Harvard Swap Toll Tops $1.25 Billion as Agreements Exited

Harvard University, the world’s richest college, lost $345.3 million terminating interest-rate swaps last year, bringing its cost of unwinding debt derivatives since 2008 to more than $1.25 billion.

Harvard made the most recent payments to exit derivatives linked to about $942 million of existing and future debt, the Cambridge, Massachusetts-based university said in a report today on the fiscal year ended June 30.

Harvard agreed to pay more than $900 million in 2008 to exit swaps linked to an ambitious expansion plan in Allston, a Boston neighborhood near the main campus. The use of the derivatives backfired at the same time the university’s endowment was on pace to lose more than a quarter of its value. Since then, the school has raised cash and cut debt to stabilize its finances.

“Like most colleges and universities, we already have exhausted the easiest opportunities for budget improvement,” Daniel Shore, Harvard’s vice president for finance and chief financial officer, and Treasurer James Rothenberg said in the report. “As a result, we will face increasingly complicated yet unavoidable choices as we seek to cover more ground in cost management.”

Allston Campus

The school agreed to many of the swaps when former President Lawrence Summers was planning to build the Allston campus, including a $1 billion science center. The swaps, which locked in interest rates for Harvard, also required the school to post collateral if rates fell. Harvard officials said that the hedges on debt that remain are unrelated to Allston.

After Drew Faust succeeded Summers as president, the school terminated swaps to avoid posting millions in collateral. Faust put the expansion plan on hold as Harvard’s frayed finances forced the school to take budget-cutting measures, including cutting some student services.

The school’s losses on terminating the swaps since 2008 were $497.6 million in fiscal 2009; $277.6 million in 2011; and $134.6 million in 2012.

Faust has since resumed the building plan, and the school is shifting its construction financing from debt to donations. In September, the school announced The Harvard Campaign, a fundraising drive with a record goal of $6.5 billion.

Harvard Deficit

Harvard had an operating deficit of $34 million for the year, an increase from $7.9 million the earlier period. While the deficit is a small proportion of the university’s $4.2 billion 2013 revenue, it’s representative of a number of pressures on the school’s funding sources, such as federal research grants, Shore said.

U.S. government funding at Harvard fell 2 percent to $653 million in the fiscal year as the increases from the American Recovery and Reinvestment Act of 2009 expired, the report said. While non-federal funding increased 17 percent to $191 million, lifting overall sponsored funds 1 percent to $845 million, the university faces “looming challenges” in managing its budget, Shore said.

“We need to think about whether there are more creative ways to think about alternative revenues,” he said in an interview posted on Harvard’s website, “and at the same time, whether there are different choices that we can make about how to manage our expenses so that we can not only survive, but thrive through what could be a challenging number of years coming up.”

Online Learning

Other ways to generate revenue might lie in areas such as online learning, where Harvard has recently established the EdX venture with the Massachusetts Institute of Technology, and the transfer of university research and technology patents to industry, Shore said.

“Those are opportunities that are completely consistent with our mission, because Harvard aspires, among other things, to have impact in the world,” he said in the interview.

In further moves to stabilize its finances, Harvard raised holdings in cash and liquid investments outside its endowment to $1.5 billion from $1.3 billion at the end of the earlier fiscal year. Outstanding debt fell to $5.7 billion from a high of $6.3 billion on June 30, 2011, the report said.

“While we believe debt is an important enabler of growth, it currently constitutes an outsized proportion of the university’s capital structure,” Shore and Rothenberg said in the report. “We are de-levering in a deliberate yet gradual manner in order to maintain flexibility.”

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