Welcome to Today s NACUBO Webcast. Our program will begin shortly with a brief introduction on how to use the desktop interface.

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1 Welcome to Today s NACUBO Webcast Our program will begin shortly with a brief introduction on how to use the desktop interface.

2 Understanding the Institutional Impact of the Current Economic Climate December 2, 2008

3 Moderator and Panelists J. Michael Gower, Vice President and CFO, Yeshiva University Stephen T. Golding, Executive Vice President, Cornell University Michael Strauss, Chief Economist and Chief Operating Officer, Commonfund Linda Fan, Managing Director, Prager, Sealy & Co., Inc. John Nelson, Managing Director, Moody's

4 We are faced with the Perfect Financial Storm: No part of the balance sheet is immune Institutional liquidity is strained Endowments face unprecedented decline Credit market contractions compromise debt strategies

5 We are faced with the Perfect Financial Storm: States are reducing in-year and multiyear budgets Fundraising support is in precipitous decline Endowments see an unprecedented drop There is a real decline in research funding

6 Historical operating assumptions have undergone significant dislocation Endowment spending policy Debt portfolio construction Credit markets Liquidity Access to capital

7 Political pressure to stay mission-centric is not receding: Teaching and service Technology development Community-based economic engine Promoting accessibility

8 Political pressure to manage costs while remaining accessible is increasing: Strains on financial aid Tuition increases are scrutinized Demands for transparency on spending

9 The current financial crisis is testing the boundaries between governance and management: The role of trustee leadership The role of trustee committees Trustees and management working together Financial reporting and disclosure Transparency

10 Goal of this session: To help you come out of the current financial predicament stronger than you were going into it.

11 How?? To help you think about how to meet the challenges To make sure we are collectively asking the tough questions To recognize that we must find institution-specific solutions To share different approaches To identify external sources to help you think through the issues

12 Polling Question #1 What is your role/perspective on campus: a) CFO/Business Office Staff b) Chief Investment Officer c) Board Member/Trustee d) Other

13 Consensus World GDP Forecasts 14% 12% % 10% 8% 6% 5.4% 5.2% 8.1% 7.0% 5.5% 9.3% 7.9% 6.9% 9.7% 9.3% 9.8% 8.5% 8.0% 8.0% 6.9% 6.1% 4% 2% 0% -2% 2.0% 1.6% 0.0% 2.1% 0.7% 0.5% 3.0% 1.0% -0.1% 2.6% 1.3% 0.2% U.S. Japan UK Euro area Brazil Russia India China BRICs Developed markets Commonfund Estimates where significant different from IMF 3.5% 2.6% 1.5% 0.5% Emerging markets % 0.5% 0.5% 5.0% 9.0% 8.0% 1.0% 6.2% % -0.2% -1.2% 3.5% 7.5% 6.0% -0.5% 4.5% Source: IMF, ISI October 2008

14 Source: BEA 10% 8% 6% 4% 2% 0% -2% U.S. Real GDP 8% 6% 4% 2% 0% -2% Percent Change From Quarter One Year Ago Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 Quarterly GDP (%)

15 Employment: January 1986 October 2008 Black Monday October 19, 1987 S&L Crisis 1990 Mexican Debt Crisis 1995 Russia/ LTCM 1998 NASDAQ Collapse 2000 Credit Crisis % 4% 8% 3% 6% 4% 2% 0% Civilian Unemployment Rate % 1% 0% Nonfarm Payroll Employment Civilian Unemployment Rate (left axis) Nonfarm Payroll Employment (right axis) -1% -2% Source: BLS

16 Housing Price Appreciation. Depreciation 25% 6.8% Price Decline 22.0% Price Decline % from October 1989 to April 1991 from June 2006 to August % 200 Year Over Year Change 10% 5% 0% -5% % -15% -20% Index Value Year over Year Change Composite-10 S&P/Case-Shiller Hom e Price Index (Composite of 10) 50 0 Source: Standard & Poors, January 1987 July 2008

17 10% 8% 6% 4% 2% 0% -2% -4% Source: BLS Inflation Has Peaked January 2003 September % 4.9% 4.0% 2.5% Percent (%) Jan 2003 Jan 2008 May 2003 Sep 2003 Jan 2004 May 2004 Sep 2004 Jan 2005 May 2005 Sep 2005 Jan 2006 May 2006 Sep 2006 Jan 2007 May 2007 Sep 2007 May 2008 Sep 2008 PPI (YoY) PPI ex Food & Energy (YoY) CPI (YoY) CPI ex Food & Energy (YoY)

18 Non-Farm Unit Labor Costs Help to Keep PCE Costs Modest Year-to-Year Changes 3/31/1960-9/30/ Core PCE vs Nonfarm Unit Labor Costs (Year-to-Year Changes) Correlation Coefficient = 0.88 Quarterly Data 3/31/1960-9/30/2008 Nonfarm Labor Costs (Smoothed) 9/30/2008 = 1.0% Core Personal Consumption Expenditures Price Index 9/30/2008 = 2.5% (E708A) Source: Ned Davis Research

19 World Population 6,000 5,000 4,000 Africa Asia Europe Latin America and the Caribbean Northern America Asia (Millions) 3,000 2,000 Africa 1, Source: U.S. Census Bureau

20 Global GDP by Region 1995 vs numbers in percent totals = 100% United Kingdom 4 5 Germany 24 United States Other Developed 5 France 4 Italy Japan Developed Developing Economies Developing Economies Source: ISI

21 3.0 Financial Conditions Index January 1992 November Standard Deviation (1.0) (2.0) (3.0) (4.0) (5.0) (6.0) (7.0) (8.0) (9.0) (10.0) (11.0) Bloomberg s U.S. Financial Conditions Index Components and Weights Money Market Index Weight Ted Spread 11.1% Commerical Paper/T-Bill Spread 11.1% Libor-OIS Spread 11.1% 33.3% Bond Market Investment-Grade Corporate/Treasury Spread 6.7% Muni/Treasury Spread 6.7% Swaps/Treasury Spread 6.7% High Yield/Treasury Spread 6.7% Agency/Treasury Spread 6.7% 33.3% Equity Market S&P 500 Share Prices 16.7% VIX Index 16.7% 33.3% Total 100% 10/8/1998 (2.65) Russian Financial Crisis 12/25/2000 (2.43) Dot Bomb 10/9/2002 (2.00) 2002 Credit Crunch Credit Crisis 9/23/2008 (5.07) 10/24/2008 (7.99) 10/20/2008 (8.25) 10/10/2008 (10.02) Jan-92 Sep-93 May-95 Jan-97 Sep-98 May-00 Jan-02 Sep-03 May-05 Jan-07 Sep-08 11/10/2008 (6.29) 11/14/2008 (6.71) Source: The Bloomberg Financial Conditions Index. The index combines yield spreads and indices from the money markets, equity markets, and bond markets into a normalized index. The values of this index are z-scores, which represent the # of standard deviations that current financial conditions lie above/below the average from 1992 Nov 14, 2008.

22 T-Bills, Fed Funds, & Eurodollar 1/03/ /14/ Fed Funds Target Rate 11/14/2008 = 1.00% ( ) 3-Month Eurodollar 11/14/2008 = 3.00% ( ) 3-Month T-Bill Yield 11/14/2008 = 0.14% ( ) Eurodollar minus Fed Funds Target Rate 11/14/2008 = 200 Mean = Eurodollar minus T-Bill Yield Mean = 53 11/14/2008 = (B0122) M J S D M J S D M J S D M J S D M J S D M J S D M J S D M J S D M J S DM J S D M J S D M J S D M J S DM J S D M J S D M J S D M J S D M J S D M J S DM J S Source: Ned Davis Research

23 S&P 500 Historical Downturns 60% (33 months) (32 months) 51.8% (15 months) (17 months) (37 months) /10/2008 (11 months) 40% 20% 32.0% 18.8% 29.1% 22.2%? 0% -20% -15.8% -23.8% -30.2% -40% % Years to -46.2% -46.3% Recovery 5.8 Peak to 0.4 trough "drawdown" ? -60% Percent change in 12 months following trough Source: Bloomberg?

24 Polling Question #2 What area is of greatest concern to your institution at this time? a) Liquidity b) Enrollment c) Fundraising d) Debt service costs e) Cuts in state funding f) Endowment decline

25 Impact on Tax-Exempt Market Prior to 9/10-9/17: Treasury conservatorship of Fannie Mae and Freddie Mac announced Merrill and Bank of America merger announced Lehman files for Chapter 11 and Barclay s buys Lehman s investment banking assets Shares of Reserve Primary fund falls below $1 due to Lehman exposure 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 4.71% 7.96% 5.74% 1.63% 3.45% 1.82% SIFMA 30-year MMD As of 11/ % As of 11/ % 0.00% 9/3/08 9/10/08 9/17/08 9/24/08 10/1/08 10/8/08 10/15/08 10/22/08 10/29/08 11/5/08 11/12/08 11/19/08

26 Impact on Tax-Exempt Market 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 4.71% 7.96% 5.74% 1.63% 3.45% 1.82% SIFMA 30-year MMD As of 11/ % As of 11/ % 0.00% 9/3/08 9/10/08 9/17/08 9/24/08 10/1/08 10/8/08 10/15/08 10/22/08 10/29/08 11/5/08 11/12/08 11/19/08 9/18/-10/1 Government announces $85 billion 2-year loan to AIG Investors pull approximately $24 billion from tax-exempt money market funds Goldman Sachs and Morgan Stanley announce they will become bank holding companies House votes down first $700 billion federal bailout plan Largest point drop in the Dow Jones (778 points) after bailout plan fails in the House

27 Impact on Tax-Exempt Market 10/2-10/14 JPMorgan acquires Washington Mutual in a government brokered deal Senate and House pass revised bailout plan 30-year Treasuries fall below 4% Federal Reserve and five other central banks cut interest rates on a coordinated basis US government announces plan to invest $250 billion in nine US banks FDIC insurance expanded Fed announces details on CPFF (Commercial Paper Funding Facility) 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 4.71% 7.96% 5.74% 1.63% 3.45% 1.82% SIFMA 30-year MMD As of 11/ % As of 11/ % 0.00% 9/3/08 9/10/08 9/17/08 9/24/08 10/1/08 10/8/08 10/15/08 10/22/08 10/29/08 11/5/08 11/12/08 11/19/08

28 Impact on Tax-Exempt Market 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 4.71% 7.96% 5.74% 1.63% 3.45% 1.82% SIFMA 30-year MMD As of 11/ % As of 11/ % 0.00% 9/3/08 9/10/08 9/17/08 9/24/08 10/1/08 10/8/08 10/15/08 10/22/08 10/29/08 11/5/08 11/12/08 11/19/08 10/14-10/29 Dow experiences worst one-day percentage decline since 1987 on 10/15 Hedge fund withdrawals may hit 25% by year end The Federal Reserve cuts interest rates 50 bps to 1%

29 Impact on Tax-Exempt Market 10/30-11/19 $700 billion bailout plan shifts from buying troubled mortgage assets to direct capital injections into financial institutions Auto industry requests government assistance to avoid bankruptcy CPI falls 1% from Sept. to Oct., the steepest one month decline in the 61 year history of the index Jobless claims approach highest level since 1982 S&P 500 falls below 750 and Dow drops below % 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 4.71% 7.96% 5.74% 1.63% 3.45% 1.82% SIFMA 30-year MMD As of 11/ % As of 11/ % 0.00% 9/3/08 9/10/08 9/17/08 9/24/08 10/1/08 10/8/08 10/15/08 10/22/08 10/29/08 11/5/08 11/12/08 11/19/08

30 Impact on Debt Portfolio Current Market Conditions Downgrades of Insurers and Banks Increased Cost/Scarcity of Bank Liquidity Facilities Credit Market Freeze Investor Concerns about Credit Dislocation of Bond/Swap Markets Impact on Debt Portfolio Higher costs on variable rate debt Secondary market disclosure on downgrades Increase in all-in-cost of VRDBs and operating lines Increase in long-term fixed rate bond rates Need for more investor education Wider credit spreads Higher negative market-to-market of swaps Collateral posting may be required

31 Impact on Debt Portfolio Current Market Conditions Lower Endowment Market Values Pressures on Broker/Dealers Decrease in Fundraising, Endowment Earnings Impact on Debt Portfolio Bond/credit covenants may be in jeopardy Unrestricted net assets will be substantially reduced Higher fees, less willing to inventory bonds, may reduce commitment to municipal business Downgrades on counterparties, remarketing agents Pressure on liquidity

32 General Impact of Current Economic Climate on Higher Ed Budgets Percentages are shown from Moody s 2007 Medians; publics on top line, privates on bottom for small and large institutions. Equity Markets State Revenues Unemployment Federal Deficit More Financial Aid Needed; Decreases in Discretionary Spending Decreased State Appropriations Fewer Federal, State and Private Grants Market Value of Endowment Down Decrease in Annual Giving Decrease in Capital Gifts Tuition & Auxiliaries State Support Grants & Contracts Investment Income Gifts & Other Capital Campaigns 26% 72% 32 % -- 14% 1-5% 2% 6-10% 3% 8-11%

33 Polling Question #3 At your institution, what is the biggest challenge you face due to the current economic climate? a) Dealing with uncertainty b) Communicating the issues c) Developing solutions d) Working with stakeholders e) Other

34 Debt Management Strategies Review existing debt structure Understand portfolio risks (e.g. put, liquidity, counterparty) Bank line of credit expiration dates Bond and bank covenants Establish debt portfolio monitoring system Review swap portfolio and documents, if any, and MTMs and collateral thresholds Governance/Management issues Evaluate liquidity needs holistically Consider relationships institutionally to maximize benefits Diversify and manage relationships with financial partners Communicate with senior management and Trustees

35 Debt Management Strategies External communications Be proactive with investors and rating agencies Establish liquidity bridges Potential issues with capital calls/diminished payout Midyear state budget cuts Gifts and timing of pledges

36 Potential Opportunities Streamline operations and improve efficiency Opportunistic budget reductions Revisions to capital plans Assumptions Timing Re-evaluate spending rule impact Rule vs proactive management Early cuts vs later

37 Potential Opportunities Improve communication across institution (e.g. schools, functions) Better align asset and liability sides of the balance sheet Improve Board-management relations to enable faster and more nimble decision making

38 Polling Question #4 What is your institution s bond rating? a) Baa b) A c) Aa d) Aaa e) Not rated yet

39 The Long & Short of It: Treasury & Debt Management is Key Capital Market Freeze Variable rate disruptions Swap losses Tighter bank capital Higher fixed rates Short-Term Challenges Liquidity Squeeze Commonfund ST fund Reduced distributions from hedge funds & other investments Higher than expected debt costs Lower annual fund receipts

40 The Long & Short of It: A CFO s Job Just Got a Lot Harder Longer Term Challenges Tuition Pricing Elasticity Deep, long recession Shift to lower-cost options Student borrowing costs Credit Now at a Premium Demand for ratings rising Demand for better disclosure rising Cost of debt higher Investment Losses Lower endowment spending Lower projected returns Impact on large donors Impact on student aid Capital Program Rethinking Invest while others defer? What is strategically critical? Linked w/ asset/debt policy?

41 Credit Spreads Widen Amid Thawing in Short Term Market How Tight Will Capital Market Access Be for Colleges? /20/2003 7/2/ /16/2003 1/29/2004 5/13/2004 8/26/ /9/2004 3/24/2005 7/7/ /20/2005 2/2/2006 5/18/2006 8/31/ /14/2006 3/29/2007 7/12/ /25/2007 2/7/2008 5/22/2008 9/4/2008 Baa-Aaa Spread 7 Day VMIG Composite Source: Moody s

42 Risks of Variable Rate Debt No Longer Hidden* Many College & University CFOs Outsourced Key Decisions Renewal/Rollover Risk Renewal/Rollover Risk Frequency & Severity of Risk is Greater Rating Triggers Rating Triggers Financial Covenants Financial Covenants Bank Bond Payments Bank Bond Payments Magnitude Swap Coll/ Terminations Swap Coll/ Terminations Probability *See Moody s 2004 publication: -- Hidden Risks of Variable Rate Debt

43 Rating Discussions: What is Moody s Looking For? Full Disclosure Municipal market information is fragmented and hard to assess Higher education accounting: opaque Higher ed has a great business model, but undercuts its own credibility with investors by poor disclosure habits

44 Rating Discussions: What is Moody s Looking For? Senior Leadership Involvement Strong President/CFO team can allay concerns about leverage & other risks Board discussion more important Frank discussion of risks and strategies to mitigate Absence of senior contact is red flag

45 Rating Discussions: What is Moody s Looking For? Make Your Own Decisions Using consultants for advice is usually a best practice But know your documents in detail Outsourcing debt/investment decisions is a red flag

46 Endowment Losses: How Big an Impact? Median Cash and Investments $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $0 $152,615 Even Substantial Declines in FY2008 and FY2009 Unlikely To Erase Gains $176,670 $195,050 $214,634 $251,913 $226, FY2008 Projected (Down 10%) $158,705 FY2009: Additional 30% Decline Source: Moody s

47 Credit Outlook: Not all Negative Large endowment losses: tough, but not fatal blow for colleges and universities ~90% of students attend schools w/ < $100K per student 4 year enrollments & up-front payments give time to adjust Public & lower cost private colleges gain in recession But less selective, high cost colleges with weak debt structure risk New strategies needed- diversification of programs; student markets, banks, swap counterparties, investments Increased rating downgrades likely for those with poor control over decisions Source: Moody s

48 Questions?

49 Next Steps. Be sure you have visited the NACUBO website for more resources and information at:

50 Thank you! Contact information: Linda Fan: Stephen T. Golding: J. Michael Gower: John Nelson: Michael Strauss:

51 Thank You For Your Participation Please complete the online evaluation