October 26 memo to the board of trustees

Background on College Finances

During calendar year 2008, there was an estimated $60 trillion of losses worldwide in commodities, stocks, bonds, and real estate worldwide, $30 trillion alone in the stock market. Needless to say, we were not immune: the College’s net wealth declined by more than $200M during the past fiscal year, and by more than $290M during the past two fiscal years, a decline of 25%. (“Net wealth” refers to the difference between total assets--endowment investments, land, building and equipment, plus some other items—and total liabilities—long-term debt plus deferred revenues--at a given time).

The approximate $240M decline in our endowment from its high point about 30 months ago is a major factor in creating the budget deficits we are now addressing. A $240M decline in the endowment translates directly into a minimum reduction in funding to the operating budget of $12M/year (with a 5% spend rate). But the impact of the decline on the College’s future plans is much greater.

In addition to the absolute loss of $12M/year (about 6% of the current budget), our planning model has assumed an annual 9% growth in the value of the endowment, so the gap between the actual revenue generated by the endowment and what we expected the endowment to be is far greater than the $12M. To illustrate this: our financial model in 2007, before there was any inkling of the financial meltdown of the past year, projected an endowment at the end of FY2009 (today) of $1.06B. Instead, our endowment at the end of the fiscal year was approximately $700M (June 30, 2009). This gap means our endowment is $360M less than what our planning model projected, and therefore we have significantly fewer resources to support our operating budget, including anticipated increases in salaries, enhanced financial aid, and other recommendations in the 2006 Strategic Plan. In short, the $360M difference in the planned and actual endowment value translates into $18M less/year to support the operating budget and any new initiatives.

Losing $18M/year in funding from our endowment is significant, but the financial meltdown we have witnessed over the past 18 months also affected the two constituencies that provide the most revenue to the College—families, who pay tuition, which accounts for about two-thirds of our annual operating budget, and donors, who, prior to the recession, contributed an average $26M/year to the endowment. Our financial model counted on these two sources of income to continue. Our comprehensive fee was projected to increase by 4.9% a year, and those capital gifts of $26M/year, were supposed to increase gradually to a high of $30+M in the final years of the Initiative. Neither of these projected increases happened in FY2008 and FY2009, and neither is likely to happen for a while.

We have lowered our estimated comprehensive fee increases for the next five years from 4.9% to 3.0%, which will reduce our revenue each year by at least $1.9M from what we had projected in 2007. And with 6 of the10 families paying the full price of >$50,000 each year, it is already apparent that the current financial crisis will affect a large number of our families and their ability to continue to pay the full comprehensive fee for a Middlebury education (which itself represents only 2/3s of the actual cost per student). Requests for reconsideration of financial aid awards are up significantly, adding $1.7M to our financial aid budget. Pressure on our financial aid budget is expected to be greater this coming year, which will force us to make cuts elsewhere, or change our financial aid policies, in order to maintain a balanced budget.

The loss of substantial wealth worldwide will also limit fundraising from our generous donors. As mentioned earlier, our financial model has assumed capital gifts to the endowment each year of $25M-$30M. Actual results have averaged $16M over the past two years, a decline of 38% from the previous years, and we have reduced our projections for the coming year to $18M (from $28M). The decline in capital gifts adds to our projected budget deficits beyond FY2011, because our annual budgets are built on the assumption that we would receive at least $10M more of capital gifts/year, and they would generate (at a 5% endowment spend rate) another $500,000 of budget support. More worrisome still, new long-term pledges, which allow us to project incremental giving over a multi-year period, have slowed significantly, so we can anticipate a shortfall in fundraising results for at least the short term.

The combined impact of these changes on our financial model and on the funds we can expect to have at our disposal in the coming year is significant. In FY2012 alone, we will have approximately $30-$35M less funding for our operating budget than what we had forecast just two years ago. This is based on an endowment that will be approximately $530M less than what we had projected in 2007, on gifts to endowment that will be $45M less than we had projected (over a three-year period), and on more than $6M less in comprehensive fee revenue as a result of lowering our increases from 4.9% to 3.0% a year for a series of years. Our financial planning has for years included stress tests that projected what were then seen as rather dramatic alternatives to the assumptions we had in our model, but the past two fiscal years have exceeded by far our worst-case scenarios, and we need to learn from that experience in modeling and planning the future.

This is the financial context in which we find ourselves. It forces us to ask some fundamental questions as we consider the long-term wellbeing of the College: what is it we must do, and what is it we should no longer do, or do differently, in order to reduce the cost structure of the institution? Given events of the past year, all of our long-term planning assumptions—about salary increases, financial aid enhancements, building renovations, increased program support, and expanded development programs for faculty and staff—must now be re-examined.

It is important to recognize that even if the financial recovery continues, we enjoy >9% returns to the endowment for the next 5 years, donors become confident and make significant pledges, and annual giving remains strong, we will still need to alter how we do things at the College. This past recession, which was/is the longest since World War II, has raised questions in the public mind about the value of a private and expensive liberal arts education. Families who previously would have sent their sons and daughters to a Middlebury, Amherst, Bowdoin, or Williams without hesitation are now questioning whether the education is worth the price, and I believe will continue to question it even when these rough economic times have subsided. The demand function for private education has shifted, and this shift will limit our ability to increase tuition and fees at the level to which we have become accustomed for more than thirty years. (Note: this year’s comprehensive fee increase of 3.2% is the lowest fee increase in 37 years).

Adding to the pressure has been a costly and at times excessive competitive attitude among colleges, exacerbated by the advent of easy credit, which drove a sense of “must haves”: new science centers, libraries, art centers, fitness centers, luxurious residence halls, and many new “student services.” The rush to add all these new items to our campuses has created what observers of higher education have labeled an “arms race”—if a competitor does X, all others feel they must do it, too, which only ratchets up the financial risk factor for all institutions that choose to join the race.

The current financial crisis has served as an effective form of arms control, at least for now. Even the wealthiest of liberal arts colleges have halted construction of expensive science centers and libraries. But judging from recent conversations I have had both on campus and with presidents of peer institutions, the pressure seems to be building already to return to past ways. It is crucial for us to discuss openly both the internal and external challenges and risks to returning to a “business as usual” approach to planning and envisioning our future, and why we cannot afford to go that route.

On the external front, we, along with our peers, are heavily leveraged, which places our current assets at risk and leaves us with too little financial flexibility; valuations of some of our endowment assets may still be significantly inflated; increased government regulation of the financial markets are likely to slow the pace of asset replacement and renewal; we face a public more skeptical about institutions with tax-exempt status; prospects are good for major tax reform, which is likely to have an adverse impact on philanthropy; and there are the already mentioned signs of a softening demand for a $50k+ liberal arts education. These factors make it difficult for anyone to believe we can return to “business as usual.”

The internal issues we face are mostly about people, and are therefore are more difficult to address. An enterprise that expends more than half of its budget on people (salaries and benefits), and provides highly sought after employment opportunities in a relatively remote region, finds it difficult to pull back and shrink the institution when it faces major recessions such as the one we have just experienced. Layoffs are especially difficult in our setting, and therefore we must exercise care when deciding where and how we expand during flush times so as to minimize the impact of severe economic downturns on our staff and the local community. We need to find a balance between pulling back without compromising the fabric of our community on the one hand, and ensuring the College’s future, on the other. Complicating matters even more is the fact that opportunities for spousal employment have become a central issue in faculty or staff recruiting, and so exercising greater restraint in the growth of staff positions carries with it all the challenges associated with securing employment in rural locations like ours.

As should be clear from the background outlined above, it cannot be business as usual for colleges like Middlebury. The assumptions that have guided the manner in which we have developed and sustained our educational programs must be revised. These revisions should be made with an understanding of the College's mission, location, institutional profile, financial capacity, and the pressures that come from the conflicting goals and perspectives of Middlebury's (at least) eight constituencies: students, faculty, staff, parents, alumni, trustees, townspeople, and prospective students. I ask for your patience and participation in the process of re-examining what we do, and how we do it, as we seek to define financial sustainability for Middlebury's future.


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