May 4, 2010

In Two Years, University Debt Nearly Doubles

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As the University sells $285 million in debt this month to help finance a new medical research facility in at Weill Cornell Medical College in New York City, Cornell’s total outstanding debt is increasing to $1.96 billion –– nearly double what it was two years ago.

This sharp increase in the University’s debt began during the financial crisis in the fall of 2008.  At that time, the University borrowed $500 million of taxable debt in order to provide liquidity, or “cash insurance,” in the time of financial uncertainty.Of that debt, $250 million will be repaid in 2014, and the other half will be paid back in 2019, according to Joanne DeStefano MBA ’98, vice president for finance and chief financial officer. “It’s a multi-year plan because we don’t want to negatively impact the faculty or students,” she said. This decision to incur even more debt this year for WCMC’s research building is a “strategic investment” for the University, according to DeStefano. She explained that WCMC has its own budget, which is balanced, and the majority of the deficit in the University’s budget is from the Ithaca campus. In fact, only $162 million, or 10 percent, of the nearly $2 billion total debt is from the medical school. The University decided to proceed with the WCMC construction project and incur debt, among other reasons, because WCMC is such a low percentage of the University’s debt. Moreover, the medical school generates one third of the University’s revenue.“We didn’t want to penalize them for the fact that the Ithaca campus [budget] is not balanced,” DeStefano said. The medical school’s loan is a 30-year loan that will go out for sale in the last week of May. This debt will be capitalized for the first two years of interest as the construction begins so that WCMC will not pay interest on the loan until year three. Another $305 million of tax-exempt debt was issued in 2009 because construction projects on the Ithaca campus began with the expectation that gifts would come in. Due to the financial crisis, not all of these gifts came in. “Cornell now has a new policy: don’t start construction until 100 percent of the gifts have been raised,” DeStefano said. The decision to increase borrowing over the past two years was a calculated decision, according to DeStefano. “We could have balanced the budget immediately,” she said, “but that could have required cutting academic programs, financial aid, etc. We did everything we could to protect those programs.” “President Skorton was adamant that he didn’t want to affect the student experience,” she added. The credit ratings issued by Standard and Poor’s and Moody’s Investors Service have a significant impact on the University’s financial outlook because the ratings serve as a benchmark to buyers to determine the risk of debt. The lower the rating, the higher the interest rate on the loan. Because the risk is considered greater, the University incurs a higher cost. Currently, Harvard, Princeton and Yale sit at the top of the ratings at Standard and Poor’s AAA  and Moody’s Aaa, whereas the rest of the Ivies are tied at the second highest levels: AA+/Aa1.  “We’ll never be at AAA because we don’t have the size of Harvard’s endowment,” DeStefano said. She added, “[Harvard] has a much higher percentage of unrestricted funds than Cornell will ever have.” Last year, with the issuing of $800 million in debt, Standard and Poor’s dropped the University from AA+ to the third-highest level: AA. Moody’s rating stayed the same. This year, Moody’s changed its “outlook” from “stable” to “negative,” but maintained the Aa1 rating. The cost of a downgrade in rating would have cost the University ten basis points: approximately $40 million of the $275 million over the course of the life of the debt. Instead, the change in outlook cost the University only one basis point, versus Standard and Poor’s 10. According to DeStefano, the decision to issue more debt for WCMC’s project this year with a possible drop in ratings was a “conscious choice.” “We decided that inflation would have a much greater impact [than the downgrade in rating] and we wanted to build when construction costs are the lowest.” DeStefano said that the University probably should have been downgraded in Moody’s ratings to Aa2, but the credit agencies also examine “qualitative metrics” such as management, admittance yield and the plan to balance the budget. “We are very happy [Moody’s] maintained the rating,” DeStefano said. Moreover, DeStefano added, “I am not worried that we’ll be downgraded [in the future]. We have to show that we will live up to the plan [to balance the budget] and show a decrease in capital construction.” Regarding the financial outlook for the University, DeStefano said that she does not expect another increase in the University’s debt in the near future. The goal is to refrain from issuing long-term debt until the first $250 million of taxable debt is paid back, and near future capital projects will not be debt-funded, she explained. “Institutionally, we have a game plan to balance the budget,” she said.

Original Author: Elizabeth Krevsky