December 2, 2015 To: Catherine Gunther Kodat, Dean of the College of Arts & Sciences From: Budget Advisor Committee: Eric Tymoigne, Chair Anne Bentley Susan Glosser Todd Lochner Joel Martinez Subject: December 2015 BAC Report Executive Summary The growth of net tuition slowed considerably and is not expected to be a significant source of growing revenue in the future. In fact a declining trend is possible as enrollment stagnates and discount rate rises. The contribution of our current endowment to total revenue will only marginally help offset the adverse trend in net tuition. Expenses are expected to grow, some of them very rapidly. Over the past decade, the margin has been erratic and rarely met the 2% of net tuition CAS sets for itself. College administrators recognize the problem and note that a viable solution will involve adjustments on both the revenue side and expense side. A capital campaign is needed but will require much more involvement of the faculty. Introduction Each year, budget managers must propose a balanced budget to the Board of Trustees. Given our reliance on tuition, in challenging times, budget managers have agreed as a last resort to grow the target size of the student body in order to balance the budget. This has been the least painful and quickest way to fix what might have been considered, at first, as a temporary problem. This decision to increase the targeted overall enrollment was not part of a plan that carefully considered the long-term implications of such choice. The last increase in CAS targeted enrollment occurred last year, when budget managers agreed to raise the target from 2040 to 2050 degree-seeking students. Given the flattening trend in net tuition, if L&C continues to rely heavily on tuitions some decisions will have to be made to adjust for growing expenses. Reliance on adjunct professors, increasing student-to-faculty ratio, decreasing faculty and staff benefits, closing programs; these are the choices that the college will have to face. In brief, the Budgetary Advisory Committee (BAC) has come to realize that our reliance on tuitions and other students expenses is not sustainable. BAC spent the fall semester getting a better understanding of the college s financial trends. BAC did so by gathering data and by inquiring with the administration about what is done to deal with our budgetary issues. For example, is there a maximum enrollment that budget managers are not 1
willing to cross? If so what is it and how was this limit chosen? How much leeway do managers have now before that maximum is reached? How do budget managers plan to make adjustments to the budget once that maximum is reached? If there is no maximum, how do managers plan to accommodate a larger and larger enrollment? Is there a plan to expand CAS? Is there an upper limit to the student-faculty ratio? Do we plan to hire more adjunct professors? Is there an upper limit on the number of administrative or non-faculty staff we will hire, especially relative to faculty position? Is there an upcoming capital campaign with this growth vision in mind? BAC met with the Dean of CAS (Katie Kodat), the Director of Admission (Erica Johnson), the Director of Financial Aid (Anastacia Dillon), the Provost (Jane Atkinson), Associate Provost (Mark Figueroa), and the VP of Finance (Alan Finn) to discuss these and other questions (the appendix contains all the questions BAC asked). Budgetary Trends of the CAS Structure of Revenues Since 2010, the college has experienced a change in net-tuition trend (Figure 1). From 2005 to 2009, financial aid grew slowly and stayed around $20 million. From 2010, the dollar amount of financial aid rose rapidly and almost doubled from $20 million to $40 million. As a consequence, the gap between tuition (and fees) and net tuition (and fees) has widened rapidly since 2010 as the growth of net tuition slowed considerably. Net tuition grew by 44% from 2005 to 2009 but only by 15% from 2010 to 2015. The flattening trend of net tuition has been observed nationally for four-year non-profit institutions (Figure 2). The margin (revenues expenses) relative to revenue has been quite unstable (Figure 1). CAS has been able to meet the 2% margin-to-net tuition it sets for itself only five times in the past decade (L&C bond covenants used to have a 2% margin ratio but it is no longer the case). All three schools (CAS, Education, Law) are supposed to meet the 2% margin ratio. Last year, CAS barely had a positive margin representing 0.003% of revenue. Figure 1 Source: CAS operating budget 2
Figure 2 Source: Trends in College Pricing 2014 Unfortunately, the endowment only marginally has been able to help compensate for stagnating net tuition. Usually, the base spending of the endowment is 4.5% of the 16-quarter moving average market value of the endowment ( the market value ). However, the 2008 global financial crisis led to poor financial performances that decreased significantly the market value of some L&C endowments. As a consequence, the Board decided to spend only 2.5% of the market value of underwater endowments (i.e. endowments with a market value smaller than the original donation). The combination of a decline in the market value and a decline in the base-spending proportion led to a decline of the funds received from the overall endowment. Budget managers partly offset that by having a supplemental endowment spending approved by the Board, which peaked at 1.5% of the market value but has been declining by 0.1 percentage point yearly. This supplemental spending was not sufficient to offset the effect of the financial crisis so, from 2010 to 2013 the contribution of the endowment to CAS revenue fell dramatically (Figure 3). While the contribution to CAS revenue is growing again, it is not yet where it was prior to the financial crisis. This is especially so percentage-wise when 12% of our revenue used to come from endowment spending. Even though the endowment contribution has been growing over the past two years, a worrying issue is that the May 2015 yearly income generated by the endowment was not sufficient to cover the spending from the endowment. In other words, given market value, L&C had to spend some of the principal in addition to the income of the endowment. This is worrisome because, as noted in the 2015 April report, the size of the endowment is low both in absolute terms and in comparison with other peer institutions. 3
In conclusion, the trend in endowment spending is worrisome and, given other financial trends of the college and the financial-market environment, it is hard to see how the endowment could grow in any significant fashion unless a major capital campaign occurs. Figure 3 Source: CAS operating budget In order to compensate for the slowdown of net tuition while expenses have been continuously rising, our main choice has been to increase the reliance on student-driven income sources; tuition, fees, and room and board. In 2005 less than 80% of CAS revenue depended on these sources of revenue and, over the following decade, this proportion slowly grew to reach almost 85% in 2015 (Figure 4). The growth of these sources of revenue has been achieved by increasing the size of the student body. From 2005 to 2010, L&C averaged 1920 degree-seeking students (1980 total students). Since 2011, there has been an average of 2020 degree-seeking students (2150 total students) (Figure 5). However, this growth in enrollment did not fully translate into revenue gains because, as explained above (see discussion related to Figure 1), CAS had to grow rapidly the amount of financial aid to attract students. The same strategy has been followed by similar institutions, and the L&C first-year full-time student discount rate has followed the national trend on average (Figure 6). A broader view of the discount rate is provided by the size of financial aid relative to tuition revenues. This ratio has grown since 2010 to reach a historical high of 42.4% as of May 2015. 4
Figure 4 Source: CAS operating budget Figure 5 Sources: Common Database, Mark Figueroa (Prior to 2007) Note: 2015 is preliminary data. 5
Figure 6 Sources: CAS operating budget, Hardwick Day s Financial Aid Optimization Analysis, Oct. 2015 Structure of Expenses Our four largest expenses are instruction-related expenses (faculty and administrative salaries, computers, supplies, etc.), overhead expenses, expenses on residential services, and overseas programs. Together they represent about 70% of our expenses. The share of each category of expenses has been stable over time (Figure 7). Administrative expenses are spread throughout the different categories of spending. To get a clearer sense of how administrative expenses have changed relative to instructional expenses, one may study the trend of salaries. The share of non-faculty salaries rose from an average of 39% of all salaries from 2005 to 2007 to 42% on average after 2007 (Figure 8). Our reliance on adjunct faculty has been stable relative to the size of the faculty over the past decade, when evaluated through the share of faculty salaries earned by adjunct professors. This share fluctuates mostly between 8% and 10%. In dollar terms, our expense on adjunct salaries grew rapidly in 2008 and 2009 and then stabilized. 2015 recorded an uptick due to the large firstyear class. 6
Figure 7 Sources: CAS Operating Budget, Robert Nayer (after 2009) Note: Classification changed in 2009. Robert Nayer (Director of Operating and Capital Budgets) reworked the numbers to stay consistent with the pre-2009 classification. Note: The category Administration contains only expenses of the Dean Office, Associate Dean Office, Institutional Research and Provost Office. Note: Overhead includes interest servicing, depreciation and common costs for shared services (Information Technology, Facilities, Human Resources, Business and Finance, Institutional Advancement, President's Office, Financial Aid, and Campus Safety) Figure 8 Sources: CAS Operating Budget, Robert Nayer (before 2009) 7
Figure 9 Sources: CAS Operating Budget, Robert Nayer Conclusion Regarding Budgetary Trends BAC is concerned that the trends above (net tuition, enrollment, endowment spending, discount rate, expenses) are not sustainable if we want to preserve the quality of education, the reputation of the college, and the salaries and benefits of full-time employees (and so our ability to attract quality faculty and staff). Growing expenses have been matched by growing enrollment in order to offset flattening net tuition revenue. While over the years the college has managed to always return a positive margin, the continuation of these trends will lead to painful choices in terms of student-to-faculty ratio, proportion of adjunct professors, decline in employee retirement and healthcare benefits, availability and size of programs, among many others. We must therefore find a means to avoid these unpleasant choices, if not fully at least in part. The following provides a summary of what we learned by meeting with the administration. Discussion with the Administration The Provost noted that CAS has reached, or is very close to reaching, its maximum enrollment capacity given the way we run the college. Growing enrollment is no longer seen as a viable option to close the budget, unless we are prepared to significantly increase student-to-faculty ratio or, for example, to extend class time earlier in the morning and later in the evening. There is no plan to do so at the time. While we could try to offset a stagnating enrollment by lowering the discount rate, Erica Johnson noted that this is not a viable solution because it would reduce our competitiveness. In addition, families ability to pay is not going up and so lowering the discount rate would increase the gap (the difference between cost of attendance and financial aid). This would make L&C unaffordable for many families and would reduce the diversity of the college. 8
BAC and AFA expressed concern about the 2015 admission and merit aid data provided by Hardwick Day. The data seems to show a move toward catering to wealthier families. Merit aid for families with $0 need almost doubled from a discount rate of 18.8% in 2011 to 34.1% in 2015, while merit aid for the neediest students stagnated with a discount rate around 76%. This has led to an increase in the yield among $0-need families and a decline in the yield among the neediest students. While BAC and AFA recognize the need to balance the books, they also expressed concern about the risks this kind of choice entail. One just needs to look at the negative impact it had on the reputation of Whitman College. Erica Johnson noted that it is not a strategy of the college to cater to wealthier families. The current large first-year class did not involve any plan to grow enrollment, it was the result of an underestimation of the yield. Admission has been working with a goal of 550 full-time firstyear students (a goal that has increased over the years but has been stable for the past few years) 1 but, given that the yield has been on a downward trend, Admission Office admitted more students in anticipation of a decline in yield. It turned out the yield went up so the college ended up with a large first-year class. This lack of predictability in our first-year enrollment ultimately underscores our high dependency on tuition and creates a lack of ability to plan ahead. If CAS had a larger endowment, CAS could have more control over the number of students it decides to admit and also more certainty over the yield, because of the ability to offer generous financial aid. Given that increasing the targeted enrollment is no longer seen as a viable solution to close our budget, and given that the discount rate is expected to increase, the college can expect that net tuition will be on a stagnating-to-declining trend in the future. At the same time expenses will keep rising as healthcare costs grow quickly, principal payment on our bonds come due, salaries keep rising, among others. For example, large increase in principal servicing are coming due on L&C bonds in about a decade. Currently, the margins of the three L&C schools are used to put some money aside in an account (a.k.a. central bank ) to meet these future principal payments, but, at least for CAS, the margin has not been a reliable means to do so on a consistent basis. Thus, unless we are prepared to make significant changes to the way the college is run, we must find other sources of revenue to meet our growing expenses or we must be prepared to decrease our expenses. In practice, Alan Finn noted that our current challenge will have to be solved through a variety of means on both the revenue side and expense side. We definitely need a capital campaign but, for example, we could collaborate with other colleges in shared services (for example, CAS currently manages its health insurance through a college consortium). Dean Kodat noted that for a capital campaign to be successful, we will need much more faculty participation in annual giving. The saying charity begins at home is very relevant to our situation. Potential donors ask if the alumni, faculty and staff are financially supporting the college, to gauge if this is a good investment. For comparison, Hamilton College alumni s rate of giving is over 50%, and in the top 1% of colleges. However, the rate of alumni giving at L&C is 18%. It is not the amount of giving but the percentage of faculty/staff who contribute. A generous Board of Trustees is also crucial. She believes that there is not yet the support in the college community for a capital campaign. 1 Since 2003, the yearly enrollment of combined First-Year Full-Time and Part-Time students averaged 566 students +/- 33 students. 9
A final worrying trend discussed with Erica Johnson concerns a potential change in the financial aid scheduling and the emergence of a parallel application system. Beginning in the fall of 2016, changes in the Free Application for Federal Student Aid (FAFSA) application procedure will allow families to know their expected financial contribution by October 1. However, L&C does not send out financial aid awards until a student is admitted and the Board of Trustees approves tuition, room-and-board fees the following February. If other colleges shift to earlier dates to inform students of their financial aid, then we would need to switch in order to stay competitive and remain on students radar; otherwise we will lose students quickly because they will have made their mind long before we inform them of their financial aid award. We are waiting to see how other colleges react to this change. Mr. Nayer thought that the Executive Council and Board of Trustees could consider setting the tuition rates in October, while still approving the final budget in February. A second issue concerns the emergence of an elite application process. Erica Johnson explained that 83 of the top institutions are establishing a coalition with their own application to this elite group. These colleges are all need-blind and meet all students financial need, so it would be easier for them to send out financial-aid letters much earlier. This coalition is marketed as about access for students, but in reality this would establish a division between the well-endowed colleges and the rest of us. This may affect families perception of the quality of education at colleges such as ours. It would also potentially decrease the pool of well-prepared and intellectually-curious students, who would find it too cumbersome to file two different applications and so would merely focus on the coalition application. Recommendation Our recommendation is to split the BAC yearly meeting into two sequences. The fall would be focused on long-term strategies. The spring semester would focus on making specific recommendations to budget managers before they meet in the fall to prepare the budget of the next academic year. Currently, it is very difficult for budget managers to take any input from the faculty because budget managers start to meet in the summer. The BAC only starts to meet in September and can provide some input only very late in the fall when the budget is almost finalized. By providing recommendation in the spring, it will be easier to include the concerns and recommendations of the faculty in the building of the year-to-year budget. The fall semester would be focused on long-term budgetary trends and issues that the college faces. It would be freed from the narrow discussion about the need to balance the yearly budget. In both cases, the BAC will need to know what the priorities of the faculty are. The spring semester should probably limit to one or two the recommended short-term priorities to the budget managers. This would require understanding the trade offs, if any, and implications involved in setting a specific priority regarding the budget. This would also require a broad acceptance of the general direction that the college should take in financial terms. This should also help for an eventual capital campaign by providing a shared vision of the future of the college to potential external donors. The broad point is that the faculty needs to be engaged in the debate about the financial future of the college. 10
Appendix: Questions Asked to Administrators Questions for the Dean: If we had to stop the growth of our student body today, where do you see major sources of adjustment in the budget? Do you see the current growth of the student body as sustainable? Why or Why not? How should we approach the provost and VP of finance? Any specific questions we should ask them? How can the faculty make the President and Board more aware of our worries regarding the financial direction of the college? Which do you find more concerning, the disparity between LC professor salaries and those of our peer institutions, or the disparities between LC professors? Do you have an opinion as to whether absolute or proportional raises are preferable? If it is true that LC will become more reliant on adjuncts in the future, do you see any policy changes that need to be made in light of this fact? What do you see as the faculty and BAC s role in influencing budget decisions in the direction of faculty priorities (assuming we can find consensus on one or two)? If possible could you please answer the following question? (See intro to this report) Questions for the Director of Admission and Director of Financial Aid: Do you see the current growth of the student body as sustainable? Why or why not? The size of the student body has increased over the past five years. How many students could we have on campus at the maximum at the moment? Are we close or far from that maximum? Are you aware of a plan to grow the size of the student body? If yes how does the college plan to achieve that? If there is no plan to grow the student body, does the college plan to cater more to high-income families in order to extract more income from a given number of enrolled students? Assuming that we do not want to raise the size of the student body, would lowering the discount rate be a sustainable means to cope with the financial needs of the college? How does the college market itself to wealthier families? This was mentioned as one of the possible reasons why the discount rate was not as high as expected this year. How will the new FAFSA schedule affect the admissions process? (Beginning in fall 2016, students and their families can submit the FAFSA using prior-year data instead of waiting until February. So they will have a sense of their EFC before the admissions deadlines. Questions for Provost and Associate Provost Which retention model from last year (the original one or the one that ultimately was used) was more accurate in predicting outcomes? Which model will be used when calculating this year s budget? Are you making allowances for the possibility that we will have a larger-than-usual retention problem due to the size of the first year class? The size of student body has increased over the past five years. How many students could we have on campus at the maximum at the moment? Are we close or far from that maximum? What is the target size for the student body going forward? How will that target be achieved? "Do we have any reason to expect retention to be affected by the size of the class?" Questions for VP of Finance Although the size of the entering first-year class increased tuition revenue, it also required expenditures (conversion of spaces to rooms, hiring adjuncts, etc.). Do you have any sense of what the net effect of the first-year class size is on our operating budget? It is our understanding that in ten years we will have to begin making sizeable bond payments (6-8 million per year). Is this correct? Given that such an expense would decimate our present operating budget, what steps, if any, are being taken to prepare for this long term challenge? Do you foresee any way other than a capital campaign to prepare for expenses of that magnitude? 11