Leslie Kirwan
Dean for Administration and Finance
Fiscal Year 2009 - 2010

In October 2009, Faculty of Arts and Sciences Dean Michael D. Smith presented a financial report to the Faculty to help them and other key audiences gain a deeper understanding of the FAS’s financial condition in light of the impacts of the global recession.  At that time, the Dean committed that future annual reports would be published each October following this new, more timely and comprehensive standard.  Accordingly, we are pleased to present here the financial results for Fiscal Year 2010, the fiscal year ending June 30, 2010.  For purposes of comparison, the results for Fiscal Year 2009 are also displayed.

This report is intended solely to present a managerial view of the FAS’s finances and operations, and to explain how our financial resources changed and how they were used during the year in support of our academic mission.  It is important to note that these results are not audited in accordance with generally accepted accounting principles (GAAP), nor should they be confused with the audited financial statements of Harvard University as a whole. 

Overview

Fiscal year 2010 represents the mid-point of Dean Smith’s multi-year financial recovery plan.  It was a challenging year in which the imperative to curtail the growth in spending and implement structural cost saving measures at times seemed to dominate the agenda of the FAS community.  Despite these pressures, the Faculty has accomplished an impressive amount of mission critical work.  FAS was able to make targeted investments in several critical priority areas, including faculty searches, research administration, undergraduate and graduate financial aid, and core facilities, with an ongoing emphasis on environmental conservation measures and greenhouse gas reduction.  These actions ensure that the unsurpassed vibrancy and richness of our educational and research mission continue and thrive, within a new context where reasoned trade-offs, thoughtful planning and new ways of organizing ourselves are the norm.  As stated by Dean Smith at the onset of the fiscal crisis, we expect the FAS to become an even stronger, more focused Faculty as a result of the financial recovery plan, and achievements to date demonstrate significant progress toward this goal.  The final result of operations was a modest unrestricted surplus of $3.6M in the FAS Core, and somewhat larger surpluses across all fund types and affiliates.  Moreover, the Faculty’s success in rapidly implementing structural, or ongoing, budget solutions in FY10 put us in a stronger than anticipated position for confronting the more severe budget shortfalls projected for FY11.  As a result the anticipated budget gap for FY11, once a crushing figure, has been reduced to a more manageable level.

Guide to the Accompanying Financial Statements

The FAS budget is both large (just over one billion dollars) and highly decentralized, with significant spending under the direct control of over 150 separate departments, centers, libraries and museums.  The consolidated Statement of Activity presents important categories of revenues and expenses of the FAS as a whole.  This view combines what is typically called the “Core” of the FAS, comprised of the Faculty, the College, and the Graduate School of Arts and Sciences, together with the other major affiliates of the FAS (e.g., Athletics, the Division of Continuing Education, Dumbarton Oaks, the Harvard College Library, the Museums, and the School of Engineering and Applied Sciences).  Given that the Core constitutes about 73 percent of the FAS FY10 consolidated revenues and nearly 74 percent of FY10 consolidated expenses, we also present a FY10 Statement of Activity for just the Core.  We include this particular view because it highlights an area of FAS finances (the unrestricted budget of the FAS Core) that has been under particular stress for some time, exacerbated by the significant impacts of the current global recession. 

Finally, we present a Balance Sheet for the consolidated FAS that displays our major assets and liabilities at the end of FY09 and FY10. 

FY10:  The Mid-Point of a Multi-Year Fiscal Recovery Plan

When the impending impacts of the global financial crisis on the endowment of Harvard University and the FAS became apparent during Fiscal Year 2009, Dean Smith announced a comprehensive plan of action that spanned several years.  A multi-year approach was both necessary and advisable:  necessary, to allow the response measures time to take hold, and advisable, to avoid needless impacts on the academic mission of the FAS and ensure that core priorities would be preserved even during this challenging period.  This phased approach was facilitated by reserve balances within the FAS that are available for restrained and strategic use as a funding bridge while other solutions were developed.

Dean Smith reported in FY09 that the FAS faced an unrestricted deficit of $130M in FY10 that was projected to grow to $220M in FY11.  These projected deficits were largely attributable to the guidance published by the Corporation that the endowment distribution would decline by eight percent in FY10 and an additional 12 percent in FY11.  With FAS’s heavy reliance on endowment income – 54 percent of revenues came from the endowment in FY09 – the decline in distributions was far and away the biggest budget challenge, but it was not the only one.  The economy’s impact on family incomes increased the demand by our students for assistance from Harvard’s generous financial aid program, resulting in increased costs.  Additionally, the FAS had recently constructed over one million square feet of new facilities, substantially increasing expenses for debt service as well as operation and maintenance.

These were among the array of challenges facing the FAS when Dean Smith launched his multi-phase plan during FY09.  The first step was to slow the rapid pace of budgetary growth that had been established in prior years. This required instituting immediate actions to reduce controllable expenses across the FAS, buying time for more thoughtful implementation of administrative cost savings and restructuring of certain academic programs aligned with intellectual priorities.  Dean Smith charged several Priorities Working Groups of faculty, staff and students to identify solutions, and created a planning website and electronic “idea bank” to engage the FAS community as broadly as possible in responding to our fiscal challenges while advancing excellence in teaching, learning and research.

Through tremendous citizenship, innovation and hard work during the FY10 budgeting cycle, the $130M FY10 projected deficit was reduced by $110M, leaving a gap of $21M to solve.  In his Town Hall discussion in September 2009, Dean Smith praised the FAS community for its initial response, and announced his intent that the remaining $21M gap would be closed by year end.

FY10 Results

Through continued hard work, resourcefulness and thrift over the course of the year, the FAS has completed FY10 with a modest unrestricted surplus of $3.6M in the Core.  On a consolidated basis (that is, including the results in Athletics, the Division of Continuing Education, Dumbarton Oaks, the Harvard College Library, the Museums, and the School of Engineering and Applied Sciences), the unrestricted FAS surplus was larger, $12.0M, and on an all-funds basis the consolidated bottom-line of the FAS was $44.5M, bolstered by positive outcomes in many of the FAS affiliates.  In short, the Faculty of Arts and Sciences met head-on the fiscal challenge it faced in FY10 as Dean Smith suggested we would in his Town Hall meeting last year.

Major contributors to this positive outcome in FY10 include the following:

• The FAS energy conservation and greenhouse gas (GHG) emissions reduction efforts resulted in substantial recurring reductions to energy usage, which in turn resulted in FY10 utility costs savings.  These sustainability initiatives were directly aligned with President Faust’s ambitious GHG reduction program, and were also responsive to the themes of many of the “idea bank” submissions by students and faculty.
• Meaningful savings across the Core through reductions to controllable non-compensation expenses such as travel, meals, purchases of goods and services, and other discretionary spending contributed significantly to the progress made during the year.
• Organizational actions including an early retirement program for staff; participating, with the rest of  the University, in a reduction in force; restraint in filling vacant staff positions,; and a freeze on compensation increases for faculty and staff (except for clerical and technical workers) contributed significant additional savings.
• The passage of “UPMIFA” (the Universal Prudent Management of Investment Funds Act) allowed Harvard and the FAS to take full distributions on endowment funds that would otherwise have been considered “underwater”^[1] and thus unavailable in the short term.
• The  use of restricted income, consistent with fund terms, to pay for essential current costs was a way in which many departments, centers and other affiliates assisted in the recovery.
• Actual expenses in the programs under the HUSEC umbrella (primarily SRCB and the Wyss Institute) were substantially lower than planned during its early ramp-up period.
• In spite of the economic downturn, the generosity and support of Harvard alumni and donors continued, and the FAS was able not only to achieve, but slightly to  exceed its annual fund raising target.  Equally important, our donors responded to the Dean’s request to shift donations into unrestricted, general use giving, providing much-appreciated flexibility in challenging times.

Making Room for Targeted Investments

The work of the Faculty did not stop as these budgetary actions were underway.  Some investments in the academic mission of the FAS were too important to wait for a more favorable economic climate, and Dean Smith’s recovery plan made room for a number of targeted investments.

For instance, during FY10, 41 faculty searches were active, resulting in 20 new successful hires to date.  This robust level of faculty search and hiring demonstrates our ongoing commitment to excellence and the attractiveness of the FAS to the world’s finest faculty.

During FY10, 4,015 undergraduate students, or more than 60% of the undergraduate class, received some level of financial aid to attend Harvard.  The financial aid budget rose in FY10 to more than $145M (in comparison, it was less than half this total as recently as FY03), at a time when resources available from the endowment that support the cost of financial aid were also substantially diminished.  The strength of our financial aid program, and Harvard College’s attractiveness to a diverse and outstanding student body, is reflected in the record year experienced by the FAS for new applicants, which surpassed 30,000 for the first time.  Also, during FY10, stipend levels for graduate students were increased modestly.

Another strong sign of the FAS’s fiscal resilience in challenging economic circumstances was the 11% growth in FY10 of total sponsored research expenditures.   While attributable in part to the availability of new federal research grants included in the ARRA, it is clear that research proposals from FAS faculty continue to offer competitive and attractive investment opportunities for external sponsors.  To ensure adequate support for the growing research enterprise of the FAS, targeted investments in staff were made during FY10 to facilitate research proposal development as well as post-award management.

As always, we aspire to have the finest physical space for teaching and learning, and while major physical expansion efforts have diminished during the past year, the FAS was able to direct resources in FY10 towards a variety of important projects that are underway and will be completed during FY11.  These include various renovation projects to accommodate new and newly-promoted faculty, a helium liquefier that will be of great benefit to many departments in the Sciences, and the program of summer maintenance projects that ensure our facilities are properly stewarded.

Finally, these results were achieved while the FAS prudently paid down internal debt obligations on a variety of retired assets.

Balance Sheet View:  A Return to Asset Growth

As set forth in the Consolidated Balance Sheet, total net assets for the FAS grew by $700M in FY10, from $13.1B in FY09 to $13.8B in FY10.  The positive results of operations described above contributed modestly to this outcome, but the increase principally reflects growth in long-term investments (primarily endowment), from $11.6B at the close of FY09 to $12.2B at the close of FY10.  While a return to positive growth in the endowment is welcome, it should be remembered that the FAS’s net assets stood at $18.0B at the close of FY08, of which long-term investments represented $16.6B.

The Outlook:  FY11 and Beyond

Fiscal Year 2011, which began this past July 1, has always been understood to present the most difficult fiscal challenge. The FAS’s strong progress toward fiscal recovery in FY10 put us in an improved position to weather FY11.   Many of the solutions which closed the FY10 budgetary gap are structural in nature, meaning that if these revenue gains and expense reductions are maintained, they contribute to closing the FY11 gap as well.  In fact, in developing the FY11 budget, which was approved by the Corporation this past June, we were able to close all but $35M of the previously-forecasted unrestricted budget gap of $220M for the FAS Core. 

As he did last year, Dean Smith has stated his intention to bring the FAS budget fully into balance through continued hard work.  However, he has set as the goal to close the remaining gap over two fiscal years, that is, by the end of FY12.  In his May 12, 2010 letter to the Faculty, he said,

“The good news is that we do not need a balanced budget in this more difficult year, since we can temporarily use our FAS reserves to preserve our core mission of research and teaching.  Overall the approach we have taken to righting our finances is working.  We just need time, and our reserves will give us the time we need.”

Although the fiscal gap has been diminished substantially, ongoing upward pressure on some of our expense categories, coupled with, at best, modest increases to our key revenue sources for the foreseeable future, suggest that “structural” fiscal balance and sustainability will nonetheless require our continued focus and innovation in the years to come. 

Foremost among the challenges faced by the FAS as we move toward fiscal sustainability is ensuring adequate resources to attract and retain outstanding faculty and graduate students.  Operating successfully in the market for the finest scholars requires competitive search budgets and authorizations as well as competitive scholarship and aid programs for graduate students.  Faculty and graduate students are the intellectual capital underlying our educational and research mission; thus, maintaining and enhancing our world class academic reputation require sufficient funds in these critical areas. 

Similarly, our generous undergraduate financial aid program ensures we continue to have the finest and most diverse undergraduate student body in the world.   Our dedication to sustaining Harvard’s “best in class” financial aid program remains steadfast, but doing so will exert pressure on the finances of this faculty for years to come, particularly on the unrestricted budget .

In the years leading up to the financial crisis, the FAS embarked on an unprecedented period of physical expansion that added more than one million new square feet of additional research and teaching space to the campus.  These projects, including the BRI, Northwest Labs, LISE and CGIS, have been transformational in their impact on the intellectual reach of the FAS.  Although prudent and necessary, these projects substantially increased the amount of long-term debt outstanding for the FAS, resulting in much larger annual payments to service our debt burden.   While debt has been and will remain an important tool to enable strategic expansion and necessary growth, Dean Smith is intent on reducing the overall debt burden while ensuring that adequate funds remain available to sustain and steward our physical plant, as well as for important aspirational projects.

The smart use of technology can enable the academic mission, mitigate business risk and better leverage our resources.  Substantial investments have been made and are underway in critical areas such as research computing; however, the FAS continues to sustain a number of administrative systems whose useful life and utility is nearing an end.  The hiring of a new Chief Information Officer to serve as technology leader for a new organization combining the IT operations of both the FAS and central administration is a strong step toward making Harvard a leader among universities in deploying technology to support its core mission and operations.  Resources will be needed to enable this transformation.

Finally, these challenges to fiscal sustainability are set within a future context where distributions from our largest source of operating revenue, the endowment, will very likely be modest at best.  This fact itself presents a major hurdle as a substantial proportion of the FAS’s cost structure is relatively fixed, and is expected, in many cases, to inflate at a pace that exceeds anticipated growth in endowment distributions. 

Looking ahead, as we strive to eliminate this remaining gap and balance future budgets in the face of these critical challenges, we will need to maintain the gains we have already made while seeking and implementing further operational efficiencies that bolster our core intellectual mission.  Many such initiatives are already underway across the FAS, and the positive results of FY10 will allow us more time to work together to make these thoughtful and important changes.

Respectfully submitted,

Leslie A. Kirwan

Dean for Administration and Finance

Click here to download Appendix: Faculty of Arts and Sciences Managerial Financial Report.

[1] “Underwater” Funds have a current market value that is less than the book (original) value of the fund.  Harvard’s adoption of UPMIFA allows for a distribution to funds whose market value is 80% or more of the original book value.