by Michael K. Townsley | Sep 19, 2024 | Private Colleges & Universities in Crisis, Strategic Planning
Failure Has Many Causes
Why are some colleges seemingly collapsing overnight? There are many causes for some private colleges surviving at the brink, but it takes a particular set of circumstances for a sudden collapse. What follows are factors that could drive a massive financial crisis. This list is based on research on financial collapse and interviews of leaders who passed through a cataclysmic financial crisis.
Elements of a Massive Financial Crisis
• The board of trustees miss signals that the college faces a financial catastrophe.
• The board needs to receive sufficient and accurate information about the financial condition of the college.
• Cash reserves are less than two months, and the next federal tranche is not expected to arrive until after cash is exhausted.
• Over-collateralization of property eliminates the college’s flexibility of selling property for cash.
• Handbook rules that prevent an immediate reduction-in-force plan or lead to ambiguity over who has decision authority over academic matters.
• Third-party enrollment contracts in which a contractor receives a portion of the tuition and fees from new students. A college with a high tuition discount rate, and if it is combined with the contractor’s rate, can find that it receives little or no cash out of new student tuition. For example, here is a case where a college discount has a discount rate of 75% and contracts with an enrollment agency that charges 25% of new student tuition revenue; this college will only receive 5% of new student revenue.
• Buildings that are empty and have been financed by loans. These buildings are a dead weight on the college’s finances.
• Very low student-faculty ratios result in a too expensive faculty and insufficient tuition revenue to support their compensation. Even worse, many colleges have low bars for tenure that makes it challenging to do a reduction-in-force or even to reduce their pay.
• Board meetings fail to have a quorum.
• Neither the president nor the board practice due diligence on plans or contracts.
• Neither the president nor the board involve legal counsel who is experienced in higher education law to vet strategies and operational plans.
• Either the president or the board chair or both publicly announce that they expect the college to close. The result is devastating. New students withdraw their applications, and donors stop giving to the college.
by Michael K. Townsley | Sep 7, 2024 | Financial Metrics, Measuring Financial Condition
Private colleges and universities are encountering unprecedented levels of financial stress that may even exceed the financial problems caused by the Great Depression in the 1930s. According to the Hechinger Report article in April 2024, “colleges are closing at a pace of one a week.[1] Sustainability for many colleges means whether they can survive the immediate financial stresses. “Fitch ratings estimated that 20-25 schools will close annually going forward.”[2] However, as of August 2024, thirty-three colleges have already closed which is well beyond the Fitch forecast.
The main financial problem for many private colleges is the continuing decline of average Unrestricted Net Assets. These assets are used for payrolls, other operational expenses, and debt service. After a small increase in the in average assets in 2018, they began a steady decline in 2019 until they hit their lowest level in the chart in 2020. The culprit for reaching the lowest average of Unrestricted Net Assets in 2020 can be traced to the COVID pandemic, when colleges had to close. Despite, COVID’S devastating effect on these assets in 2020, they came roaring back in 2021, when large governmental (federal and state) funds arrived to save the day. Nevertheless, average Unrestricted Net Assets collapsed in 2022 with their value nearly returning to the 2021 COVID level. As Bloomberg reported in 2023, “…government aid during the pandemic helped as a Band-Aid on the long-simmering issue of dwindling enrollments, the expiration of relieve(sp) next year (2024) is likely to expose that a reckoning is already playing out at dozens of colleges.”[3] Sad to say, the chickens are coming home to roost.
The Vulnerability Guage©, which predicts financial failure was applied to a data set of 949 private colleges, to predict financial risk for three FTE enrollment groups and four risk bands. Table 1 shows that the distribution of colleges by each enrollment group is nearly equal with 37% in the smallest group, 32% in the middle group, and 31% in largest group. However, financial risk as measured by the ‘Greater Risk and High-Risk Bands’ are not equally distributed. Private colleges with enrollments less than 1,000 FTE students were assigned to the ‘Greater and High-Risk Bands’. The next two enrollment groups, FTE 1,000 to less than 2,000 and FTE greater than ,000 FTE respectively had 29.8% and 12.7% assigned to the ‘Geater and High-Risk Bands’. To recap, colleges with enrollments less than 1,000 FTE students face the greatest risk of financial failure.
The following chart shows more clearly the relationship of enrollment and financial risk.
Because many private colleges have felt the full-force of falling enrollment, they can no longer count on tuition revenue to generate the net revenue or cash to support operations and capital expenses. The next chart illustrates what has happened to net tuition since 2016. Although the last year of the chart is 2021, it is probably a fair assumption that net tuition has not increased given that NACUBO reported average tuition discount for private colleges was 56.1%. This was 2% higher than in 2021. Larger discounts mean less cash.
Final Comments
Higher education, in general, and private colleges and universities, in particular, faces a woeful future as slackening demand, rising costs, and excess supply of seats grinds down their financial stability. In most cases, catastrophic conditions did not suddenly appear. They have been present, since student market demographics began their downhill slide at the start of this century. (See the Bloomberg essay, “The Economics of Small US Colleges Are Faltering”)[4]
The preceding discussion suggests that only small colleges are in danger. This is a false assumption because even some medium and large private institutions are rated as high risk. Moreover, with declining enrollment medium and large institutions can slide into the small college column and be subject to higher financial risk
Final comment: Time is of the essence; delaying action does not diminish the factors shaping financial risk for a specific private college or university.
References
-
Marcus, Jon (April 26, 2024); “Colleges are now closing at a pace of one a week”; (Retrieved April 30, 2024); The Hechinger Report; Colleges are now closing at a pace of one a week. What happens to the students? – The Hechinger Report. ↑
-
Querolo, Nic (December 13, 2023); “The Economics of Small US Colleges Are Faltering; (Retrieved April 30, 2024); Bloomberg; US Small Colleges Battered by High Costs, Enrollment Declines (bloomberg.com). ↑
-
Querolo, Nic (December 13, 2023); “The Economics of Small US Colleges Are Faltering; (Retrieved April 30, 2024); Bloomberg; US Small Colleges Battered by High Costs, Enrollment Declines (bloomberg.com) ↑
-
Querolo, Nic (December 13, 2023); “The Economics of Small US Colleges Are Faltering; (Retrieved April 30, 2024); Bloomberg; US Small Colleges Battered by High Costs, Enrollment Declines (bloomberg.com). ↑
by Michael K. Townsley | Sep 7, 2024 | Financial Metrics, Measuring Financial Condition
Economic equilibrium for a college or university is a state of long-term financial sustainability. Richard Cyert, late President of Carnegie Mellon University and a noted economist, originally developed the concept. This paper treats Economic/Financial Equilibrium as analogous to. Economic Equilibrium.
Economic/Financial Equilibrium Model
- Premises- Equilibrium:
- Is subject to the mission of the institution
- Should support the mission of the institution.
- Requires dynamic and positive states of positive financial change (net income and net cash must increase) in the short and long-term
- Financial changes must be large enough to offset inflation and to provide sufficient financial reserves when there are unexpected changes in markets, technology, and governmental regulations.
- Equilibrium Conditions1:
- There is sufficient quality and quantity of resources to fulfill the mission of an institution.
- Equilibrium maintains
- The purchasing power of its financial assets.
- Its facilities in satisfactory condition.
- Disequilibrium is a financial state when there are insufficient financial resources to maintain financial assets and to keep facilities in satisfactory condition.
- Difference between equilibrium and disequilibrium is the ‘equilibrium gap’.
- Reaching a state of financial equilibrium requires identifying and eliminating the causes of disequilibrium.
Disequilibrium usually does not occur overnight and most likely is due to long-term conditions that lead to the erosion of cash reserves, short-term loans, endowment principal, and plant value. When the financial condition of a college or university has so eroded that its cash and financial reserves have been seriously depleted, designing a strategic plan to achieve equilibrium is difficult.
Easy decisions, such as raising tuition or cutting expenses across the board, can be counterproductive if it pushes the college outside its competitive boundaries (that is, the set of colleges that compete to enroll the same students). As Richard Cyert noted,
“The trick of managing the contracting organization is to break the vicious circle which tends to lead to disintegration of the organization. Management must develop counter forces which will allow the organization to maintain viability.”2
In sum, boards of trustees must expect presidents and chief financial officers to clearly show that the college is currently in economic-financial equilibrium and will remain in equilibrium in the future. In addition, the board has a fiduciary responsibility to provide the president with the authority, subject to legal constraints, to take strategic and operational action to achieve economic/financial equilibrium.
Template for Estimating the Disequilibrium Gap
The preceding template provides a means to identify the scale of disequilibrium. In addition, it allows the analysis to extend beyond the current year when contracts and other constraints impose costs leading to continuing disequilibrium in the future.
Common Strategies for Eliminating an Equilibrium Gap
- Enrollment, Recruitment, and Retention
- Enrollment, recruitment, and retention strategies requires analysis of current academic programs and the characteristics and goals of the prospective student market.
- Tuition discounts, since discount strategies have increased beyond their net cash value, any further increases in discounts must be carefully evaluated and carefully targeted as a competitive strategy.
- Marketing campaigns must precisely target prospective students with all forms of media and aggressively recruit students considering enrollment with a competitor.
- Retaining students is an imperative given the cost of replacing an attrited student. .
- Enrollment strategies should be guided this basic financial goal: net student revenue (net tuition plus net auxiliary revenue) must increase net cash.
- Gifts
Gift agreements should be written to reduce loan liabilities. At many private colleges, debt service makes-up a large portion of the Cyert Gap. Furthermore, the gift/advancement department should meet with prior donors and request permission to use their endowed gifts to reduce the pay down loans. Prior donors could be offered the bargain that the college would establish a scholarship in perpetuity in lieu of using the funds to pay down current loans.
If the size of the disequilibrium gap is so large that neither increases in enrollment nor cutting expenses will eliminate the gap, then the college should appeal to the state’s attorney general to allow a loan against the endowment.
Investment committees have conflicting preferences because they are expected to maximize endowment returns over the long term. A long-term investment strategy is valid if the gap is not massive. However, if cash deficits are so large that the
college faces the distinct possibility of closure; the investment committee must change its investment priorities to generate short-term cash flows.
Too many colleges and universities ignore deficits produced by auxiliary operations. At a minimum, auxiliaries should cover their direct expenses plus related capital expenses. If the auxiliary cannot achieve this elementary financial goal, then the institution should outsource money losing auxiliary operations.
Cutting costs is essential for institutions at disequilibrium. Usually, a college will find that new revenue is insufficient to close an equilibrium gap. Under those circumstances, the college must evaluate every expenditure, be it, chief administrative positions, academic programs, student services, or third-party contracts. In some instances, the president may need to take over a chief administrative role, such as the provosts or chief academic officer roles, until the gap is eliminated.
Too often, presidents and chief administrative officers waste their scarce time and the colleges scarce resources tinkering around the edges of the operations. If the college is heavily loaded with debt, a first priority should be to refinance the debt to reduce debt service expenses and to reduce collateralization that, in some cases, restricts the sale of college assets.
Summary
Economic/Financial equilibrium requires constant and regular monitoring of key activities by the board of trustees and the president. Equilibrium plans may require soul searching to determine if how the college can best serve the mission of the college and retain its financial viability.3
Final Points
- Economic Equilibrium is reached when an institution can fulfill its mission with adequate quantity and quality so that it retains its purchasing power while maintaining the conditions of its facilities and equipment so serve its students.
- The primary financial goal for tuition-driven private colleges should be to achieve a dynamic state of economic equilibrium that looks beyond the current year.
Economic/Financial equilibrium strategies must be continuously monitored and revised to accommodate changes in: the mission of the institution, student markets, academic programs, financial assumptions, and major changes in the economy or in financial markets.
References
1 Ruger, A., J. Canary, and S. Land.; (2006); “The President’s Role in Financial
Management” in A Handbook for Seminary Presidents; edited by G. Lewis and L.; William B. Erdman Publishing Company; Grand Rapids, Michigan.
2 Cyert, R. (July, August 1978); The Management of Universities of Constant or Decreasing Size; Public Administration Review; p. 345.
3 Townsley, M. (2002); The Small College Guide to Financial Health. Washington, DC: NACUBO; p. 180
by Michael K. Townsley | Sep 5, 2024 | Financial Strategy and Operations, Private Colleges & Universities in Crisis
Introduction
For the past decade, our colleagues and columnists have remorsefully muttered about friends in terminally ill colleges. Now, we know “for whom the bell tolls.” As more old colleges are thrown on the death cart, other small colleges only wait and wonder if their college is next to be chucked on the heap of history.
This paper introduces a Vulnerability Gauge to predict if a private college or university is or is not at risk of financial failure. A logit regression tested the model with several different combinations of variables. The model was applied to a random sample of forty-four private colleges and universities drawn from the Integrated Postsecondary Education Data System (IPEDS). database. The tests found the most robust and parsimonious model had an 86.3% prediction rate of financial risk when these two factors were used:
- Annual percentage change in unrestricted net assets over five-years (for most private colleges, these assets represent the ready financial reserves that cover operational expenses);
- The total change in FTE (full-time enrollment) over five-years.
The logit regression yielded the probability of financial failure for each school in the sample. The probabilities were then arrayed into four risk bands: low, moderate, greater, and high risk of financial failure as shown in Table 1. The risk bands indicate that the lower the probability, the lower the risk of closing and the higher the probability, the greater the risk of closing.
Table 1
Risk Bands of Probabilities for Study Sample
Findings from Large Sample Analysis of Unrestricted Net Assets and Enrollment
After the random sample was tested, the model was then employed to test the vulnerability of 949 private colleges that were open in 2016. This sample excluded medical schools, research institutes, arts programs, seminaries, and other specialty colleges. The analysis covered the period 2016-17 to 2021-22, which was the most recent year in which IPEDS higher education data was available.
Chart 2
Colleges Assigned to Two Classes of Risk and Enrollment for 2021 and 2022
Here are several observations from Charts 2:
- In 2021, 255 private colleges with less than or equal to 2,000 students were rated at greater to high risk, but only 37 colleges with more than 2,000 students were rated with the same risk. In other words, institutional size seems to be a major factor in determining risk. In 2021, the risk rating for small colleges was 6.9 times greater than for larger colleges.
- In 2022, 201 more smaller colleges than larger rated as greater to high risk, 54 fewer colleges than in 2021. Yet, the greater to high-risk rating for smaller colleges was 8.0 times larger than larger colleges.
- In 2022, the enrollment group with more than 2,000 students saw seventy-three more colleges rated as low to moderate risk, in comparison to 2021, but this group had twelve fewer colleges rated as higher to greater risk.
Conditions Unique to Higher Education that Degrade Response to Risk
Before any remedy can be prescribed, we need to understand why so many private colleges are slow to respond to economic and financial threats to their existence. The list at the start of this paper identified several factors that shape financial stress, but there are further internal and operational issues that also shape the financial vulnerability at small private colleges. See the following list of issues that may foster financial stress.
- Contradictions of dual governance, where major academic financial problems, and their solutions may be stymied by conflict between how faculty and administration govern their respective areas.
- Faculty tenure that places costs, sometimes substantial, for the dismissal of faculty due to a major reorganization and the termination of academic majors or programs.
- Explicit and implied contracts with students, faculty, and external parties in student handbooks that set out the liability to students when programs, athletic programs, student services, or dormitories are ended or downsized, faculty handbooks that specify work conditions, alumni traditions that carry costs, or unstated relationships with local governments that have inherent costs.
- Accreditation and governmental regulations that may stipulate financial conditions to sustain operations and standards for academic programs and student services that can a) raise the cost of operations and b) make it difficult to change academic programs. Governmental regulations can also stipulate financial conditions and standards for maintaining eligibility for federal funds or for compliance with federal mandates.
- State Non-Compete Regulations can keep a college from offering a new program if another institution already offers it.
- Human Capital, buildings and equipment may not match what a college needs during a strategic reorganization to serve its student market better while reducing costs.
Besides the preceding organizational failures, leadership failures by the president and board of trustees to reshape a private college’s capacity to rapidly respond to financial crisis and reducing financial vulnerability
Potential Remedies for Reducing Financial Risk
Responding to the highest level of financial risk requires information that delineates the financial, operational, and market conditions of the institution. Before diving into strategic and operational turnaround strategy, the president and board need to acknowledge whether or not operational deficits have become a recurring and increasing threat. In the next step, both the board and president need to know the level of financial reserves currently available, whether those reserves are expanding or shrinking, and how long those reserves will last, if there are operational deficits. Also, there is no surer sign of performance inefficiency than a major with three or more full-time faculty instructing four students in a major.
It is imperative for Boards to recognize the need to support Presidents who lead with fortitude, intelligence, and foresight, otherwise it will be difficult for the institution to withstand conflict generated by internal and external dissension in response to major strategic changes. Conflicting solutions and dissension could become a regular event. Nonetheless, every day lost, before taking steps to overcome the inertia toward failure, will push the college closer to its demise.
The factors that make up the Vulnerability Gauge can guide the development of an effective strategy to generate larger and positive net incomes that increase unrestricted net assets. Focusing on factors in the Vulnerability Gauge will lead to optimizing markets, generating higher cash flows from tuition, cutting administrative expenses, improving the financial and operational relationship between faculty and students, imposing controls on the operational efficiency of capital investments in grounds, buildings, and equipment, and moving revenue generating centers toward positive contributions to the bottom line.
For colleges that have arrived at the brink of survival, there seem to be three strategic options that colleges at the brink of extinction consider:
- Merger
- Forming a partnership;
- Looking for wealthy alumni or local donors.
To access the Vulnerability Gauge, Go To: Education Consulting & Strategic Planning for Colleges & Schools – Stevens Strategy
by Michael K. Townsley | May 26, 2024 | Financial Strategy and Operations, Private Colleges & Universities in Crisis
Michael Townsley, Ph.D. Senior Associate Stevens Strategy
Private colleges and universities are encountering unprecedented levels of financial stress that may even exceed the financial problems caused by the Great Depression in the 1930s. According to the Hechinger Report article in April 2024, “colleges are closing at a pace of one a week. [1] Sustainability for many colleges means whether they can survive the immediate financial stresses. “Fitch ratings estimated that 20-25 schools will close annually going forward.”[2] The curve in Chart I shows the exponential acceleration of closings by private colleges in the first four months of 2024. If this pace continues through this year, there is a possibility that sixty private colleges could close.
Chart 1
PRIVATE COLLEGES and UNIVERSITIES CLOSED
(Trend Line a Second Order Polynomial Line)
Colleges in two enrollment group in Chart 2 reported outflows of funds from unrestricted assets between 2018 and 2021. The middle FTE group of colleges with enrollments between 1,000 and 2,000 FTE students had the largest number of average unrestricted asset outflows (2018, 2019, and 2021) over the five years of the chart. These colleges in 2020, also, had the largest average inflow of pandemic funds. Nevertheless, as noted these colleges returned to negative outflows in 2021. It is interesting that private colleges in the smallest enrollment group (less than 1,000 FTE students) only dipped into unrestricted assets in 2019. On the other hand, only colleges in the largest enrollment group (greater than 2,000 FTE students) did not have fund outflows from unrestricted net assets. As Bloomberg reported in 2023, “…government aid during the pandemic helped as a Band-Aid on the long-simmering issue of dwindling enrollments, the expiration of relief [in (2024] is likely to expose …reckoning [for] dozens of colleges.” [3] Sad to say, the chickens appear to be coming home to roost.
Percentage Change
Chart 2
In order to answer why colleges are closing and exhibiting greater financial instability, this study used a Vulnerability Gauge© to predict risk, which was defined as the probability that a private college or university will or will not fail in the near future. A series of logit tests of the Vulnerability Gauge found that the most robust and parsimonious model had an 86.3% prediction rate of financial risk when these two factors were used:
- Annual percentage change in Unrestricted Net Assets over five-years (for most private colleges, these assets represent the ready financial reserves that cover operational expenses);
- The total change in FTE (full-time enrollment) over five-years.
The probabilities for each member of the sample were then arrayed into four risk bands: low, moderate, greater, and high risk of financial failure as shown in Table 2. The risk bands indicate that the lower the probability, the lower the risk of closing and the higher the probability, the greater the risk of closing. The last two rows of Table 2 include the number and proportion of colleges in each risk band. The largest percentage were concentrated in the fewest number of colleges are in the high-risk band. Time will tell if the institutions in the greater risk band move to the high-risk band.
Table 2
Chart 3 assigns colleges in the sample to three FTE groupings, FTE < 1,000; FTE >= 1,000 and
<= 2,000, and FTE > 2,000. The three graph lines show several interesting dynamics. Since 2016, the number of institutions with lest than 1,000 FTE have increased from 311 to 352, i.e., forty-one colleges. While both sets of colleges with enrollments between 1,000 to 2,000 FTEs and more than 2,000 FTE declined by forty-two colleges. This would appear to indicate that enrollment is having an unwelcome impact on those colleges that lost enrollment and move from
large or middle-sized colleges to smaller schools. Of course, lost enrollment more than likely leads to lots tuition revenue which begins to undermine Unrestricted Net Assets. The effect of lost enrollment will become more apparent as we delve into tuition discounts and unrestricted Net Assets.
Chart 3
Table 3 and Chart 4 pull together the data from the Vulnerability Gauge variables. The table gives the counts by FTE groups and risk bands. This table indicates that
- Low risk institutions are concentrated in the FTE group with enrollments greater than 2,000 students. (132 colleges)
- Moderate risk institutions are closely spread across the three enrollments groups. (respectively from smallest to largest enrollment group: 131, 141, and 129 colleges)
- The FTE enrollment group with less than 1,000 has the largest number of colleges rated as greater risk. (respectively: (127 colleges)
- The less than 2,000 enrollments also have the largest number of institutions (41 colleges) rated as high risk.
Table 3
Chart 4 displays the percentage distributions for the four risk bands and risk bands. This chart clearly indicates that although the middle enrollment group has fewer colleges than the low enrollment group rated as greater risk, the percentage of the middle group is more than twice the number in the FTE group with more than 2,000 students. The near-term question is whether or not institutions rated as greater risk of failure will move into the high or moderate risk band.
Given these continuing declines in the: pool of prospective students, re-valuation of many degree majors by prospective students, coupled with the falling return-on-investment in a degree for graduates, it would not be surprising that risks will remain high and probably drive more colleges into the high-risk band.
Chart 4
Unresolved Issues
- Is the collapse of the value of Net Unrestricted Net Assets a quirk or a harbinger of more bad news for private colleges?
- Will those colleges rated as greater risk move to the high-risk category as enrollments and other factors diminish the pool of potential students?
- Will the fifty-one institutions rated as high risk in all three FTE enrollment groups move to extinction in the near-future?
- How much time do the institutions rated as high- risk have to devise a strategy and implement an operational plan to avoid closure?
- How much time do the institutions rated as greater risk have to avoid dropping into the high-risk category?
Final Comments
Higher education, in general, and private colleges and universities, in particular, as an industry faces a woeful future as slackening demand, rising costs, and excess supply of seats grinds down their financial stability. In most cases, catastrophic conditions did not suddenly appear. They have been present, more than likely, since student market demographics began their downhill slide at the start of this century. (See the Bloomberg essay, “The Economics of Small US Colleges Are Faltering”) [4]
The preceding discussion suggests the assumption that small colleges are the only institutions in danger is a false assumption. This finding of this study suggests that larger colleges can slide into the small college column. Also, the size assumption ignores that the second Vulnerability Gauge variable – Unrestricted Net Assets – that provides the pool of financial reserves to fund on-going operations of a college or university.
Two equations explicate the problem of financial stability for many private colleges and universities:
-
- Financial Stability Dynamic: shrinking student pool, rising costs, waning net unrestricted assets and small endowments
- Risk of Failure – Vulnerability Gauge Model: changes in net unrestricted assets and full- time-equivalent enrollments can increase or decrease the risk of failure.
Final comment: Time is of the essence; delaying action does not diminish the factors shaping financial risk of a college or university.
References
1 Marcus, Jon (April 26, 2024); “Colleges are now closing at a pace of one a week”; (Retrieved April 30, 2024); The Hechinger Report; Colleges are now closing at a pace of one a week. What happens to the students? – The Hechinger Report.
2 Querolo, Nic (December 13, 2023); “The Economics of Small US Colleges Are Faltering; (Retrieved April 30, 2024); Bloomberg; US Small Colleges Battered by High Costs, Enrollment Declines (bloomberg.com).
3 Querolo, Nic (December 13, 2023); “The Economics of Small US Colleges Are Faltering; (Retrieved April 30, 2024); Bloomberg; US Small Colleges Battered by High Costs, Enrollment Declines (bloomberg.com)
4 Querolo, Nic (December 13, 2023); “The Economics of Small US Colleges Are Faltering; (Retrieved April 30, 2024); Bloomberg; US Small Colleges Battered by High Costs, Enrollment Declines (bloomberg.com).