The pressures facing colleges in recent years were already bad. Now higher education faces the Covid-19 crisis, which could be an extinction event for a broad swath of institutions with small endowments, diminishing cash and few other liquid assets, uneven student demand, and stiff competition. Administrators and boards of trustees at small colleges across the country are taking a look at their empty campuses and mounting expenses, and wondering what the future might bring for their institutions.
In our experience — as a reporter covering college finance, and a former finance officer and financial adviser to colleges — we have witnessed small colleges struggle, flounder in distress, and close. And we are surprised at the extent to which the warning signs elude some college leaders and campus communities. In The College Stress Test, Robert Zemsky and his co-authors write of the blissful optimism that college administrators project — until the financial realities settle in, and closing becomes inevitable.
Clearly, many people have a picture of the kind of institution that might be in trouble right now: small, underendowed, rurally situated colleges with substantial tuition discounting and a high reliance on international students. What follows is a series of additional financial warning signs — characteristics, actions, or moments that can be easy to overlook but should prompt a college’s leaders to sit up and take notice.
Your institution has never assessed the costs of its operation. Colleges that have not done a cost analysis could have a hard time knowing costs in this high-pressure moment — but it’s essential. For many colleges, the costs of programs and departments — and the return on investment in those activities — is a mystery, an “elephant in the room” during meetings with board members, who are often too polite to ask for those hard numbers. A college’s finances, with a wide array of revenue sources and expenses, are complicated, and many finance officers — particularly at small institutions — have never had the time, resources, and staff to conduct an analysis. An inaccurate assessment of costs and liquid assets could lead a college to cut programs on the perception of demand and revenue, rather than the reality. Administrators might move to cut small programs, on the perception that they lose money, for example. “Almost all money-losing programs are small,” says Robert Atkins of Gray Associates, a firm that performs market reviews of academic programs. “What is not true is that all small programs lose money. In fact, in the analytics we’ve done, most small programs actually make money.”
Your institution relies on a range of third-party contracts. Most colleges have significant long-term costs that go beyond academic programs, with many embedded in the physical plant. Deferred maintenance, a long-term physical-plant problem for many institutions, is hardly the most immediate concern. Rather, it’s the contracts with companies that own or operate a college’s buildings or services, in deals called public-private partnerships, or P3s: Because colleges felt pressure to grow over the past two decades, an increasing number of them struck long-term deals with third-party organizations that provide housing, food, energy, and other essentials to running a modern campus. In many of those deals, the company is guaranteed a base payment over a decade or more, calculated on the projected use of that service. In P3 deals involving residence halls, for example, the private partner’s payment frequently relies on a minimum number of beds being filled; colleges can be contractually bound to make up the difference when fewer students enroll.
Administrators aren’t sure when the institution will hit its inflection point. Colleges will reach the inflection point of the Covid-19 crisis when they can’t cover costs and expenses with their liquid assets, the first liquid asset being cash. Most colleges typically rely on two major infusions of cash, which come from tuition-and-fees payments in the fall and spring, to get through the year. But those sources of income now face a series of challenges: With widespread layoffs and furloughs, students and their families might not be able to come up with the money to return in the fall, and a re-emergence of the virus might force institutions to cancel the fall semester anyway. In addition to these pressures, colleges might have to refund some of the student fees from the spring semester, particularly for room and board. (Revenue from summer programs, courses, and camps for children also provide some cash for institutions, but the prospect of convening those programs now seems problematic.)
Your college depends heavily on a line of credit in the summer. Colleges that don’t have enough cash to get to the start of the next tuition payment may try to borrow. Borrowing at the end of a fiscal year has been the pattern for many colleges for decades now. The fall and spring infusions of cash traditionally helped colleges get through the year, but an increasing number of colleges now need a line of credit — starting in the summer — to meet payroll and other obligations before the next infusion in the fall. The lines of credit can become a double-edged sword if the college is unable to pay it back when fall semester tuition fails to materialize. Because of the financial pressure on higher ed in recent years, colleges have been borrowing that money earlier and earlier in the summer. A big question at the moment is whether banks will loan money to institutions — and at what rate? Institutions that haven’t built a relationship with a lender might have a difficult time getting money. Those colleges that already carry other forms of debt could be in trouble: Debt covenants have a series of financial benchmarks that colleges must meet, or bond holders could ask for their money back; colleges might have trouble meeting those benchmarks in the current environment.
Your college is considering liquidating parts of its endowment. This desperate measure would require the approval of the board. Depending on how the endowment is structured, this can raise yet more troubles. A college will need to determine what portions of the endowment are restricted or unrestricted. The restricted portions of an endowment have been legally designated to pay for specific needs or activities on a college campus, and administrators can’t use that money to cover other things without the permission of the donor or a judge. But liquidating any portion of the endowment carries significant risks for an institution. The restricted endowment is already earmarked for those obligations on campus, and those don’t go away once the college starts raiding the endowment. If anything, the college budget comes under more pressure: With portions of the endowment liquidated and spent to help keep the institution afloat — and with the endowment losing value in the crashing stock market — the now-smaller endowment produces a smaller return, and colleges will need to either generate money to cover the activities once supported by that return or cut those activities altogether. If improperly managed, liquidating the endowment can lead to a downward spiral.
No single characteristic or action above indicates that an institution is doomed. But the warning signs should prompt the campus community to act proactively. They might consider some of the actions below:
Aggressively examine and cut costs. Leadership will need to make some short-term decisions based on data, the costs and revenues of programs being the most important. Colleges can look at enrollments and graduation rates by major and program, with an eye toward reducing or eliminating instructional and overhead costs in various programs. Pressured colleges will likely have to consider furloughs and layoffs (already beginning at some institutions), hiring freezes, early retirements, a halt to new construction, mothballing of existing buildings, cutting athletic programs (which is tricky, as those programs can attract students), or the draconian steps of reducing contributions to retirement or other benefits, or of eliminating student advising and passing that responsibility to faculty.
Negotiate with private partners on deals involving residence halls, dining halls, and other assets. Jill Jamieson, a managing director who specializes in public-private partnerships at JLL, a real-estate company, advises institutions to study their contracts closely. Force majeure clauses may protect institutions in some cases. In others, the private company or developer may have assumed the risks in demand for the residence hall or other project or service. For now, colleges and P3 partners do not seem to be in conflict, she says, but tensions around the deals could rise if lockdowns extend into 2021. Best to start a conversation now with the P3 partners about how to handle the next year if students don’t come back in the fall. A P3 partner has its own revenue pressures, Jamieson says, but its long-term interest is to see its college clients survive.
Communicate with external stakeholders, taking a page from an automotive giant. Colleges play an important role in the economy of their immediate communities and their states. For many small, rural towns, a college is the key anchor institution that supports restaurants, hotels, retail, housing markets, and public services. Colleges should remind public officials of this. Public colleges are justly concerned about the future of their appropriations, and seek to defend them as much as they can. Private colleges, meanwhile, should renew their efforts to lobby public officials for increased funding during this period. In 1979, as Chrysler faced bankruptcy, Lee Iacocca, then the chairman, met with members of the U.S. Congress to tell them how supporting Chrysler would support jobs and the economy. He was able to procure low-cost loans to support Chrysler’s realignment.
Communicate with and activate the internal stakeholders: the faculty, students, and alumni. When a college is in crisis, too often the administration leaves faculty members and alumni in the dark until it’s too late. But a college’s professoriate and former students have the most significant long-term relationship with an institution, and they can help administrators and the board respond to the crisis. Faculty members can work with their deans and other administrators to try to get a clear picture of how money flows through the institution, what programs are producing income, how underenrolled programs important to the mission could be reinvigorated, and how other programs could be closed. Alumni can activate fundraising, help persuade prospective students to attend the institution, and offer advice, mentoring, and connections to employment networks, further boosting the value of the institution for prospective students.
Come up with a Plan C. Most colleges are working on a new budget plan for the 2021 fiscal year — a “Plan B,” if you will. But in the absence of data on true costs, and with a general reluctance to face realities among college leadership and boards, that Plan B will probably be more of an optimistic projection than a realistic one. Instead, college leaders — with input from the stakeholders listed above — should form a Plan C that takes a hard look at the future, closely examining revenue streams coupled with a projection of expected cash. Can a school successfully operate — meeting payroll, benefits, and other costs — with Plans B or C? If survival looks unlikely under those plans, a college should consider a graceful closure.
As a last resort, use the endowment as a bargaining chip, not to stave off the inevitable. Before an institution begins to liquidate the endowment, its trustees should consider whether the name or the mission of the institution would be carried forward in a more secure way if the endowment were used to support that name and mission in a merger with a stronger institution. Many weak colleges wait too long to seek partners for a merger, and years of struggling to stay afloat depletes the resources that an institution could use to bargain to preserve its heritage, and its most distinctive programs, faculty, and research. Before Covid-19, a university with secure finances and student demand might be reluctant to merge with a financially weak institution; in the current downturn, such a merger would be even more difficult to pull off. Instead of chipping away at the endowment, a college that had weak demand and deficits before the virus should consider offering that endowment as a dowry.
