John Harvard's Journal
Getting and Spending
The University’s annual financial accounting—usually a forbidding and retrospective document—this year sports a new look and abounds with news about important matters fiscal, academic, and strategic. The new title (the fusty Financial Report to the Board of Overseers of Harvard College has given way to a more modern, matter-of-fact Harvard University Financial Report for fiscal year 2007) introduces a streamlined text and colorful graphics. (The report is available at http://vpf-web.harvard.edu/annualfinancial.) Among the highlights within:
• Federal funding for research—a critical source of revenue—declined 1 percent, to $515 million, a clear indication of the multiyear leveling-off of the National Institutes of Health’s (NIH) appropriations. NIH is the principal source of support for biomedical research, and, overwhelmingly, Harvard’s single most important provider of research funding. (The National Science Foundation reported in late September that during fiscal year 2006, federal funding of academic research grew less than the rate of inflation for the first time in a quarter-century.)
• The endowment continued to grow rapidly, totaling $34.9 billion as of June 30—a gain of $9 billion, or 35 percent, in the past two fiscal years (see “The Endowment: Up, and Upheaval”). Accordingly, the Corporation has become more ambitious about using the funds. It has changed the policy from the prior target of distributing 4.5 percent to 5.0 percent of the endowment’s market value annually in support of University operations, to a new targeted aggregate spending rate of 5.0 percent to 5.5 percent (see discussion below). Given the endowment’s size, that seemingly modest adjustment means a great deal to the schools.
• During fiscal year 2007, a previously undisclosed $100-million “decapitalization” from the Faculty of Arts and Sciences (FAS) endowment was used “primarily to fund construction and other facilities costs.” FAS has been investing heavily in buildings—several hundred million dollars for new science laboratories alone—and faces large deficits resulting from the debt incurred for those projects and the subsequent costs of operating them. This decapitalization (a one-time disbursement of accumulated funds within endowment accounts for discrete purposes) begins to relieve FAS’s problem—and may be a harbinger of more systematic, wider-ranging efforts to meet other faculties’ most pressing priorities when, as is now the case, the endowment has appreciated, but a capital campaign has been deferred.
Characterizing the year, vice president for finance Elizabeth Mora, the University’s chief financial officer, said, “The picture looks very positive.” Revenue rose 7 percent, to $3.21 billion, roughly the same pace as in fiscal year 2006. The 12 percent increase in endowment income distributed for operations, to $1.04 billion from $933 million in the prior year, was a principal factor. The $23.2-million rise in revenue from continuing and executive education programs (a 14 percent gain, to $193.2 million) also stood out.
Expenses increased only 5.7 percent, to $3.17 billion, a much more moderate pace than the 8.8 percent growth in the prior fiscal year. In part this reflects some one-time factors—the logging of employee-vacation allowances as new information systems came on line in the past couple of years, 2006 start-up funding for the Broad Institute, a genomics joint venture with MIT—as well as restrained spending on new initiatives in 2007 during Derek Bok’s year as interim president. But Mora also pointed to good control of energy costs that reflected hedging strategies to procure supplies, investments in conservation, and a mild winter.
Space and occupancy costs continued to rise, up 13 percent to $405.2 million, as buildings came on line. (Capital expenditures—construction, acquisitions, renovations—totaled $594.7 million, up sharply from $422.5 million in fiscal year 2006. Although work on the first Allston science complex, the most expensive project in University history, may begin before year end, if permits are issued, its main costs lie in the future.) Travel costs continued to climb, up more than 10 percent to $66.6 million, reflecting the fact that “everybody’s going everywhere,” Mora said, particularly as international outreach expands for research and for alumni affairs.
Mora cited three substantial concerns. The erosion of federal research funding has serious consequences for FAS and the medical and public-health schools. Given the federal deficit, she said, growth in NIH funds is unlikely for several fiscal years—at a time when only one in nine grant applications is being funded, and Harvard and peer institutions continue to expand their life-sciences and biomedical faculty and facilities. Were it not for the 2007 growth in a limited-term Harvard School of Public Health AIDS project in Africa, the reported decline in federal support would have been much steeper. In the near term, Mora said, endowment resources likely will have to be more heavily used to subsidize research.
That raises her second concern: the health of the endowment. In the first quarter of the current fiscal year, she noted, the financial markets have been nowhere near as favorable as the conditions during 2007. And Harvard Management Company, on whose board Mora serves, faces the challenge of finding a successor to president and CEO Mohamed A. El-Erian (see “An Unexpected Risk Factor”).
This is the background for the new policy of distributing more from the endowment in support of the University. The new 5.0 percent to 5.5 percent aggregate spending rate includes distributions of income for operations (historically known as the “distribution rate”); plus decapitalizations (such as the FAS construction decapitalization); plus the annual 0.5 percent levy on endowment accounts generally to support Allston campus development (the “strategic infrastructure fund,” $140.5 million in 2007). Among the rationales for planning and reporting the use of the endowment this way, Mora said, is that “I foresee some pretty large decapitalizations, and I would like [Harvard] to be able to take credit for that.” Thus, even as the distribution for operations rises significantly this year under the new Corporation targets, consideration is being given to certain one-time capital distributions to finance construction, financial aid, and other critical priorities. That would demonstrate Harvard’s commitment to using endowment gains for academic purposes, rather than “keeping the money under the mattress”—and would do so when Congress is scrutinizing nonprofit institutions’ use of their resources, and as the University plans a capital campaign.
Mora’s third concern relates to construction generally: debt financing, the endowment funding of current projects where necessary, the impending groundbreaking in Allston, and beyond. Rapid inflation in construction costs looms over the “multibillion-dollar project in Allston.” The first science building is near at hand, but other elements of the project may be somewhat longer in coming as Harvard, appropriately, conducts more thorough academic planning. That, in turn, will shape physical plans for the future education and public-health school sites, and for arts facilities—on which, in turn, the financial plans will depend. Those events are all in the “right order,” Mora said, but as they are worked through, costs overall are burgeoning.
Making use of endowment riches, while keeping a wary eye on the markets and on expenses, is the stuff of an annual financial report. But those are also the key elements highlighted in President Drew Faust’s introduction to this report. “[I]t will be more important than ever to make sound decisions about how we invest our resources, how we can direct endowment returns to priority areas within the schools and the University as a whole,” she wrote, “and”—foretelling the capital campaign, “how we can most effectively make the case to Harvard’s generous community of alumni and friends about the importance of continued investment in the University’s work.” The “comprehensive academic planning effort” she has begun will do much to determine the narrative of Harvard’s financial reports in the years to come.