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The recession spotlighted the need for more-rigorous reserving.
David M. Katz, CFO.com | US
June 24, 2010
In the early part of the economic downturn, liquidity became a watchword among corporations and their banks. Companies issuing "good-as-cash" investments such as auction-rate securities suddenly couldn't get to their funds. Debt covenants based on corporate liquidity suddenly looked wobbly. Cash calls abounded.
Liquidity was no less important in the nonprofit sector, as many nonprofits found themselves starved for cash. With large amounts of money sunk in limited partnerships, hedge funds, and other alternative investments, universities, trade associations, hospitals, and others saw their endowments shrink and their loan covenants wobble through 2009.
The reserve funds backed by those endowments began diminishing sharply, meaning there was less money in reserve to operate the organizations. In response to the downturn, 87% of nonprofits cut expenses, 49% delayed capital projects, and 54% laid off people in 2009, according to a Grant Thornton survey of 465 CFOs, chief executives, and other nonprofit officials released early this year.
With memories of the liquidity crunch lingering, nonprofit finance executives have begun paying closer attention to the state of their reserves. "In a relatively stable market, everyone is typically focused on what the market value of your endowment portfolio is," says Tom Guinan, assistant controller of the University of Notre Dame, which has a $5.6 billion endowment. "Now we've become really focused on liquidity. If nothing else good comes out of [the recession], it's a wake-up call that if we are investing in a lot of alternative instruments, we need a higher level of insurance."
Gauging the reserve levels needed can be a tricky matter, though. Before the recession,
Sen. Charles Grassley (R-Iowa) and other members of Congress slammed universities for building up huge endowments even as they continued to hike tuitions. Donors have applied similar pressure on organizations aiming to promote a public good to use the funds for that purpose. "If I were donating money to a not-for-profit and saw them piling up assets, I'd be wondering why they weren't using it for programs to feed the poor or educate students," says Frank Kurre, a managing partner of Grant Thornton's not-for-profit practice.
The downturn, however, highlighted the need to plan for more backup funding. For example, the Dallas Theological Seminary, a graduate school with an endowment of $18 million and total assets of $104 million, suffered a loss of 18% on its net assets for the fiscal year ending June 30, 2009, according to CFO Dale Larson. Part of the problem was that the bleak investment picture left the institution with a $7 million unfunded liability in its defined-benefit pension plan. In the near term, the shortfall "didn't cause us a problem. But what it did show us was that we needed to increase our annual operating budget by $600,000 for pensions," says Larson. "And that really wasn't part of our long-term plan."
Unfortunately, there are no rigorously set, adequately detailed benchmarks to guide nonprofit managers in how much to put away for a rainy day, Kurre contends. True, rating agencies such as Standard & Poor's and Moody's rate the creditworthiness of nonprofits that issue public debt, and the Better Business Bureau, the American Philanthropy Association, and the Websites Charity Navigator and Guidestar offer varying levels of scrutiny.
Nevertheless, says Kurre, "you can have one watchdog agency looking at a financial statement and saying this not-for-profit has too much in reserves, and then you can have another one criticizing the same not-for-profit as having too little in reserves, because there's not a common measure being used."
Many organizations are guided by overly broad rules of thumb, notes Kurre, such as setting aside the equivalent of six months to two years of operating expenses as a reserve. Such measures don't distinguish between the sharply different needs of different kinds of nonprofits, he says. Trade associations, for example, don't require the high reserve levels that universities do. With most trade-association revenues coming from dues, members push associations to keep dues low rather than pile up reserves.
Universities, on the other hand, need hefty reserves to account for the uncertain costs of maintaining large physical plants. Trade associations and universities "are in very different businesses," says Kurre. "They have different kinds of risks, and they certainly should have different types of reserves."