PwC Ten Things Boards Need to Know Now about Higher Education Finances AGB’s National Conference on Trusteeship March 22,

AGB Annual Meeting March 22, 2010 PwC 2 Agenda  Introduction- Lessons Learned from Financial Crisis & Long Experience  Five Lessons from Auditing Perspective  John Mattie, PwC  Five Lessons from Credit Rating Perspective  John Nelson, Moody’s

AGB Annual Meeting March 22, 2010 PwC Five Lessons from an Auditing Perspective

AGB Annual Meeting March 22, 2010 PwC  Risk (e.g. financial, compliance, reputational, operational) should be an annual agenda topic  Find the right balance between compliance controls (e.g. research, IRS (990), debt compliance), vs. financial reporting controls  Operating liquidity is a financial risk  Alignment of the operating budget to external financial reports  Integration of University Audit Committee with Medical Center/Hospital Audit Committee Build Business Risk Discussion into the Audit Committee Agenda Slide 4

AGB Annual Meeting March 22, 2010 PwC  Understand the components of unrestricted net assets “(URMA)” – How liquid is URNA?  What is included in “Investments?” – Donor Restricted Endowment – Quasi - Endowment – Other General Investments  Percentage to Net Asset Change Subject of Market Fluctuation  Forecasting URNA – Alignment with Operating Activities  Greater Sensitivity to Asset Allocation Supporting Fund Balances (e.g. Plant Funds, Working Capital Funds, Strategic Initiative Funds) “Net Assets” Can Be Misleading Slide 5

AGB Annual Meeting March 22, 2010 PwC  What actually is a “cash and cash equivalent?”  Commitment and Contingency Disclosures (e.g. debt swaps, legal vs moral commitments, liquidity requirements)  Interfund Borrowing and Lending Activities – Where are they?  Unencumbered Fund Balances – How much? What purpose? How liquid?  GASB vs FASB – MD& A Requirements – Operations – Financial Strength – Liquidity Focus on the Balance Sheet – What is included? What is not included? Slide 6

AGB Annual Meeting March 22, 2010 PwC  Interfund borrowing and financing activities  Borrowing from endowment to support strategic initiatives  Renewal and replacement reserves  Operating margin related to auxiliary activities (e.g., dining operations, bookstore, student housing)  Reconciliation of development fundraising results with externally-reported financial results  Benefit programs—relationship between cash payments, cash funding, and external expense recognition  Financial aid—”hard vs. soft” dollar funding  Physical plant activities—cash investment  Components of endowment payout (e.g., recurring operations, future investment, debt service)  Legal and moral cash flow commitments Ask the “10 Non- Evident Financial Reporting Questions” Slide 7

AGB Annual Meeting March 22, 2010 PwC  Fair Value Accounting – Ongoing Focus  Convergence of US and International Accounting Standards – Lease Accounting – Pension Accounting  Greater Note Disclosure of Commitments and Contingencies  Alignment of External Financial Reporting with Tax Reporting  Enhancing the Utility of the Statement of Cash Flow What’s Ahead? Slide 8

AGB Annual Meeting March 22, 2010 PwC 9 5 LESSONS FOR UNIVERSITY GOVERNANCE A Credit Rating Perspective

AGB Annual Meeting March 22, 2010 PwC 10 CREDIT RATINGS: Governance & Management is Key Risk Student Demand Financial Resources & Liquidity Operating Performance Capital Needs, Debt and Other Liabilities Legal Structure Covenants of Debt Governance & Management

AGB Annual Meeting March 22, 2010 PwC 11 KEY TREND=PUBLICS: Long-Term State De-funding Helps Publics? Governance Change Has Not Changed as Funding Declines  What does Market-Driven mean?

AGB Annual Meeting March 22, 2010 PwC 12 KEY TREND PRIVATES: Pricing Resistance Finally Here for Many? Competing w/ Publics & For-Profits  M&A, Partnerships on Horizon?

AGB Annual Meeting March 22, 2010 PwC 13 #1– Re-examine Core Financial Assumptions 1.“ Safest ” Investments Will Always Hold Value   Housing always go up  Money market funds cant “break the buck” 2. “State Of The Art”, Innovative Financial Ideas Are Better   Its OK if I don’t understand the transaction-- I trust my banker  Swaps are a win-win  Public-Private partnerships are win-win 3. Auction/Floating Rate Bonds: Cheapest Way to Borrow   These bonds have never failed; interest rates are only risk  Dealers will always support floating rate debt 4. Big, Diversified Endowment Mangers Know Best   There are “uncorrelated” assets in a crisis  Liquidity is Not Important

AGB Annual Meeting March 22, 2010 PwC 14 #2: Visionary President Needs More Oversight 1.Compliant Board Enables   Charismatic personality  One of two key board members clear path  Excessive compensation and freedom of action allowed 2.Hires Weak Staff/ Poor Disclosure   Weak, compliant CFO  Not open to external review from press, rating agencies  High turnover of senior staff 3.Financial Damage Builds Over Time   Recurrent operating deficits  Excessive debt and capital spending

AGB Annual Meeting March 22, 2010 PwC 15 #3: A Good CFO is Hard to Come By 1.Old Weak Model CFO Ill-suited for Today’s Risks   Need independent, capable CFO  Not Banker-dependent  Understands complexity, communicates simplicity 2.Truth Teller, not a Spinner   Not President or Board-dominated  Can speak to faculty and gain respect  Credible with auditors, investors, lenders, rating agencies, regulators 3.Leader, Looks Ahead, Anticipates Tough Budgets Before Needed-->  May prevent/reduce needs for furloughs, layoffs, other cuts  Avoiding debt/capital project overreach

AGB Annual Meeting March 22, 2010 PwC 16 #4: Universities: Great Business Model…But 1.Survived Last Crisis in 1980s/early 1990s   Predictions of doom & gloom; “Baby-bust Generation”  Deferred maintenance, tuition discounting, belt-tightening 2.Universities Are Inherently Stable   Students pay upfront/ 2-4 years largely locked in  Donors/Government subsidies not tied to explicit performance 3.Universities Are Central to Economy Now   Educate/develop youth-- Train labor force of all ages  Research/Development “Engines” for regional economies 4.For-Profit Success Points to Weakness of Traditional Model->  Gross underutilization of facilities during day and seasonally  Poor service to students/Lagging in Technology  Tenure and consensus enemy of efficiency

AGB Annual Meeting March 22, 2010 PwC 17 #5: Prepare for Longer Term Risks 1.Student Market Pricing Resistance Is Rising:  Crisis today for many small privates?  Risks may play out for years for publics  Publics can hold low-income students harmless 2.Government Funding Will Decline; Taxes Increase:  States have no money; reconsidering tax-exempt status  Federal $ in doubt: Pell grants, Research grants, Tax-credits 3.Political Tolerance of Higher Education Waning:  Industry Does Poor Job Explaining Itself  Career planning/ Placement Service to students must improve 4.Market-Driven Globalization is Happening:  Students, Faculty, Donors, Research Grants  M&A / Partnerships Resisted by Boards- may be unwise

AGB Annual Meeting March 22, 2010 PwC 18 Questions/Discussion

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