Balance Sheet

Debt

HBS uses debt strategically as a means of optimizing its capital structure. The School borrows only on qualified capital projects, carefully considering the interest-rate environment and expectations for the performance of the Harvard endowment. The School's policy is to borrow when market conditions make accepting the incremental debt service obligation preferable to using endowment principal and appreciation.

In fiscal 2006, HBS decided to increase borrowings on a multiyear basis to finance scheduled residence hall renovations and other major capital projects. This reflected the favorable interest-rate environment at the time, as well as anticipated returns from the School's endowment. New borrowings increased to $38 million in fiscal 2006, and building debt rose to $108 million.

Reflecting the modest level of capital investment this past year,new borrowings declined to $7 million in fiscal 2007, and debt principal payments rose from $4 million for the prior year to $7 million.Building debt for fiscal 2007 remained level at $108 million.

Since fiscal 2006, the School's balance sheet has included other University debt, which primarily reflects repayment obligations to the University for mortgage loans made by the School as a faculty recruiting incentive. In prior years, these obligations were netted against receivables, loans, and other assets. Other University debt increased by $1 million in fiscal 2007 to $26 million.

The University functions as a banker for HBS, as well as the other Harvard schools, allowing HBS to borrow on a triple-A-rated tax-exempt basis. The School's balance sheet remains modestly leveraged. Total debt has averaged only 3.5 percent of total assets for the past five years. The interest portion of the School's debt service amounted to 1.9 percent of total operating expenses in fiscal 2007, compared with 1.2 percent in fiscal 2006. At June 30, 2007, the School's building debt-to-asset ratio was 3.1 percent.

Liquid assets, consisting of cash and reserves, decreased to $81 million at June 30, 2007, from $85 million a year earlier. For the five-year period ending in fiscal 2005, the School's liquid assets were confined to a range of $70 million to $78 million, covering current liabilities an average of 1.3 times for the period. The increase in fiscal 2006 reflected stronger cash from operations, lower capital expenses, and the higher level of new borrowings determined as part of the School's long-term financial plan.

The $4 million decrease in liquid assets in fiscal 2007 was due to investments in HBSP. The ratio of liquid assets to current liabilities was 0.9 for fiscal 2007. As in prior years, however, the majority of the School's operating expenses were paid, as incurred, out of current cash flow.

Endowment

The market value of the HBS endowment and current use funds grew to $2.8 billion, or approximately 8 percent of total University endowment assets, as of June 30, 2007, from $2.3 billion at the end of fiscal 2006. The total return on the endowment was +23 percent, net of all expenses and fees, following a +16.7 percent return in fiscal 2006.

Harvard Management Company, a wholly owned subsidiary of the University, continues to outperform the market. As measured by the Trust Universe Comparison Service (TUCS), a universe of institutional funds with assets greater than $1 billion, the performance of the University's endowment has exceeded its benchmark and the median return of other large institutional funds in each of the past five years, placing Harvard in the top 5 percent of all institutional funds.

Unrestricted Reserves

HBS relies on unrestricted reserves as a resource for responding to unforeseen opportunities and—as part of the mix with gifts, internally generated cash, and debt—to finance capital projects. With the decline in capital projects, in fiscal 2006 the School's year-end reserves balance grew by $8 million to $60 million.

In fiscal 2007, HBS transferred $25 million of current use reserves to the unrestricted endowment reserve established several years ago in order to capture higher investment returns. Reflecting these additional funds and the performance of the endowment, the market value of this reserve grew to $94.4 million at June 30, 2007, from $55.7 million a year earlier.

Looking ahead to fiscal 2008 and future years, HBS remains confident that its reserves are sufficient to provide funding for future capital projects and to leverage emerging opportunities to deliver on the School's mission of educating leaders.