When investment returns were going gangbusters years ago, most colleges paid little attention to whether they’d have quick access to cash if a severe economic downturn occurred. The pitfalls of that oversight are now clearer than ever, and a major rating agency is asking colleges to produce ever-more detailed reports about their “liquidity” positions.
Roughly translated into cash on hand, liquidity proved in short supply for colleges that got tied up in long-term investments like real estate and venture capital. Struggling just to keep operations afloat, many have now had to borrow money or cut costs just to meet liquidity needs. The extreme financial crunch has proven a difficult lesson, and now Moody’s Investors Service is calling on colleges to provide unprecedented levels of disclosure about how much cash they can get to quickly and how much money is wrapped up in complex investments.
Before 2008, liquidity was commonly perceived as a given in higher education, analysts say. Investment returns, tuition revenues and donated funds typically proved sufficient to cover basic operations among most Moody’s-rated institutions. What’s now obvious, however, is that many governing boards weren’t asking much about liquidity – and neither was anyone else. Nonprofit colleges aren’t compelled by the Securities and Exchange Commission to provide financial data, and tax filings are largely silent on the issue as well. As for Moody’s, the agency “didn’t have a standing requirement for all colleges and universities to provide this liquidity information,” said John Nelson, managing director of Moody’s Public Finance Group.
While Moody’s has often asked individual institutions about liquidity, the agency hasn’t had comprehensive data on the liquidity positions of its rated institutions. Consequently, it’s been challenging to establish norms and benchmarks. What’s a standard amount of cash on hand, for instance, for a college with a lot of debt and a lot of long-term investments? The agency hasn’t had a definitive answer to that question, Nelson said.
In a report on liquidity issued today, Moody’s reiterates concerns that colleges weren’t preparing for worst case scenarios – a criticism that’s also been leveled at ratings agencies themselves. The report notes, for instance, that college leaders were often convinced impressive investment returns would cover operations, and they were inclined to borrow money to fund capital projects, rather than tap endowment funds that were making money in real estate, private equity, hedge funds and other strategies.
To finance capital projects, colleges increasingly hoped to lower borrowing costs by issuing variable rate debt. While that seemed like a good idea at the time, issuing variable rather than fixed rate debt later subjected colleges to volatile interest rates when the credit markets contracted. As debt financing demands grew, and investment dollars were increasingly tied up in long-term instruments, problems emerged for many colleges – as evidenced by the need to borrow more money or tighten belts just to pay the bills. The problems were particularly pronounced at large endowment institutions, which were heavily reliant on investment returns to fund operations and also had significant illiquid investments.
“The recent credit/liquidity crisis made evident the structural deficiency of management and board oversight at many institutions,” the Moody's report states. “Leading up to the crisis, some institutions considered and became more comfortable with the associated risks they were taking on. Many, however, did not fully weigh the embedded risks of variable rate debt or believed there was little value in preparing for the extraordinary, low-probability events that would have to occur for these risks to become manifest.”
Moody’s warned about the “hidden risks” of variable rate debt in a 2004 report, and declared by December 2008 that the risks were “no longer hidden.” That said, all ratings agencies have come under some criticism for not better assessing the risks that led to the financial crisis. But Nelson said that criticism wasn’t driving the call for more liquidity information.
“I wouldn’t say it is that at all,” he said. “It’s more driven by the fact that we want to make sure investors get much better disclosure and that we have a systematic database to review all our ratings against.”