PwC
Ten Things Boards Need to Know Now
about Higher Education Finances
AGB’s National Conference on Trusteeship
March 22, 2010
www.agb.org
2
Agenda
 Introduction- Lessons Learned from
Financial Crisis & Long Experience
 Five Lessons from Auditing Perspective
 John Mattie, PwC
 Five Lessons from Credit Rating Perspective
 John Nelson, Moody’s
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AGB Annual Meeting
March 22, 2010
Five Lessons from an
Auditing Perspective
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AGB Annual Meeting
March 22, 2010
Slide 4
Build Business Risk Discussion into the Audit Committee
Agenda
 Risk (e.g. financial, compliance, reputational, operational) should be an
annual agenda topic
 Find the right balance between compliance controls (e.g. research, IRS
(990), debt compliance), vs. financial reporting controls
 Operating liquidity is a financial risk
 Alignment of the operating budget to external financial reports
 Integration of University Audit Committee with Medical Center/Hospital
Audit Committee
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AGB Annual Meeting
March 22, 2010
Slide 5
“Net Assets” Can Be Misleading
 Understand the components of unrestricted net assets “(URMA)” – How
liquid is URNA?
 What is included in “Investments?”
–
Donor Restricted Endowment
–
Quasi - Endowment
–
Other General Investments
 Percentage to Net Asset Change Subject of Market Fluctuation
 Forecasting URNA – Alignment with Operating Activities
 Greater Sensitivity to Asset Allocation Supporting Fund Balances (e.g. Plant
Funds, Working Capital Funds, Strategic Initiative Funds)
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AGB Annual Meeting
March 22, 2010
Slide 6
Focus on the Balance Sheet – What is included? What is
not included?
 What actually is a “cash and cash equivalent?”
 Commitment and Contingency Disclosures (e.g. debt swaps, legal vs moral
commitments, liquidity requirements)
 Interfund Borrowing and Lending Activities – Where are they?
 Unencumbered Fund Balances – How much? What purpose? How liquid?
 GASB vs FASB – MD& A Requirements
–
Operations
–
Financial Strength
–
Liquidity
PwC
AGB Annual Meeting
March 22, 2010
Slide 7
Ask the “10 Non- Evident Financial Reporting Questions”

Interfund borrowing and financing activities

Borrowing from endowment to support strategic initiatives

Renewal and replacement reserves

Operating margin related to auxiliary activities (e.g., dining operations,
bookstore, student housing)

Reconciliation of development fundraising results with externally-reported
financial results

Benefit programs—relationship between cash payments, cash funding, and
external expense recognition

Financial aid—”hard vs. soft” dollar funding

Physical plant activities—cash investment

Components of endowment payout (e.g., recurring operations, future
investment, debt service)

Legal and moral cash flow commitments
PwC
AGB Annual Meeting
March 22, 2010
Slide 8
What’s Ahead?
 Fair Value Accounting – Ongoing Focus
 Convergence of US and International Accounting Standards
–
Lease Accounting
–
Pension Accounting
 Greater Note Disclosure of Commitments and Contingencies
 Alignment of External Financial Reporting with Tax Reporting
 Enhancing the Utility of the Statement of Cash Flow
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AGB Annual Meeting
March 22, 2010
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5 LESSONS FOR
UNIVERSITY GOVERNANCE
A Credit Rating Perspective
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AGB Annual Meeting
March 22, 2010
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CREDIT RATINGS: Governance & Management is Key Risk
Capital Needs,
Student Demand
Debt and
Other Liabilities
Governance &
Operating
Management
Performance
Financial
Resources &
Liquidity
Legal Structure
Covenants of Debt
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AGB Annual Meeting
March 22, 2010
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KEY TREND=PUBLICS:
Long-Term State De-funding Helps Publics?
State Funding % of Operating Revenues
60%
50%
40%
30%
20%
10%
Governance Change Has Not
Changed as Funding Declines
What does Market-Driven mean?
0%
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
Singe Campus Universities
Large Research Systems
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AGB Annual Meeting
March 22, 2010
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KEY TREND PRIVATES:
Pricing Resistance Finally Here for Many?
% Reporting Net Tutiion Rev Decline
35%
29%
30%
25%
Competing w/ Publics & For-Profits
20%
M&A, Partnerships on Horizon?
15%
10%
9%
5%
4%
1%
5%
3%
5%
4%
2007
2008
0%
2003
2004
2005
2006
2009
2010
Fiscal Year
*Data for Fiscal Years 2009 and 2010 are estimated based on Moody's Enrollment Survey
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AGB Annual Meeting
March 22, 2010
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#1– Re-examine Core Financial Assumptions
1. “Safest” Investments Will Always Hold Value
 Housing always go up
 Money market funds cant “break the buck”
2. “State Of The Art”, Innovative Financial Ideas Are Better
 Its OK if I don’t understand the transaction-- I trust my banker
 Swaps are a win-win
 Public-Private partnerships are win-win
3. Auction/Floating Rate Bonds: Cheapest Way to Borrow
 These bonds have never failed; interest rates are only risk
 Dealers will always support floating rate debt
4. Big, Diversified Endowment Mangers Know Best
 There are “uncorrelated” assets in a crisis
 Liquidity is Not Important
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AGB Annual Meeting
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#2: Visionary President Needs More Oversight
1. Compliant Board Enables
 Charismatic personality
 One of two key board members clear path
 Excessive compensation and freedom of action allowed
2. Hires Weak Staff/ Poor Disclosure
 Weak, compliant CFO
 Not open to external review from press, rating agencies
 High turnover of senior staff
3. Financial Damage Builds Over Time
 Recurrent operating deficits
 Excessive debt and capital spending
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AGB Annual Meeting
March 22, 2010
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#3: A Good CFO is Hard to Come By
1. Old Weak Model CFO Ill-suited for Today’s Risks
 Need independent, capable CFO
 Not Banker-dependent
 Understands complexity, communicates simplicity
2. Truth Teller, not a Spinner
 Not President or Board-dominated
 Can speak to faculty and gain respect
 Credible with auditors, investors, lenders, rating agencies,
regulators
3. Leader, Looks Ahead, Anticipates Tough Budgets Before Needed-->
 May prevent/reduce needs for furloughs, layoffs, other cuts
 Avoiding debt/capital project overreach
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AGB Annual Meeting
March 22, 2010
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#4: Universities: Great Business Model…But
1. Survived Last Crisis in 1980s/early 1990s
 Predictions of doom & gloom; “Baby-bust Generation”
 Deferred maintenance, tuition discounting, belt-tightening
2. Universities Are Inherently Stable
 Students pay upfront/ 2-4 years largely locked in
 Donors/Government subsidies not tied to explicit performance
3. Universities Are Central to Economy Now
 Educate/develop youth-- Train labor force of all ages
 Research/Development “Engines” for regional economies
4. For-Profit Success Points to Weakness of Traditional Model->
 Gross underutilization of facilities during day and seasonally
 Poor service to students/Lagging in Technology
 Tenure and consensus enemy of efficiency
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AGB Annual Meeting
March 22, 2010
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#5: Prepare for Longer Term Risks
1. Student Market Pricing Resistance Is Rising:
 Crisis today for many small privates?
 Risks may play out for years for publics
 Publics can hold low-income students harmless
2. Government Funding Will Decline; Taxes Increase:
 States have no money; reconsidering tax-exempt status
 Federal $ in doubt: Pell grants, Research grants, Tax-credits
3. Political Tolerance of Higher Education Waning:
 Industry Does Poor Job Explaining Itself
 Career planning/ Placement Service to students must improve
4. Market-Driven Globalization is Happening:
 Students, Faculty, Donors, Research Grants
 M&A / Partnerships Resisted by Boards- may be unwise
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AGB Annual Meeting
March 22, 2010
18
Questions/Discussion
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AGB Annual Meeting
March 22, 2010
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Contact:
John Nelson
John A. Mattie
Managing Director
National Education & Nonprofit Leader,
212.553.4096
PricewaterhouseCoopers
John.nelson@moodys.com
646-471-4253
john.a.mattie@us.pwc.com
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AGB Annual Meeting
March 22, 2010