March 24, 2009

U.S. Colleges Sell Bonds to Weather Crisis

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Following in the footsteps of Harvard, Princeton and Notre Dame, Cornell chose to sell $500 million of taxable bonds earlier this month in response to recent endowment losses.
In the face of a global financial crisis that has erased $29 trillion from the stock market in 2008, according to Bloomberg, the average university endowment has decreased by 24.1 percent across the U.S. in the past six months, according to the Stamford Advocate.
In December 2008, Harvard sold $2.5 billion in taxable bonds to repay borrowed funds. Princeton sold $1 billion in bonds in January, University of Pittsburgh plans to sell up to $421 million, Notre Dame already sold $150 million and University of Pennsylvania plans to sell $300 million, according to the Bond Buyer.
“It’s really tough,” Kristin Gilbertson, chief investment officer at University of Pennsylvania, told Bloomberg News. “The whole purpose of keeping a decent-sized allocation to high-quality fixed income is for times like this to provide [universities] with [a] liquidity buffer so you don’t have to sell assets to buy new things,” she said.
Proceeds from bond sales allow institutions to fund operations, ensure liquidity and solvency in case of further credit market freezes, and hold on to investments such as private equity and real estate that may be profitable in the future, according to The New York Times.
Simultaneously, Harvard, Columbia, Duke and other schools are joining crippled financial firms like AIG to attempt to sell their private-equity assets for the same purpose, according to Bloomberg.
“Whether selling private equity would be a better strategy than issuing bonds would depend upon the price an institution would get for its private equity and what the likely expected returns were on that investment over the next few years,” Prof. Ronald Ehrenberg, director of Cornell Higher Education Research Institute, stated in an e-mail.
“If the value of private equity has fallen substantially, but is expected to go up in the future, selling the private equity now would not be a smart thing to do,” he said.
“Other institutions, notably Harvard, have had a hard time trying to sell their private equity holdings because of excessively low offers,” Leixin Zhao ’11, president of the Cornell Economics Society, stated in an e-mail. “The worst thing to do now is sell our [private equity] when prices are bottoming out, so our decisions to sell bonds is preferred.”
Furthermore, the interest Cornell has to pay on bonds is much lower than the expected return on the Cornell endowment over the periods that the bonds cover, so selling bonds and preserving the endowment would maximize net expected return, stated Ehrenberg.
The Cornell bond received an Aa1 rating from Moody’s, a rating agency. Although both Harvard and Princeton received AAA, the highest possible rating, Prof. Charles Chang, finance, maintains that Aa1 is “a very good rating.” Also, due to Cornell’s relatively low quantity of bonds compared to Harvard and Princeton, Cornell will probably enjoy lower rates, according to Matt Nagowski ’05, creator of the Cornell blog MetaEzra.
However, “the sale of bonds is not to reduce the reductions we have to make — it is to provide liquidity,” said Ehrenberg.
Even though the University will take on $500 million of debt, tuition hikes, enrollment increases, and budget cuts will continue to happen.
“$500 million is quite a lot of debt,” said Gregory Gutierrez ‘11. “Many parents are losing their jobs, so my biggest concern would probably be the rise in tuition.”
“What worries me the most is the drop in the quality of education if more measures are taken,” said Zhao. “If [enrollment increases] are continued and Cornell stops hiring new faculty, the overall quality and competitiveness of our institution will suffer. Most of us are here for the education, so that is my biggest concern.”
According to the Undergraduate Enrollment Trend report published in fall 2008, undergraduate enrollment has already been consistently exceeding the enrollment target of 13,000 students since fall 2001. Undergraduate tuition will increase by 4 percent for endowed colleges, 7.2 percent for statutory colleges.
Even so, students and faculty remain confident in Cornell’s decision-makers, given the state of the economy,
“I think right now Cornell is doing everything right,” said Zhao. “There’s only so much the leaders can do facing these economic conditions.”
“It’s a multi-faceted solution of readjusting spending, tightening belts around campus, raising capital through actions like [selling bonds], [and] reinvesting in the long term … no one aspect solves anything but it requires more than one action to allow us to both fix the problem and run a competitive program,” Chang said.
“I assure you [the administrators] are always thinking about the future,” Ehrenberg added.