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Understanding the Institutional Impact of the Current Economic Climate

December 2, 2008

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

No part of the balance sheet is immune Institutional liquidity is strainedEndowments face unprecedented

declineCredit market contractions compromise

debt strategies

We are faced with the Perfect Financial Storm:

States are reducing in-year and multi-year budgetsFundraising support is in precipitous

declineEndowments see an unprecedented dropThere is a real decline in research

funding

We are faced with the Perfect Financial Storm:

Endowment spending policy Debt portfolio construction Credit markets Liquidity Access to capital

Historical operating assumptions have undergone significant dislocation

Teaching and service Technology development Community-based economic

engine Promoting accessibility

Political pressure to stay mission-centric is not receding:

Strains on financial aid Tuition increases are

scrutinizedDemands for transparency on

spending

Political pressure to manage costs while remaining accessible is increasing:

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

The current financial crisis is …

To help you come out of the current financial predicament

strongerthan you were going into it.

Goal of this session:

• 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

How??

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

Consensus World GDP Forecasts2.

0%

2.1%

3.0%

2.6%

5.4%

8.1%

9.3%

11.9

%

9.8%

2.6%

8.0%

1.6%

0.7% 1.0% 1.

3%

5.2%

7.0%

7.9%

9.7%

8.5%

1.5%

6.9%

0.0% 0.

5%

-0.1

%

0.2%

3.5%

5.5%

6.9%

9.3%

8.0%

0.5%

6.1%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

U.S. Japan UK Euro area Brazil Russia India China BRICs Developedmarkets

Emergingmarkets

200720082009

Source: IMF, ISI – October 2008

2008 1.0% 0.5% 0.5% 5.0% 9.0% 8.0% 1.0% 6.2%

2009 -0.5% -0.2% -1.2% 3.5% 7.5% 6.0% -0.5% 4.5%

Commonfund Estimates where significant different from IMF

U.S. Real GDP

Source: BEA

-2%

0%

2%

4%

6%

8%

10%

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Per

cent

Cha

nge

From

Qua

rter O

ne Y

ear

Ago

-2%

0%

2%

4%

6%

8%

1Q00

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

Qua

rter

ly G

DP

(%)

Employment: January 1986 – October 2008

Source: BLS

Black MondayOctober 19, 1987

S&L Crisis1990

Mexican Debt Crisis | 1995

Russia/ LTCM1998

NASDAQ Collapse | 2000

0%

2%

4%

6%

8%

10%

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Civi

lian

Unem

ploy

men

t Rat

e

-2%

-1%

0%

1%

2%

3%

4%

Nonf

arm

Pay

roll

Em

ploy

men

t

Civilian Unemployment Rate (left axis)Nonfarm Payroll Employment (right axis)

Credit Crisis | 2007 – 2008

6.8% Price Decline

from October 1989 to April 1991

Housing Price Appreciation …. Depreciation

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Year

Ove

r Yea

r Cha

nge

0

50

100

150

200

250

Inde

x Va

lue

Year over Year Change

Composite-10S&P/Case-Shiller Home Price Index (Composite of 10)

Source: Standard & Poors, January 1987 – July 2008

22.0% Price Decline

from June 2006 to August 2008

Inflation | Has Peaked January 2003 – September 2008

Source: BLS

8.7%

4.0%

4.9%

2.5%

-4%

-2%

0%

2%

4%

6%

8%

10%

Jan

2003

May

200

3

Sep

2003

Jan

2004

May

200

4

Sep

2004

Jan

2005

May

200

5

Sep

2005

Jan

2006

May

200

6

Sep

2006

Jan

2007

May

200

7

Sep

2007

Jan

2008

May

200

8

Sep

2008

Perc

ent (

%)

PPI (YoY)

PPI ex Food & Energy (YoY)

CPI (YoY)

CPI ex Food & Energy (YoY)

Non-Farm Unit Labor Costs Help to Keep PCE Costs Modest Year-to-Year Changes 3/31/1960 - 9/30/2008

Source: Ned Davis Research

Quarterly Data 3/31/1960 - 9/30/2008

(E708A)

Core Personal Consumption Expenditures Price Index

9/30/2008 = 2.5%

Nonfarm Labor Costs (Smoothed)

9/30/2008 = 1.0%

Correlation Coefficient = 0.88-1.2-0.8-0.40.00.40.81.21.62.02.42.83.23.64.04.44.85.25.66.06.46.87.27.68.08.48.89.29.6

10.010.410.811.211.6

-1.2-0.8-0.40.00.40.81.21.62.02.42.83.23.64.04.44.85.25.66.06.46.87.27.68.08.48.89.29.6

10.010.410.811.211.6

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Core PCE vs Nonfarm Unit Labor Costs

(Year-to-Year Changes)

World Population

0

1,000

2,000

3,000

4,000

5,000

6,000

1750 1800 1850 1900 1950 2000 2050 2150

(Mill

ions

)

AfricaAsiaEuropeLatin America and the CaribbeanNorthern America

Source: U.S. Census Bureau

Africa

Asia

18

Global GDP by Region | 1995 vs. 2007 numbers in percent | totals = 100%

24

26

8

96

Germany4 5

United Kingdom

5United States France

4

44

Italy

14

13

Other DevelopedJapan

1995

2007

Developed

Developing Economies

Source: ISI

22

34

Developing Economies

11/14/2008 (6.71)

11/10/2008 (6.29)

10/24/2008 (7.99)

9/23/2008 (5.07)

10/8/1998 (2.65)

12/25/2000 (2.43)

10/9/2002 (2.00)

10/20/2008 (8.25)

10/10/2008 (10.02)

(11.0)

(10.0)

(9.0)

(8.0)

(7.0)

(6.0)

(5.0)

(4.0)

(3.0)

(2.0)

(1.0)

0.0

1.0

2.0

3.0

Jan-92 Sep-93 May-95 Jan-97 Sep-98 May-00 Jan-02 Sep-03 May-05 Jan-07 Sep-08

Stan

dard

Dev

iatio

n

Russian Financial Crisis Dot Bomb

2002 Credit Crunch

Credit Crisis

Financial Conditions Index January 1992 – November 2008

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.

Money Market Index WeightTed 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%

Bloomberg’s U.S. Financial Conditions Index Components and Weights

T-Bills, Fed Funds, & Eurodollar 1/03/1989 - 11/14/2008

Source: Ned Davis Research

(B0122)

3-Month T-Bill Yield11/14/2008 = 0.14%

( )

Fed Funds Target Rate11/14/2008 = 1.00%

( )

3-Month Eurodollar11/14/2008 = 3.00%

( )123456789

10

123456789

10

Eurodollar minus Fed Funds Target Rate 11/14/2008 = 200

Mean = 200

60120180240300360420

060

120180240300360420

Eurodollar minus T-Bill Yield

11/14/2008 = 286Mean = 530

100200300400500

0100200300400500

1989M J S D

1990M J S D

1991M J S D

1992M J S D

1993M J S D

1994M J S D

1995M J S D

1996M J S D

1997M J S D

1998M J S D

1999M J S D

2000M J S D

2001M J S D

2002M J S D

2003M J S D

2004M J S D

2005M J S D

2006M J S D

2007M J S D

2008M J S

S&P 500 | Historical Downturns

Source: Bloomberg

Years to Recovery 5.8 0.4 1.7 0.3 4.7 ?

?

-46.2%

-23.8%

-30.2%

-15.8%

-46.3%-41.96%

32.0%

51.8%

18.8%

29.1%

22.2%

-60%

-40%

-20%

0%

20%

40%

60%

1972-1975(33 months)

1980-1983(32 months)

1987-1988(15 months)

1990-1991(17 months)

2000-2003(37 months)

2007-10/10/2008(11 months)

Peak to trough "drawdown"

Percent change in 12 months following trough

?

Polling Question #2

• What area is of greatest concern to your institution at this time?

a) Liquidityb) Enrollmentc) Fundraisingd) Debt service costse) Cuts in state fundingf) Endowment decline

• 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

3.45%

5.74%

7.96%

1.63% 1.82%As of 11/19

1.12%

4.71%As of 11/19

5.20%

0.00%

1.00%2.00%

3.00%

4.00%5.00%

6.00%

7.00%8.00%

9.00%

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

SIFMA

30-year MMD

Impact on Tax-Exempt Market

3.45%

5.74%

7.96%

1.63% 1.82%As of 11/19

1.12%

4.71%As of 11/19

5.20%

0.00%

1.00%2.00%

3.00%

4.00%5.00%

6.00%

7.00%8.00%

9.00%

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

SIFMA

30-year MMD

Impact on Tax-Exempt Market

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

• 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)

3.45%

5.74%

7.96%

1.63% 1.82%As of 11/19

1.12%

4.71%As of 11/19

5.20%

0.00%

1.00%2.00%

3.00%

4.00%5.00%

6.00%

7.00%8.00%

9.00%

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

SIFMA

30-year MMD

Impact on Tax-Exempt Market

3.45%

5.74%

7.96%

1.63% 1.82%As of 11/19

1.12%

4.71%As of 11/19

5.20%

0.00%

1.00%2.00%

3.00%

4.00%5.00%

6.00%

7.00%8.00%

9.00%

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

SIFMA

30-year MMD

Impact on Tax-Exempt Market

• 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%

3.45%

5.74%

7.96%

1.63% 1.82%As of 11/19

1.12%

4.71%As of 11/19

5.20%

0.00%

1.00%2.00%

3.00%

4.00%5.00%

6.00%

7.00%8.00%

9.00%

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

SIFMA

30-year MMD

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 7500

Current Market Conditions Impact on Debt PortfolioDowngrades of Insurers and Banks

• Higher costs on variable rate debt• Secondary market disclosure on downgrades

Increased Cost/Scarcity of Bank Liquidity Facilities

• Increase in all-in-cost of VRDBs and operating lines

Credit Market “Freeze” • Increase in long-term fixed rate bond rates

Investor Concerns about Credit • Need for more investor education• Wider credit spreads

Dislocation of Bond/Swap Markets

• Higher negative market-to-market of swaps

• Collateral posting may be required

Impact on Debt Portfolio

Impact on Debt PortfolioCurrent Market Conditions Impact on Debt Portfolio

Lower Endowment Market Values

•Bond/credit covenants may be in jeopardy

•Unrestricted net assets will be substantially reduced

Pressures on Broker/Dealers •Higher fees, less willing to inventory bonds, may reduce commitment to municipal business

•Downgrades on counterparties, remarketing agents

Decrease in Fundraising, Endowment Earnings

•Pressure on liquidity

Tuition & Auxiliaries

26%72%

State Support

32 %--

Grants & Contracts

14%1-5%

Investment Income

2%6-10%

Gifts & Other

3%8-11%

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

General Impact of Current Economic Climate on Higher Ed Budgets

Capital Campaigns

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

Decrease in Capital Gifts

Polling Question #3

At your institution, what is the biggest challenge you face due to the current economic climate?

a) Dealing with uncertaintyb) Communicating the issuesc) Developing solutionsd) Working with stakeholderse) Other

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

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

Debt Management Strategies

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

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

Potential Opportunities

Polling Question #4

• What is your institution’s bond rating?

– a) Baa– b) A – c) Aa– d) Aaa– e) Not rated yet

The Long & Short of It: Treasury & Debt Management is Key

• Short-Term Challenges• Capital Market Freeze

– Variable rate disruptions– Swap losses– Tighter bank capital– Higher fixed rates

• Liquidity Squeeze– Commonfund ST fund– Reduced distributions from hedge funds & other investments– Higher than expected debt costs– Lower annual fund receipts

• 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

The Long & Short of It: A CFO’s Job Just Got a Lot Harder

• 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?

Longer Term Challenges

Credit Spreads Widen Amid Thawing in Short Term Market

Source: Moody’s

How Tight Will Capital Market Access Be for Colleges?

020

406080

100120

140160

5-1-

988-

14-9

811

-27-

983-

11-9

96-

24-9

910

-7-9

91-

20-0

05-

4-00

8-17

-00

11-3

0-00

3-15

-01

6-28

-01

10-1

1-01

1-24

-02

5-9-

028-

22-0

212

-05-

023/

20/2

003

7/2/

2003

10/1

6/20

031/

29/2

004

5/13

/200

48/

26/2

004

12/9

/200

43/

24/2

005

7/7/

2005

10/2

0/20

052/

2/20

065/

18/2

006

8/31

/200

612

/14/

2006

3/29

/200

77/

12/2

007

10/2

5/20

072/

7/20

085/

22/2

008

9/4/

2008

0.001.002.003.004.005.006.007.008.009.00

Baa-Aaa Spread 7 Day VMIG Composite

Risks of Variable Rate Debt No Longer Hidden*

Many College & University CFOs Outsourced Key Decisions

Financial CovenantsFinancial Covenants

Renewal/Rollover RiskRenewal/Rollover Risk

Bank Bond PaymentsBank Bond Payments

Rating Triggers Rating Triggers

Probability

Ma

gn

itu

de

Swap Coll/ TerminationsSwap Coll/ Terminations

*See Moody’s 2004 publication:--“Hidden Risks of Variable Rate Debt”

Frequency & Severity of Risk is Greater

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

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

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

Even Substantial Declines in FY2008 and FY2009 Unlikely To Erase Gains

$152,615$176,670

$195,050$214,634

$251,913$226,722

$158,705

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

2003 2004 2005 2006 2007 FY2008 Projected(Down 10%)

FY2009: Additional30% Decline

Med

ian

Cas

h an

d In

vest

men

ts

Source: Moody’s

Endowment Losses: How Big an Impact?

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 are @ 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

Questions?

Next Steps….

• Be sure you have visited the NACUBO website for more resources and information at:

• http://www.nacubo.org/economy

Thank you!Contact information:

Linda Fan: linda.fan@prager.comStephen T. Golding: stg8@cornell.edu

J. Michael Gower: gower@yu.eduJohn Nelson: John.Nelson@moodys.com

Michael Strauss: MStrauss@cfund.org

Thank You For Your Participation

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