receivable are being drawn down, by nearly $90 million and $50 million, respectively. More than $1.6 billion of pledges for such gifts remain on the books, but the peak may have passed.

Sponsored support for research has been a subject of particular concern, given the Trump administration’s plan to sharply reduce the National Institutes of Health budget (happily offset, from universities’ perspective, by the decision of Congress to increase that spending). Federal funds rose by about 4 percent, to $618 million; nonfederal support increased about 8 percent, to $267 million, continuing recent robust gains. Nonfederal research funds typically come with less generous “indirect” support for overhead costs; in fiscal 2017, even as such sponsors’ direct support for research increased, their payments for indirect costs declined, leaving it to the University to pick a larger share of building, administrative, and related expenses associated with such work. 

Consistent with recent experience, undergraduate tuition revenue rose about 4 percent, to $313 million, and graduate- and professional-degree programs yielded about 5 percent more revenue, totaling $559 million. Net of financial aid, combined undergraduate and graduate tuition revenue increased some 6 percent. (Financial aid, an expense, is economically sensitive; scholarships applied to student income rose $16 million, or 4 percent, to $414 million. In the current benign economic environment, the moderate increase in aid produced the faster growth in net tuition revenue.)

The standout figure was associated, again, with tuition revenue from continuing- and executive-education programs, up about 8 percent to $411 million. The latter result, an area of recent emphasis across the University, in part reflects Hollister and Finnegan’s “healthy economic times”: such programs, discretionary items for many businesses and professions, have in the past proven subject to reduced spending during recessions.

Expenses. Salaries, wages, and benefits—roughly half of total expenses—increased 5 percent, to $2.5 billion. Salaries and wages increased 4 percent, to $1.9 billion, reflecting annual merit increases and, to a limited extent, growth in the number of employees, principally associated with expanded sponsored research and growth in executive- and continuing-education programs. Benefits expenses rose 7 percent, to $569 million—driven principally by higher costs for defined-benefit pension and post-retirement healthcare costs associated with the annual adjustment in discount rates applied to such plans. (In the current fiscal year, that adjustment will cause such costs to decrease.) According to the report, healthcare expenses for active employees rose more than 4 percent, reflecting both higher costs for prescription drugs and increased enrollment in the University’s plans (attributable to a larger workforce and employee decisions on where to enroll in coverage). As previously reported, Harvard’s healthcare costs remain well controlled, compared to past experience, with University expense per employee rising just 2.6 percent and 0.2 percent in calendar years 2015 and 2016, respectively, and employee spending rising 4.6 percent and 2.5 percent during the same years (reflecting changes in plan designs instituted then).

Although building projects are largely capitalized and therefore do not directly affect the annual financial results, it is worth noting the historic dimensions of Harvard’s campaign-fueled capital-spending boom. During fiscal 2017, the University invested $906 million in building projects and acquisitions—up hugely from the already large total of $597 million in the prior year. The headline projects, depicted here, include:

  • concluding the renovation of Winthrop House and beginning the large, complex renewal of Lowell House (featured on this year’s report cover, shown above; prospective donors are warmly encouraged to contact the FAS development office);
  • accelerating construction on the science and engineering complex in Allston, and an associated district energy plant—together, a billion-dollar undertaking;
  • continuing the expansion and reconfiguration of the Kennedy School campus, and the renovation of Holyoke Center into the Smith Campus Center; and
  • pressing toward completion of Harvard Business School’s Klarman Hall, a large conference center scheduled to open next fall.

Capital spending on this scale can be expected to continue for the next few years, at least through the completion of these major projects.

In one respect, the building program does affect fiscal 2017’s reported results: “other expenses” are up $52 million (11 percent). Much of that change reflects the accounting charges required to adjust the carrying values of buildings when they are scheduled to undergo renovation—in this case, the renewal of Lowell House, now under way.

The Balance Sheet. In October 2016, Harvard refinanced $2.5 billion of outstanding debt and restructured other obligations. The result was to reduce the associated interest expense by $33 million for fiscal 2017—an effect that should increase when realized for a full 12 months during the current year. (Part of the cost of effecting the transactions was to increase the amount of debt outstanding by about $200 million, to $5.4 billion—a negligible figure over the life of the bonds.)

Refinancing the debt at lower rates and reducing annual interest expense represents a further step toward recovering from the expensive borrowing Harvard undertook following the financial crisis in 2008, when it had to secure access to liquid funds quickly. From a peak of nearly $300 million in fiscal 2011, annual interest expense has now been reduced by nearly one-third, to $201 million: savings that can be applied to academic priorities and operations. Those savings are particularly important now, because it is reasonable to expect Harvard’s borrowings to increase in the next few years, to finance the construction projects outlined above.

Financial-statement connoisseurs will note that Harvard’s reported total assets shrank by nearly $20 billion during fiscal 2017, to $53.7 billion. In large part, this reflects changes in HMC’s strategies, including the cessation of a “relative value” fixed-income trading operation that entailed multibillion-dollar domestic and foreign bond portfolios.

The University has also decreased its liquid holdings outside the general investment account, from $1.2 billion a year ago to $800 million at the end of fiscal 2017. That decision apparently reflects a new assessment of the University’s liquidity needs, and the conclusion that the larger sum kept more idle cash on hand than its operations now warrant.

One unexplained change in the financial statements is a large increase in land listed among other fixed assets: from $784 million at the end of fiscal 2016 to $968 million this past June 30. It is possible that the difference relates to the final steps in purchasing Allston property from CSX, the railroad corporation, as reported by The Harvard Crimson, but the University has not made disclosures about the land acquisitions referred to in general terms in the annual reports this year or last (when the value of land held increased a reported $112 million).

In Prospect

The University has enjoyed 5 percent and 6 percent revenue growth during the past two fiscal years. Can the salad days continue?

The hurdle is high. Given the decision to hold the endowment distribution level in fiscal 2018, the source of 36 percent of Harvard’s revenue will yield essentially no additional dollars this year (beyond the relatively small sums associated with incremental distributions from new gifts to the $37.1-billion corpus).

In light of recent tepid endowment returns, in fact, the University’s distribution formula would have yielded nominal growth in distributions for fiscal 2019, beginning next July 1, and perhaps in the succeeding one. Accordingly, as reported, the Corporation has recently decided to use a “collar” to determine endowment distributions in fiscal 2019 through 2021. Under this 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 HMC’s protracted restructuring. Such forward-looking guidance, of course, is subject to revision if investment results turn out to be unexpectedly good, or dire.

Both economic growth, which has lasted for an unusually long time, with unusually low interest rates and robust financial markets, and the capital campaign, are long in the tooth. Important sources of revenue growth—continuing and executive education, and current-use giving—are, respectively, sensitive to economic conditions and to fundraising fatigue. University wage restraint may contain salary expense and associated benefit costs this year; but a weaker economy would presumably put upward pressure on financial-aid spending. And all those new buildings will inevitably drive up space and occupancy costs, and depreciation, both of which are already rising.

Tuition growth for degree programs is largely locked in, and is unlikely to accelerate. And even though federal spending on research appears more secure today than it did in the spring, no one would describe the budgetary prospects in Washington, D.C., as stable or predictable. Certainly, the University can try to sustain its recent momentum in foundation- and corporate-funded research; new entities like the Chan Zuckerberg Initiative have the capacity to make enormous commitments—witness CZI’s recent $600-million “biohub” project involving Stanford, Berkeley, and the University of California, San Francisco. Greater Boston (anchored by Harvard Medical School, its affiliated research hospitals, MIT, and other biomedical institutions) is an obvious venue for future CZI commitments of that scale—or so scientists and fundraisers can hope.

Harvard’s financial officers weigh these factors continually; they appreciate that the last couple of years have been fortunate for the University, and know that HMC has to improve its performance over the long term to sustain the academic enterprise. As the University’s leader during an historic capital campaign and amid unprecedented turbulence in Washington—where in recent months she has repeatedly made the case for funding research—President Faust spoke from experience in writing that

The past year was marked by deep uncertainty over levels of federal research funding. Continued pressures on the cost of educating students confront institutions even as we seek to contain tuition, increase affordability, and broaden access. And there is a shared understanding across higher education that endowment returns are likely to be more constrained in the decade to come.

She and her financial officers can all be forgiven for looking back fondly on the surpluses Harvard has accumulated from 2014 through 2017. They may come in handy.

A Gazette article on the fiscal year and report appears here.

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