“In Bad Times We’re in Relatively Good Shape”

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It’s been a tough fall for the economy. As the Gazette was going to press in mid-December the Dow was down some 40 percent from its October all-time high, and news of mortgage defaults and job losses were going from really bad to worse. Institutions of higher education have hardly been immune to the effects of the downturn. Alumni who’ve taken time from contemplating their own financial woes to notice media accounts of plummeting endowment values may be wondering how Penn is faring in the current environment.

The short answer, according to Penn President Amy Gutmann: “I would say, in bad times we’re in relatively good shape.” All the same, “We will be tightening our belts in ways that don’t threaten our highest priorities.” One commitment that is “untouchable,” she emphasized in a late-November interview, is the University’s enhanced financial-aid program aimed at eliminating loans for all students who qualify for financial aid [“Gazetteer,” Mar|Apr 2008].

“We’re looking at an economy that continues to be in turmoil and trouble,” Gutmann went on. “Here at Penn, we have a very strong track record of balancing budgets, and that will allow us to meet our mission of teaching and research while conserving resources for all contingencies.”

Recent weeks have seen a slew of stories in The New York Times, The Wall Street Journal, Barron’s, and other media outlets detailing the impact of rapidly declining assets on college and university campuses across the country. While just about all types of investments have been down, a common theme has been the particular disadvantages of once highly touted “alternative” investment categories such as hedge funds, private equity, real estate, and natural resources. “[A]lternative assets have offered too little diversification and liquidity while generating returns that indeed are correlated with the miserable ones now being turned in by the stock market,” scolded an article in Barron’s, for example.

Harvard University, along with Yale and Princeton, led the move to alternatives, scoring big gains with them until this year. But it announced on December 2 that its endowment—the largest in higher education at $36.9 billion as of June 30, 2008—had lost 22 percent of its value as of October 31, or about $8 billion. Harvard President Drew Faust G’71 Gr’75 Hon’08 added that further losses could be forthcoming, and set an assumption of a decline of 30 percent for future planning purposes. A number of other schools, including Brown and Cornell among the Ivies, have mandated hiring freezes, construction slowdowns, and other cost-cutting measures.

Back in October, after the stock market first tumbled, President Gutmann issued a statement in which she began by noting that “by every major measure, we are stronger than ever before in our history,” having raised a record-setting $608 million, including $476 million in cash, in the last fiscal year, and being well on the way to meeting the current year’s goal of $450 million. Even then, however, she warned that “volatility in the markets is likely to continue for some time” and promised to update the Penn community “should the impact of the economic situation on the University change significantly.”

That update came on December 3, when she announced a series of measures—including a salary freeze for herself and the University’s vice presidents, deans, and other senior management—designed to rein in costs for compensation, current expenses, and capital projects over the next 18 months. (For more, see this issue’s “From College Hall.”)

Penn’s endowment ended the last fiscal year with a 3.9 percent decline, for a value of $6.3 billion. For the quarter ending September 30, it was down a bit more than 7 percent, said Executive Vice President Craig Carnaroli W’85 in an interview that day, and it is safe to say that the decline since then has been sharper.

The main difference between Penn and some of its peers—and the reason that the drop in value will not wreak as much havoc in the immediate term—is that the University does not fund nearly as much of its operating expenses from the endowment as do some other schools. Penn gets about 8 percent of its operating budget from endowment sources, compared to an average of about 18 percent among the Ivies and similar schools, Carnaroli explained. Some institutions fund as much as 40 percent of operations from endowment income. Also muting the stress, for now, is the fact that Penn’s endowment is much more liquid than those of peers who have had the bulk of their funds committed to illiquid, alternative asset classes.

The corollary to Penn’s relatively limited dependence on the endowment for operating expenses is a proportionately greater reliance on tuition income. The revenue outlook there is mixed, because the economic impact of the downturn will differ across Penn’s 12 schools—with professional programs expected to benefit, on balance. 

On the other hand, declining family wealth—as home values, retirement accounts, and investment portfolios all lose value—will have an impact on both potential tuition income and the demand for financial aid. “We will need to be respectful and mindful of [those factors] in setting our own tuition increases,” Carnaroli said. “At the same time, we need to continue to prioritize and set aside the resources to provide the financial aid that people need.” 

Other revenue sources are also being squeezed. Support from the Commonwealth of Pennsylvania for the School of Veterinary Medicine has been reduced. Declining interest rates have hurt income from Penn’s short-term investments. The outlook for federal research funding is murky, but hopes for “some type of stimulus” from the new administration in Washington are less bright, given the economy and dollars being poured into troubled industries, Carnaroli said. “We may continue to be in a very flat environment.” Possible reductions in revenue for Penn’s health system—from people delaying elective and outpatient procedures, patients losing insurance, and possible further cutbacks in Medicare and Medicaid reimbursements—are another concern, but right now “they continue to manage well and hold their own,” he added.

The measures announced in December, Carnaroli said, are designed to “pull multiple levers to be able to prepare next year’s budget for this decrease in revenue.” With compensation (salary and benefits) consuming just over half the total operating budget, Penn will try to limit that spending by not filling most open staff positions, eliminating bonuses, and reducing the use of temporary workers; departments will also be asked to reduce current expenses for things like travel and meals. The president and the rest of the University’s senior leadership will forego salary increases for 2009-10. In general, capital projects will be put on hold unless they are fully funded.

While there have been “no broad layoffs, no broad salary freezes” imposed by the central administration, the University’s schools will have the flexibility to impose such measures if necessary. “We’re going to count on local leadership to implement these [steps] in ways that balance their budgets.”

Like most universities, Penn has a formula for setting endowment expenditures to smooth year-to-year ups and downs, and under the current version the decline in income will show up in FY2011, which will begin in July 2010, ushering in what will likely be several years of “modest” declines in endowment spending, Carnaroli said. “That’s why we’re asking people to take these measures today to buffer some of those downturns.”

If there is a bright side to the current environment, it is that it presents an opportunity to rethink structures and practices that could have long-term positive outcomes, Carnaroli said. “This could be a great jumpstart in what we want to achieve in sustainability, if I can get some traction on conservation,” he added, by way of example. Also, the University’s bill for utilities is $70 million; squeezing out even a 5 percent reduction in energy use would yield $3.5 million. “This is not a time to just say, ‘We’ve got to cut, we’ve got to cut.’ We have to think about how we do things and see if there are ways we can save money.”

In some ways, this represents an intensification of Penn’s standard operating procedure of doing more with less. “This is not like we’ve been fat, dumb, and happy the last four years, and there’s a lot of low hanging fruit. We’ve been doing this rigorously every year.” Culturally and managerially, he said, Penn is “well-equipped to deal with this challenge”—though he allowed that it is “unlike any other we’ve faced.”

Beyond the endowment, when it comes to the impact of current economic conditions on Penn, the other elephant in the room is the University’s five-year $3.5 billion Making History fundraising campaign, launched in October 2007 [“Seizing the Moment,” Nov|Dec 2007]. As of the end of November, the campaign had raised more than 60 percent of the total and was ahead of projections to meet its FY2009 goal of $450 million.

Whether that pace will hold remains to be seen. “A lot will be told between now and the first or second week in January—we’ll have a much better idea of what the impact is [then],” said John Zeller, vice president for development and alumni relations, in November. 

As cause for optimism, Zeller offered a bit of historical perspective: For the last half-century at least, philanthropy has continued to increase even in times of economic distress. On the one occasion when actual dollars contributed did drop year-to-year—in 1987—the initial assumption that the October market crash was to blame later proved false; the main culprit had been changes in tax laws that had artificially boosted giving in 1986. “So the real question is, ‘Is this [crisis] unlike anything we’ve seen in the last 50 years?’ And I don’t think we’ll really know that for a while.”

“Until we get some level of stability [in the market], it’s going to be hard for some” donors, he said. At the same time, “there are people who are making very generous gifts, who have the capacity to do that, that maybe aren’t quite as impacted by what is going on on a daily basis. We see that not only here at Penn but around the country. For many philanthropists, this is the time where they fully realize that they need to step up and be counted.”

Zeller doesn’t foresee any alteration in priorities for the campaign arising from the economic turmoil.  Similarly, any questions about modifying the amount or length of the campaign, scheduled to conclude in 2012, are a long way off, he said.

President Gutmann noted this fall that the University had the best attendance ever for its annual scholarship dinner. “The scholarship donors, when I repeated what I’ve said from the beginning of this crisis—that we’re going to stand firm behind our new financial-aid package—they couldn’t have been more enthusiastic, and many of them will continue to give us money for that,” she said.

 “We’re going to continue cultivating our donor base, and we’ll be very understanding of people who are not ready at this point to give the biggest gift that they might have contemplated a year ago.” It would be “really surprising were there not some slowdown,” she added, but “at the same time, we’re on course. So I have to be very, very grateful to the thousands of people who have enabled us to be in such a strong position.”


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