Colleges and universities blessed with generous endowments and successful investment policies have been able for years to distribute large supplements to their institutions’ annual budgets: In the fiscal year ended June 30, 2010, endowments with more than $1 billion in assets upstreamed on average 17 percent of their schools’ operating revenues, according to the National Association of College and University Business Officers. But any academic institution with a long-term mission is able to make only limited adjustments to its programs in the short run, so during the high-stress fiscal years 2009 and 2010, schools were obliged to keep drawing from their endowments’ shrinking liquidity even as investment returns fell, new gifts dropped off and alternative investment funds made capital calls. Some endowments raised cash by selling the most liquid portions of their prized portfolios — public equities, bonds and hedge funds that allowed exits — but the downturn also touched off a coast-to-coast surge in bond issuance in 2009, amounting to $7.25 billion in taxable borrowing among 15 elite schools (see the accompanying table). Notes John Nelson, head of Moody’s higher education finance group: “All of these forces, plus the need to park some liquidity on their balance sheets, led these institutions to go to the market and issue debt. This was a counterintuitive crisis of the wealthy.”
It’s yet one more example of the short term colliding with the long term during 2008 and 2009. University treasurers and endowment managers had no idea how or when the investment markets might recover, and even after trimming operating budgets and deferring capital spending, needed to defend their endowment funds against further large withdrawals and build cash reserves for future spending. At Cornell University, for example, operating revenues included endowment distributions of $227 million in 2009 and $196 million in 2010, up from an average of $180 million in the two years prior — notwithstanding a fall in endowment asset values of 27 percent for the year ended June 2009 to $3.8 billion. The 2009 distribution from the endowment alone accounted for 8 percent of assets.
Institutions’ borrowing was meant to cover shortfalls not just in the endowment pools but in day-to-day operating funds as well. In the years leading up to the financial crisis, some institutions had directed some of their cash toward the endowment office to take advantage of the rich and irresistible returns. Moody’s Nelson cites such investment as common practice among the largest schools, and notes that in June 2009 the 15 borrowers reported to Moody’s that just 28 percent of their investments could be liquidated within a month, as compared with 39 percent for a group of 270 other institutions.
Many of the bond issues were equal to two or three years’ worth of recent distributions from their respective schools’ endowments and were available at the comparatively low rates that high-grade companies could get. Because the bonds’ purpose was liquidity management, the debt had to be issued at taxable rates; most resemble corporate debt, with ten-year maximum maturities.
“We obtained excellent terms for this debt... with our taxable ten-year bonds yielding 4.96 percent,” wrote Dartmouth College treasurer Adam Keller in a note to the school community on June 5, 2009, of the $250 million taxable bond issue a few days earlier. The ten-year slice of Stanford University’s $1 billion issue, brought to market on April 23 of that year, carries a coupon of 4.75 percent. The ten-year portion of Duke University’s January 2009 $500 million taxable issue yields 5.2 percent.
The members of the taxable class of 2009 are the largest bond issues many institutions have undertaken. At Dartmouth, the $250 million taxable bonds, plus other net issuance, sent total debt higher by 74 percent during 2009, to $950 million. With its $500 million issue plus other new borrowing, Duke’s total debt grew 45 percent to $2.6 billion. Johns Hopkins University’s $400 million taxable issue, plus other new debt, raised its total 45 percent to $1.5 billion.
In spite of the added burden, just a few schools suffered downgrades in their credit ratings. Moody’s, for instance, downgraded Dartmouth from Aaa to a still-sturdy Aa1. The agency also issued negative outlook reports on Cornell and Amherst College but later reversed its outlook to stable for Amherst.
Notwithstanding the size of the bond issues, the institutions should be able to make good to lenders when the bonds mature come 2014 to 2019. Colleges and universities typically hold balances in investments that far outweigh their borrowings, and the group of 15 elite 2009 borrowers is especially asset-heavy. For instance, at June 30, 2010, Johns Hopkins reported long-term debt of $1.5 billion, against total investments of $3.8 billion, plus cash and equivalents of $166 million. Duke showed $2.9 billion in debt at 2010 fiscal year end, versus investment assets of $7.9 billion and cash and equivalents of $251 million.
Even accounting for the credit crisis, 2008 and 2009 were not devastating to U.S. higher education as a whole. Enrollments rose 7 percent in fiscal 2009, to about 21 million, and net tuition revenues rose 8 percent, according to a February 2011 report from the Department of Education’s National Center on Education Statistics. Although gifts to institutions fell by 12 percent to $28 billion in the year ended June 2009, they held steady in 2010, albeit at levels equal to 2006, according to the Council for Aid to Education.
Even outside the circle of elite institutions with stellar credit ratings, however, colleges and universities have been relying for years on more and more debt financing. Moody’s cites a median debt balance of $93 million for private institutions for fiscal 2009, their most recent tally, up 33 percent from 2005; private schools rated Aaa added 66 percent over the period. At public institutions, median debt reached $177 million in fiscal 2009, a 31 percent increase from 2005. Growth in borrowing was far more rapid than the underlying business of higher education: Since 2005 enrollments have gained just 13 percent, and revenues 25 percent, according to Moody’s.
“It’s actually tough to put a college out of business, because they often have high-net-worth individuals on their boards who can raise enough donations to keep them going for a while,” says Nelson. “But many small schools, to avoid closing or selling out to for-profit companies, will likely have to merge with other institutions.”
