The Ohio State University Board of Trustees
                                Fiscal Affairs Committee
Subject:              Annual Financial Report

Date:                 October 29, 2008

From:                 William Shkur...
• Debt remained within approved limits.
           • All regional campuses ended the year with positive balances, as did t...
As mentioned previously, the long term investment pool returned a negative 8.2% in FY 2008.
For the first quarter of FY 20...
not have most of our bonds tendered back to us, and all of our bonds have been successfully
remarketed. On September 30th,...
over the next six months to prepare for 2010 and beyond. The structure of this section is organized by
revenue source, exp...
look at affiliated entities to determine which ones need to become more self-supporting, down-sized or


       The University has set aside various reserves to address economic uncertainty (see Attachment
D). In July...
The longer term picture (FY 2010 and beyond) is much more uncertain, but the University
possesses the assets, the leadersh...
Attachment A
                                            Status of Financial Performance Goals

Attachment B

                           FY 08 Status of Development Efforts for Projects with a significant
Attachment C

                          Summary of Potential Impact of Economic Turbulence
Attachment D

                                        Status of Specialized Reserve Accounts
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08 Annual

  1. 1. The Ohio State University Board of Trustees Fiscal Affairs Committee Audit and Compliance Committee November 6, 2008 TOPIC: Annual and Quarterly Financial Report CONTEXT: At this time each year the Board receives a combined Year End and First Quarter Financial Report from the Chief Financial Officer. SUMMARY: Because of the unusual financial environment across the country, this report is presented in a modified format. Reports on year end and first quarter have been summarized and a new section on prospects for FY 2010 and beyond has been added. CONSIDERATIONS: • Are the results for FY 2008 and First Quarter 2009 clear and complete? • Are the issues identified for FY 2010 clear and complete? • How does what we are doing compare with our benchmarks? • Is there any additional information the Committees would like to have? • What happens next? REQUESTED OF FISCAL AFFAIRS and AUDIT AND COMPLIANCE COMMITTEES: For information and discussion only. No vote required.
  2. 2. Subject: Annual Financial Report Date: October 29, 2008 From: William Shkurti To: Gordon Gee The purpose of this report is to give you a sense of how we ended FY 2008 financially, to share with you the results from the First Quarter of FY 2009, and then to discuss emerging issues for the year ahead. This document has also discussed with the Integrated Financial Planning Group. The University's financial results for both FY 2008 and the first quarter of FY 2009 show stability in nearly every area. Consequently, except for the financial stress on the long term investment pool caused by the decline in the stock market, the fallout to the University from the worldwide economic turmoil has been minimal to this point. However, the longer the economic crisis continues, the greater the risk of collateral damage to the University's financial stability and its support of core academic functions. Therefore, this a particularly appropriate time to review potential financial risks to make sure they are managed strategically so the University can continue to advance its academic mission and take advantage of opportunities. This report is structured differently than past reports. Financial results for FY 2008 year end and the first quarter of FY 2009 are presented in summary form and a new section has been added identifying the risks posed by economic uncertainty, along with possible strategies to address them. Year End FY 2008 The University ended FY 2008 in a stable position. The status of each financial risk area is summarized below. • Health System exceeded its financial targets in all three measures (margin, cash on hand and debt coverage). • Enrollments on the Columbus Campus exceeded both the previous year totals and budget projections. • State support increased significantly. • Both externally funded research grants and private gifts increased. • The long term investment pool declined 8% because of the decline in the stock market. • The deficit in Student Financial Aid was reduced dramatically and should be eliminated entirely by FY 2010, two years ahead of schedule. Large deficits in the College of Math and Physical Sciences and the Heart and Lung program continue to be a concern, but are being addressed. • All major auxiliaries (Recreational Sports, Students Life and Athletics) met or exceeded budgets. 2 f:fin/files/annualfinancialreport2008
  3. 3. • Debt remained within approved limits. • All regional campuses ended the year with positive balances, as did the Hawk's Nest Golf Course. • Most affiliated entities are stable financially. However, UMC Partners/Prologue, Campus Partners and SciTech merit additional review. • Reserves are very close to target in General Funds and over target in restricted funds. • The SIS installation continues on time and on budget, with 12 months remaining. • All major capital projects in the construction phase (including the Library and the Ohio Union) are on time and on budget; however, carryover issues remain with the private fund raising portion of several legacy projects. • Most of the financial targets approved by the Board in June 2008 were met except for the SB6 score (see Attachment A) and the debt service coverage. Both of these declined primarily due to net investment losses. However, even though an SB6 score of 3.4 is below the target of 3.6, it is still well above the 1.8 minimum threshold established by the State of Ohio. The decline in the debt service coverage is more marked, but is based on the Moody's median, which means other universities are likely facing similar drops. All three credit rating agencies did reaffirm an AA2 rating or its equivalent for the University in September. A more complete report of year end financials can be found on the Resource Planning website. First Quarter FY 2009 The first quarter of FY 2009 (July 1 – September 30, 2008) got off to a good start in most areas. First quarter enrollment was up over last year and over projected headcounts, essentially because of higher numbers of returning students and transfer students at the undergraduate level. The Health System performed better than budgeted in the three financial target areas, although volume at the Ross Heart Hospital was below target. Most of the areas under the University's control continue to perform well, but there are several areas that merit additional discussion. These are state support, investments, student loans, fundraising for capital projects, general fund deficits, bond sales and cash management, and selected affiliated entities. State Support In September, Governor Strickland directed that most state appropriations be cut by 4.75% to deal with a growing projected budget deficit. Fortunately, the Governor protected the State Share of Instruction so that state universities, including Ohio State, could continue the second year of the resident undergraduate tuition freeze. However, other state line items were cut, including several that affected Ohio State, such as OARDC, Cooperative Extension, the Glenn Institute and various medical support line items. The total cost of those reductions to Ohio State campuses will be $6.1 million, almost half of which are related to agriculture. Since the fiscal year is not yet half over and the economy continues to decline, the possibility of additional cuts cannot be ruled out. Investments 3 f:fin/files/annualfinancialreport2008
  4. 4. As mentioned previously, the long term investment pool returned a negative 8.2% in FY 2008. For the first quarter of FY 2009, the loss is nearly 12%. October was the worst month for the stock market in recent memory. The University's new Chief Investment Officer, Jonathan Hook, arrived on campus August 1. He has already taken steps to diversify investments and improve returns, but it is important to remember that the focus for the long term pool is the long term and it will take some time for the changes Jon is making to be reflected in the fund's performance. Meanwhile, the Investments Office will seek to use this environment as an opportunity to make selective investments and strategically rebalance the portfolio. Student Loans The impact of the credit crisis on loans for Ohio State students has been muted because Ohio State has been a participant in the U.S. Department of Education's direct lending program, which has not been affected. However, due to previous federal policy changes regarding consolidations and slower repayments, there may be less money available under the Perkins Loan Program. Perkins loans account for less than 3% of OSU's loan volume. Stafford loans, which are not affected, make up the remainder. This issue is currently under review for corrective action. General Fund Deficits The stabilization of the General Fund Financial Aid accounts was a significant positive event. However, three other large deficits continue to be a concern: • The College of Math and Physical Sciences has an accumulated deficit of $23 million as of June 30. The new leadership team in the college has developed a plan to eliminate the deficit by 2014. That plan has been approved. • The Heart and Lung Institute had a year end deficit of $7 million. A deficit reduction plan is being prepared. • The College of Engineering ended FY 2008 with a deficit of $3.9 million in its central operations. A plan to eliminate that deficit is being prepared. Fundraising for Capital Projects Appendix B summarizes the status of legacy fundraising shortfalls. Unfortunately, little progress was made in FY 2008, except for the Thompson Library Renovation where a generous $9 million commitment from the Department of Athletics allowed that campaign to be successfully closed. Two large projects coming forward, the Medical Center Master Facilities Plan and the Chemical Engineering Expansion, have significant fundraising components. Consequently, we need to make sure the Board policy that requires 75% of the fundraising target be on hand in the form of cash or written pledges is met prior to proceeding to construction. Bond Sales and Cash Management The University has over $400 million in variable rate debt. This represents about 40% of the outstanding debt. Because of the University's strong credit rating and high liquidity, Ohio State did not suffer the same fate as many other tax-exempt entities. We did not pay rates as high as 10%, we did 4 f:fin/files/annualfinancialreport2008
  5. 5. not have most of our bonds tendered back to us, and all of our bonds have been successfully remarketed. On September 30th, the University issued $127.8 million in variable rate bonds. Due to market volatility, the bonds were issued in "term mode" with a maturity date of January 14, 2009 at a rate of 3.75%. It is our expectation that at maturity in January, the bonds will be reset in our typical "weekly reset mode". $81 million of the proceeds were used to retire the outstanding commercial paper program, with the remaining proceeds to be used to pay issuance costs and be available to pay Board approved bond projects. The fixed rate bond issue of $240 million was scheduled to be priced on October 14th. We have decided to postpone that issue indefinitely due to market volatility. Tax-exempt long term interest rates rose over 1.5 percent between the middle of September and the middle of October. We will wait until tax-exempt rates approach a more reasonable level before issuing. Prior to our bond issuance, all three rating agencies affirmed our AA/AA2 ratings with a stable outlook. The University had approximately $57 million of its $850 million short term portfolio invested with the Common Fund when the fund was frozen by its trustee, Wachovia Bank, at the end of September. These funds are now being liquidated. As of this date, about $17 million, or 30% of the investment has been returned. We expect to receive most of the remaining money over the next 12 months. Because our portfolio is diversified we do not expect an impact on our financial operations at this point. Affiliated Entities As mentioned previously, most of our affiliated entities are in good shape financially; however, some will require additional attention. • UMC Partners has been dissolved and the carryover deficit assigned to the Medical Center. Prologue, a self-sustaining, for profit clinical trials organization, has market value. Our hope is to continue to strengthen Prologue to make it an attractive candidate to eventually sell to an appropriate buyer. • Campus Partners has been successful programmatically, but has not met all of the University's expectations regarding its financial goals. Consequently, the business model is under review by the University in collaboration with Campus Partners' management and its Board. • SciTech has made all required payments to the university and equity remains positive; however, financial strength has eroded and the SciTech Board has taken this issue under review. FY 2010 and Beyond The University is reasonably well prepared to address the economic challenges remaining in FY 2009, assuming no additional major negative economic news. However, this does not mean we can afford to be complacent about FY 2010 and beyond. If the credit crisis is not resolved, we could face slowdowns in needed capital investments. Even if the credit crisis is resolved, we could face the consequences of a long worldwide recession. The University has survived prolonged downturns before – most recently 1980-1982, 1991-1993 and 2002-2003, but in all three cases the University was required to make major adjustments in management philosophy, organization and financing of University activities. Consequently, this portion of the memo is focused on what needs to be done 5 f:fin/files/annualfinancialreport2008
  6. 6. over the next six months to prepare for 2010 and beyond. The structure of this section is organized by revenue source, expense and compensating event as summarized in Attachment C. This is intended to be the starting point for a discussion rather than a final recommendation. Revenues The biggest challenge here is a precipitous decline in state support, similar to reductions in previous downturns. Fortunately, the University is less dependent on state support today than 10 or 20 years ago, but it is also more difficult to make up the loss of state revenue through tuition increases. Consequently, we need to work with state officials to make sure they understand the relationship between the two. In addition, if state support is declining, the state needs to provide more relief from burdensome and duplicative state regulations, such as restrictions on the use of construction delivery methods widely used in private industry. In past downturns, enrollments have gone up, presenting the opportunity to generate additional tuition revenue. However, we do not know how declining home prices and other pressures on family income will affect ability to pay. The University should be better positioned than many of its competitors because we are a direct lender, but it still may make sense for the University to target additional financial aid, similar to the emergency aid fund the University used successfully during the Asian financial crisis of the 1990's. An economic downturn is almost always preceded by a stock market collapse and that pattern has certainly held at this point. Fortunately, the University's long term investment fund is intended for the long term, but the short term consequences of reduced distributions on unit budgets and the President's Strategic Investment fund need to be addressed. It is also likely that a downturn will adversely affect revenues of the University's self- supporting auxiliaries. For example, receivables may go up for the Health System if patients lose insurance coverage, conference business may decline at the Blackwell and Athletics could see a flattening in corporate sponsorships. All of these units are currently healthy financially and have some reserves set aside, but the University and management will need to closely work together to make sure they remain financially strong. Expenses The uncertainty on the income side means the University will have to devote more effort to controlling expenses. One area we have already targeted is outdated facilities. Plans are underway to selectively demolish buildings that are no longer worth saving, such as Lord hall and Brown Hall. This will not only save money in utility and maintenance costs, but will open up opportunities for more efficient use of land and space. A second area of savings involves strategic purchasing, benefit costs and energy savings. We have an opportunity to build on successful efforts already begun, while seeking additional new opportunities. Difficult decisions lie ahead regarding capital projects. The University cannot afford to stop everything, nor can it afford to proceed with business as usual. The University also needs to take a 6 f:fin/files/annualfinancialreport2008
  7. 7. look at affiliated entities to determine which ones need to become more self-supporting, down-sized or eliminated. 7 f:fin/files/annualfinancialreport2008
  8. 8. Reserves The University has set aside various reserves to address economic uncertainty (see Attachment D). In July, the Board of Trustees approved holding back $10 million in continuing General Funds generated by higher than expected enrollments for this purpose. This income is the equivalent of a $250 million unrestricted endowment or 3% of our annual state share of instruction appropriation. While these funds will help address uncertainty for FY 2009, they are not likely to be sufficient to address a long term downturn. The University also has a $13.5 million rainy day fund and a $64 million debt service stabilization reserve, but both of these are one-time funds, so once they are expended, they are gone. Compensating Events The turmoil associated with a downturn may also provide some opportunities. A sagging economy will most likely exert downward pressure on prices, as well as create other opportunities. The University needs to be prepared to address these on a strategic basis, perhaps increasing investment in some areas, while decreasing investment in others. For example, the Office of Research is establishing an Industry Liaison Office to help diversity our research portfolio. As industry downsizes its internal research and development operations in response to economic pressures, this increases OSU's opportunities to form industry-university partnerships. Conclusions The short term impact of the current economic crisis on the University has been noticeable, but manageable. It is most evident in the following areas: • $6 million cut in state line item appropriations, particularly for agriculture. • Significant unrealized losses in the long term investment portfolio due to the precipitous decline in stock prices. • Placement of the variable rate portion of the CY 2008 bond issue at a slightly higher interest rate. • A temporary (hopefully) delay in the fixed rate portion of the bond issue planned for CY 2008. • A portion of the cash pool tied up in the Common Fund, which should hopefully be recovered in full over the nest several months. There are also assets available to the University that will help us manage these challenges over the short run, including: • Solid financial standing for the University overall, including higher than expected fall enrollments and stable finances in the Medical Center. • Governor's efforts to protect State Share of Instruction from budget reductions. • OSU's participation in the direct lending program. • Confirmation of the University's AA2 credit rating. • Appropriate management of reserves. 8 f:fin/files/annualfinancialreport2008
  9. 9. The longer term picture (FY 2010 and beyond) is much more uncertain, but the University possesses the assets, the leadership and the determination to continue to improve academically under a variety of circumstances. Clearly, the events of the last two months have created a series of serious challenges that are not yet fully understood. The University cannot afford to continue business as usual under these circumstances, nor can it afford to react hastily or hunker down in fear. We have substantial resources to apply. Our size and revenue diversity can be allies in circumstances such as these. My colleagues on the Integrated Financial Planning team have discussed this at length and have agreed to recommend that we make shaping the University's response to this crisis our first priority for the next 60 days, so that by the time the mid-year financial report is due in early February, we will be able to report on how the University can continue to move ahead in FY 2010 and beyond. If you would like any additional information or would like to discuss this further with the Integrated Financial Planning Group, please feel free to call on us. Attachments c: Joe Alutto Steve Gabbe Chip Souba 9 f:fin/files/annualfinancialreport2008
  10. 10. Attachment A Status of Financial Performance Goals The Ohio State University Financial Performance Goals Annual Scorecard Category Target Performance Performance In FY 2007 In FY 2008 Liquidity Primary Reserve Ratio At least 150 days of cash1 150 Days 145 days Rainy Day Fund At least 1% of General Fund 1.1% 1.1% Operating Margin General Fund2 At least 1% 4.6% 2.8% Debt Total Financial Resources to Direct Debt3 At least 1.0X 2.6X 2.6X Actual Debt Service to Operations3 No greater than 4.0% 2.2% 2.1% Debt Service Coverage3 At least 3.0X 6.3X 0.7X SB6 Ratio4 At least 3.6 4.2 3.4 Credit Rating3 At least AA2 AA2 AA2 Health System Operating EBIDA Margin5 10.0 – 12.5% 12.1% 12.1% Days of Cash on Hand Increase by 3-5 days annually +6.4 days +5.1 days Debt Service Coverage At least 4X 7.7X 7.3X Office of Business and Finance 10/22/08 1 In this case, cash means expendable net assets. This includes cash, liquid investments and current receivable minus current payable. 2 The operating margin in FY 2007 was unusually high. Some FY 2007 expenditures were carried over to FY 2008 resulting in a decrease in the operating margin more in line with the recent trend. 3 Moody's definitions. The decrease in debt service coverage is due to unrealized investment losses of the endowment. The endowment return went from 18% in FY 2007 to -8% in FY 2008. 4 State of Ohio definition 5 EBIDA means earnings before interest, depreciation and amortization. 10 f:fin/files/annualfinancialreport2008
  11. 11. Attachment B FY 08 Status of Development Efforts for Projects with a significant Development Funding Component Development Total Total Total Remaining Project Funds Required thru FY07 in FY08 thru FY08 Balance Comments (Millions) (Millions) (Millions) (Millions) (Millions) Biomedical Research $25.0 $7.6 $0.1 $7.7 $17.3 Note 1 Tower Jennings Hall $5.0 $4.0 $0.1 $4.1 $0.9 Renovation Knowlton School of $20.0 $18.4 $0.3 $18.7 $1.3 Architecture Mech. Engineering $22.0 $16.2 $0.4 $16.6 $5.4 Replacement Page Hall Renovation $5.0 $1.6 $0.05 $1.65 $3.35 Thompson $30.0 $23.8 $6.2 $30 $0 Note 2 Library Renovation Note 1 The funding of the remaining balance for this project is under review with the Medical Center and the Office of Development in conjunction with the development of the fund-raising plan for the Medical Center Master Facility Plan. Note 2 Total includes $19M in private gifts, $9M transfer from Athletics, and $2M from University funds. The information for this chart was received from University Development Office of Business and Finance 10/22/08 11 f:fin/files/annualfinancialreport2008
  12. 12. Attachment C Summary of Potential Impact of Economic Turbulence and Possible Response Area Additional Risk Countermeasure Revenue Health System Increased Accounts Receivable Circuit Breakers Enrollments Ability to Pay Targeted Financial Aid State Support Mid-Year State Budget Reductions FY 2008 Carryover/Rainy Day Fund Research Long-Term Funding Diversification Development Economic Pressure on Donors TBD Investments Loss of Value Diversification/Long-Term Horizon Expenses General Fund Operations State Support FY 2008 Carryover/Rainy Day Fund Auxiliaries Varies Varies Bond Sales/Debt Management Credit Market Uncertainty Debt Service Reserve Affiliated Entities Varies Varies Reserves Varies Varies Systems N/A N/A Compensating Events Reduced Inflationary Pressure • Energy • Construction • Wages • Interest Rates (possibly) Other • Stress on Competitors • Enrollment Tends to Increase • Federal Stimulus Package (?) 12 f:fin/files/annualfinancialreport2008
  13. 13. Attachment D Status of Specialized Reserve Accounts September 30, 2008 This table summarizes the status of various specialized reserve accounts. Amounts available are below targets in some cases due to the financial stress of the last several years. The goal is to bring all reserves up to target levels within the next 1-2 years. In the interim, the $13.5M Rainy Day Fund and other cash balances will serve as an additional back up, if needed. Sep 08 Target Account Amount Amount Target Description (in millions) (in millions) General Fund Reserves Enrollment $6.0 $7.4 1% of annual tuition and Reserve/College IDC’s Stabilization Utility Reserve 12.6 14.6 15% of annual expense Financial Aid Reserve 2.8. 3.9 5% of annual expense Legal Reserve 0.9 1.0 $1M Property and Liability 5.8 5.0 Size of deductible Insurance Reserve Rainy Day Fund 1% of University’s annual 13.5 11.9 general funds revenue General Fund Totals $40.6 $43.8 Restricted Reserves Malpractice Insurance 155.4 122.0 Actuarially determined Reserve One Month of total claims Health Benefits Reserve 45.5 28.3 and admin costs One year’s principal Debt Service Reserve 63.6 48.4 payment on all general receipt bonds Restricted Reserves Total $264.5 $198.7 Grand Total $305.1 $242.5 Office of Business and Finance 10/22/08 13 f:fin/files/annualfinancialreport2008