Harvard's New-Normal Financial Results
The University’s fiscal year 2015, concluded last June 30 and detailed in the annual financial report released today, in many ways mirrors the outcome of the prior year: Harvard again operated modestly in the black, following a couple of years of modest deficits. In their introductory letter, Harvard’s new senior financial-management team—Thomas J. Hollister, vice president for finance and chief financial officer, appointed last spring, and Corporation member Paul J. Finnegan, who became treasurer in July 2014—wrote that “[T]he results of this past fiscal year follow a recent trend of modest, but continued improvement in the University’s overall financial health.”
In a conversation about the University’s finances, Hollister noted that achieving a “$62-million surplus is a good thing,” not least because that operating result—combined with gifts and modest endowment appreciation—means that Harvard “happily has more resources at the end of the year than we did at the beginning, and we balanced our revenues and expenses.”
Among the report’s highlights:
- Revenue increased $138 million (3.1 percent), to $4.53 billion from $4.39 billion (figures are rounded throughout this article). Major contributors were the endowment distribution for operations (up $54.8 million, or 3.6 percent); tuition and other income from students (up $52.3 million, or 6.0 percent); and gifts for current use (up $16.5 million, or 3.9 percent). Total support for sponsored research edged up by $5.9 million, to $805.8 million—but only because corporate, foundation, and international underwriting rose by more than 10 percent, while federal direct funding decreased by nearly $15 million (3.4 percent).
- Expenses increased $97.2 million (2.2 percent) to $4.46 billion from $4.37 billion. Salaries and wages were 5.2 percent higher, reflecting a larger workforce and merit increases in compensation. Employee benefits were reported to have decreased 4.7 percent—but adjusting for a one-time, $45.9-million pension-related charge incurred in fiscal 2014, benefits costs increased somewhat less than 5 percent, to nearly an even $500 million. Among lesser categories, space and occupancy costs soared more than 9 percent, but were more than offset by a $40-million reduction in other, miscellaneous expenses; both were affected by one-time items.
- An operating surplus was the result, as Harvard finished the year in the black to the tune of $62.5 million. Fiscal 2014, as originally reported, yielded a surplus of just $2.7 million. That has been restated to a surplus of $22 million; fiscal 2014 losses associated with the Medical School’s New England Primate Research Center (NEPRC), totaling $19.2 million, have now been reclassified as non-operating, net losses from a discontinued operation, and so removed from the operating results. If the pension-related charge, discussed above, were also excluded, to produce comparable results shorn of one-time noise, fiscal 2014 would have closed with a surplus of $68 million—slightly ahead of the fiscal 2015 gain reported today.
As always, certain points merit more detailed examination.
Tuition and financial aid. Income from students—typically the largest source of flexible, unrestricted funding for Harvard’s schools—has been growing smartly: up 7.3 percent in fiscal 2014 after deducting scholarships applied to tuition and fees, and a further 6 percent in fiscal 2015, to $930 million. As recently as fiscal 2013, sponsored-research funding was Harvard’s second-largest source of operating revenue (after the endowment distribution, and ahead of student income); now, with research funding stagnant and tuition and fees growing, their relative standing has been reversed, with tuition and fees progressively outstripping sponsored support.
The tuition results vary by category. In fiscal 2015, gross tuition (before netting out scholarships) rose 3.3 percent for undergraduates (to $292 million); 5.1 percent for graduate and professional programs; and 7.4 percent for continuing education and executive programs (to $346 million).
The performance of the latter category has to please Hollister and Finnegan, who emphasize what has been a recurring theme in recent financial reports: the focus on “exploring alternative revenue sources.” Harvard Business School (HBS) has invested heavily in its executive-education facilities in recent years, as well as introducing a growing, fee-based online operation. And the Faculty of Arts and Sciences’ Division of Continuing Education (FAS DCE) has been rapidly expanding programs, facilities, and staff; according to FAS dean Michael D. Smith’s 2015 annual report, DCE has been “growing at 15 percent per year” during the past two years, and “targeted” investments in growth, totaling $5.6 million in fiscal 2015, were rewarded by revenue growth of $10.5 million. (In past recessions, executive education, in particular, has proven somewhat economically sensitive: companies can easily pull back on sending employees for advanced-management training when times are tight. The newer offerings from HBS and DCE may well be immune to, or at least buffered from, such pressures.)
Tiny now, but of prospective importance as one of those “alternative” revenue sources, is income from general-interest online courses; in a recent white paper on HarvardX and other teaching initiatives, Provost Alan Garber listed “economic sustainability” as the first of three priorities deserving “special attention,” noting:
Although we expect most HarvardX courses to continue to be free and open, our online learning efforts cannot rest solely on the support of generous donors and unrestricted University funds. Like nearly every university producing MOOCs and other online course materials, we have begun to experiment with approaches to earning revenue from our online offerings. These opportunities range from fee-based, non-credit credentials to higher-touch professional programs.
The after-financial-aid tuition and fee figure, of course, is what matters to financial managers: the cash available to deans once they have met student needs. The fiscal 2014 and 2015 results are suggestive, with those 7.3 percent and 6.0 percent aggregate growth rates in student income, after deducting scholarship expenses. Scholarships applied to student income (reductions in term bills, for instance) rose just 3.0 percent, to $384 million—below the 3.7 percent growth in fiscal 2014. And other scholarships and awards paid directly to students increased just 4.6 percent, to $136 million. Even with robust growth in continuing and executive education (which affects the mix of tuition income), demand for financial aid in degree programs appears to be easing—perhaps a proxy for the improving economy and somewhat better family circumstances.
FAS’s supplementary financial data confirm the trend for undergraduate aid: its spending rose from $164.2 million in fiscal 2012 to $165.6 million the next year, and $170.2 million in fiscal 2014—before decreasing, minimally, to $170.1 million in the most recent year. That deceleration reflects a sharp change from the period beginning in 2007, when financial aid was expanded significantly, and then demand soared as family incomes came under severe pressure during the deep, extended recession. (From fiscal 2008 through the most recent year, the FAS annual report notes, its total financial-aid budget rose $82 million, or 52 percent.)
In the meantime, of course, University fundraisers continue to pursue, and to attract, gifts for aid: to secure the programs put in place during the past decade; to cope with families’ rising education costs; and to enable deans to apply more of those unrestricted net tuition receipts to other academic needs. President Drew Faust’s letter in the annual report focuses on The Harvard Campaign; she notes that to date, $686 million has been secured for financial aid across the University—roughly halfway toward the goal for aid within the $6.5-billion drive. (FAS has secured $386 million for undergraduate financial aid and $38 million for graduate fellowships, according to its 2015 campaign report: it seeks $600 million for undergraduate aid, and an unspecified amount for fellowships.)
The endowment and the capital campaign. The endowment remains the centerpiece of Harvard’s finances, again contributing 35 percent of operating revenues: $1.59 billion in fiscal 2015, and $1.54 billion in fiscal 2014. As Hollister put it, referring to past benefactions as well as current philanthropy, “So much of current operations is financed by the endowment draw and gifts from generous alumni and friends—we’re lucky to have that.”
The Corporation is being careful with endowment funds, reflecting its adherence to a multiyear smoothing formula that takes into account the relatively stronger and weaker investment returns generated by Harvard Management Company (HMC). The operating distribution, detailed in note 10 to the financial statements, equaled just 4.6 percent of the endowment’s value at the beginning of the fiscal year, down from 4.9 percent in the prior year. Because the schools availed themselves of somewhat more restrained “decapitalizations” (distribution of appreciation on endowment funds)—$193 million this year, versus $241 million in fiscal 2014—the total payout rate was 5.1 percent, down from 5.6 percent in the prior year.
As previously reported, HMC realized a 5.8 percent return on endowment assets in fiscal 2015 (all returns are given after investment expenses). The relatively modest increase in the operating distribution during fiscal 2015 in part reflects the slightly negative investment return in fiscal 2012; following the more robust fiscal 2013 and 2014 results (11.3 percent and 15.4 percent returns, respectively), the stage had been set for a more generous release of funds to the faculties, who are no doubt ready and willing to put them to use. For fiscal 2016, the financial guidance to deans envisions a 4 percent increase in the operating distribution, plus a sort of “bonus” distribution of 2 percent for verifiably one-time expenses (ensuring that those extra activities will not be built into schools’ permanent expense base, and perhaps a premonition of the weaker HMC results just realized). By formula, the fiscal 2015 HMC returns may have the effect of dampening the distribution in future years, compared to the level the Corporation might authorize given continuing strong investment results.
The annual financial report provides details on HMC’s results. Net investment income and gains were slightly under $2 billion—a bit less than suggested in a back-of-the-envelope estimate prepared when HMC reported; decapitalizations were a bit lower, too. Gift receipts were $338 million, contributing to the growth in the endowment’s fiscal year-end value of $37.6 billion.
Sponsored research. Not for nothing have higher-education administrators, and science and medical faculty members, been raising alarms about the federal research budget. As noted, federal direct sponsorship for research continued to decrease (although payments for indirect research costs rose modestly, a function of a changed mix in federal awards, which carry differing indirect reimbursement rates—the funds provided for facilities and other overhead). In absolute dollars, other sources of direct research support increased by $18 million (more than federal funds declined); but as has been previously reported, indirect-cost recoveries associated with such non-federal grants are at best a small fraction of those accompanying federal sponsorship, placing a burden on the institution as a whole to maintain the research enterprise.
The problem is sufficiently acute that Dean Smith, of the FAS, sharing his annual report with colleagues in early October, emphasized research funding as among his highest priorities. The financial commentary in the FAS report singles out the importance of “enhanc[ing] our internal program of research support to lessen faculty anxiety in an increasingly competitive market and challenging external funding landscape”—so much so that FAS expects to maintain its ladder-faculty ranks at approximately the current level (729 members), rather than investing funds in seeking to grow the faculty ranks.
Compensation and employee benefits. Compensation—salaries and wages plus benefits—increased 5.0 percent, to $2.21 billion. Salaries and wages increased 5.2 percent, to $1.71 billion; contributing factors, apparently of roughly equal magnitude, were additions to staff and merit pay increases. Areas of staff growth cited in the report include online learning (such as HarvardX), continuing education (31 new positions in FAS’s DCE, discussed above), and information technology.
Employee benefits expenses, as noted, rose about 4.4 percent compared to the fiscal 2014 figure, adjusted for a one-time charge in that year. Some of that reflects additional covered employees. But even after nonunion faculty and staff began paying deductibles and coinsurance in their health plans on January 1, the report notes, the expense for the active-employee health plan rose by 6 percent as more lives were covered, medical costs inflated, and claims costs generally increased. The new benefit coverage may have restrained growth in expenses somewhat, but clearly not enough to offset the larger trend, at least during the six months of the fiscal year affected. (As reported in September, in calendar year 2016, employee healthcare premiums are expected to rise an average of 7.3 percent.)
Other expenses. Space and occupancy costs jumped 9 percent, to $330 million. New facilities coming into operation (the renovated Harvard Art Museums, Tata Hall at the business school) account for some of the growth. But the number appears inflated by one-time recognition of costs for environmental remediation at one building site, so it would be incorrect to assume that there is a new trend in place. The catch-all “other expenses” category decreased by nearly $36 million—but again (and alas for budget officers), one-time factors were at work: the fiscal 2014 total was inflated by items such as asset writeoffs associated with undergraduate Houses undergoing renewal.
Faculty growth. In their letter, Hollister and Finnegan cite investments in the University’s academic program, including “expanded faculty.” The Harvard Campaign, of course, aims at many objectives—financial aid, building projects like House renewal and the new Allston facility for the engineering and applied sciences faculty—but faculty growth is not identified as a major, explicit priority in most schools’ goals. President Faust’s letter notes that the campaign has secured support for 75 endowed chairs, but most of these are understood to be existing professorships. As noted, FAS has determined that it will hold its faculty census essentially level. Engineering and applied sciences is expected to grow significantly, with the gift for computer-sciences professorships alone adding 12 new positions—suggesting modest attrition, perhaps, in other areas.
As noted above, FAS’s academic plan has been given a new rationale, and new urgency, in light of the pressure on research support (not only to establish the laboratories and programs of newly appointed faculty members, but to sustain existing ones); for now, the campaign in FAS is not about raw growth. Given persistent, and large, operating deficits in FAS and Harvard Medical School, a conservative course toward growth appears in place. Thus, only scattered expansion of the faculty ranks across the University appears to be the likeliest outcome, even as the campaign secures new resources.
Debt. The annual report discloses that in July, after the end of the fiscal year, Harvard paid down $316 million in outstanding bonds, reducing debt to $5.3 billion. For those who keep count, that is a $1-billion reduction from the peak indebtedness of $6.3 billion in fiscal 2011. The report notes that Harvard “is currently limiting the use of new debt in order to allow for future flexibility in financing of major initiatives.” In light of its strengthened financial position, the University could clearly borrow more and retain its AAA bond rating—but it has other sources of funding, too: those budget surpluses; strong philanthropic support; and other uncommitted reserves. Some new borrowing is certainly likely—FAS’s plans to complete the House renewal program anticipate debt, and the Allston science and engineering center is beyond big-ticket status—but the University happily emerges from the financial crisis at the end of the last decade with multiple options to proceed on these and other priorities.
The primate center. Finally, beyond reclassifying fiscal 2014 operating losses associated with the NEPRC to discontinued status (removed from the reported operating results for the University that year), the new report records, in the dry language of financial accounting, the closure of that facility, resulting in a $50.8-million charge for the “net loss from discontinued operations”: a $15.8-million loss on impairment of fixed assets (the Southborough building), plus staff reductions and the relocation of the primates to other facilities around the country.
The Campaign Context and Endowment Performance
It is not surprising that President Faust focused her message on the capital campaign. As noted above, the proceeds from past giving and investment returns on the endowment contributed 35 percent of Harvard’s revenues this year; gifts for current use, generated during the current fund drive, yielded another 10 percent. Referring to those flows of funds in financial terms, Hollister said, “We have an enormous, fortunate mainstay of our operations.”
The campaign’s success matters a great deal. With more than $6 billion received or pledged, cash gifts and fulfillment of pledges included both the $338 million in additional endowment funds invested this year (down from $513 million in fiscal 2014, as the campaign’s quiet-phase fundraising segued into the public launch in September 2013), and the $436 million in current-use gifts (up from $419 million in the prior year). Pledges receivable are a good gauge of what is on tap: $2.25 billion at year-end, up more than 40 percent from $1.59 billion at the end of fiscal 2014.
That demonstrates both that the pipeline is filling robustly—and that there is a lag, sometimes considerable, between donors’ gift pledges and the delivery of the funds to Harvard (and a further lag until funds received for the endowment are invested and begin generating money the schools can use). FAS, where current-use gifts rose 21 percent during fiscal 2015, explicitly noted the importance of “a new hybrid gift policy, which encourages donors to provide a share of certain major gifts in the form of current use funds in order to activate their philanthropy more quickly.”
The message to eager faculties would appear to be twofold: be patient—the fruits from the campaign are coming; and be clever, so that donors who are committed to investing in Harvard may be encouraged to do so more quickly.
In the long run, HMC’s performance looms large. HMC president and CEO Stephen Blyth’s September letter to the community, reprinted in the annual financial report, makes clear the importance of improving investment returns, given Harvard’s academic aspirations and the role of endowment funds in supporting their realization. In coming years, if HMC can raise the annualized rate of return on endowment assets (7.6 percent for the most recent 10-year period) toward the level of the University’s best-performing peers (about 250 basis points higher), that would yield nearly $1 billion in incremental endowment value annually on the current asset base, and more as the gains and gifts compound: nearly as much as the current campaign aims to raise, but recurring, every half-decade. And each billion dollars of added endowment value translates over time into a $50-million increase in annual funds distributed to support the University’s teaching and research.