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The School’s capital investments in the campus peaked at $79 million in fiscal 2005 with the construction and improvement of classroom space, the addition of new core facilities, and major residential space renovations. Since then, as these large projects reached and neared completion, the School has focused on protecting the long-term value of the physical plant through the renewal and maintenance of buildings, campus infrastructure, and IT systems. Capital spending has declined, as a result.
The exception was fiscal 2008, when capital expenses doubled year-over-year to $40 million, largely due to renovations of MBA residence space and classroom facilities for executive programs. The only large capital projects in fiscal 2009 were the completion of renovations and systems upgrades in two residence halls, which represented a combined $7 million in capital expense. Unlike prior years, there were no gifts specified for the capital projects that were under way this past year. As a result, net capital expenses for fiscal 2009 were $19 million.
In addition to gifts and internally generated cash, as well as unrestricted reserves, the School finances major capital projects with debt financed through the University, using leverage strategically as a means of optimizing its capital structure. HBS borrows only on qualified capital projects, carefully considering the interest rate environment, expectations for the performance of the Harvard endowment, and the availability of University debt.
New borrowings have generally declined since mid-decade in line with the lower capital spending and in fiscal 2009 roughly equaled debt principal payments, decreasing to $3 million from $22 million a year earlier. Debt principal payments decreased to $5 million, from $9 million in fiscal 2008, reflecting the winding down of scheduled gift pledge payments during the year.
Other non-reserve activity in fiscal 2009, primarily consisting of digital platform investments by HBP, was $7 million, compared with $33 million in fiscal 2008. Prior-year non-reserve activity was unusually high because it included the transfer of $25 million of current use reserves to the unrestricted endowment reserve established several years ago. Reflecting the negative investment returns on the University endowment in fiscal 2009, the market value of this reserve was $85 million at June 30, 2009, compared with $126 million a year earlier.
The School’s balance sheet remains modestly leveraged. The University functions as a banker for Harvard schools, allowing them to borrow on a triple-A-rated tax-exempt basis. In fiscal 2009, the School’s building debt decreased by $2 million to $119 million, as the $3 million of new borrowings were offset by $5 million of principal repayments. Other University debt—mainly consisting of repayment obligations to the University for mortgage loans made by the School as a faculty recruiting incentive—decreased by $3 million, to $26 million.
Total debt has averaged only 4.3 percent of total assets for the past five years. The interest portion of the School’s debt service amounted to 1.4 percent of total operating expenses in fiscal 2009, compared with 1.6 percent in fiscal 2008. At June 30, 2009, the School’s building debt as a percentage of net assets was 4.6.
As part of the mix with gifts, internally generated cash, and debt, HBS relies on unrestricted reserves to finance capital projects. The School also uses unrestricted reserves as a resource for capitalizing on unforeseen strategic opportunities. In fiscal 2009, the decrease in cash before capital activities was more than offset by declines in net capital expenses and net debt and other activity.
As a result, the School’s year-end reserves balance grew by $17 million to $96 million. Given the uncertain outlook for revenue from Executive Education, HBP, and the endowment, and potential constraints on the availability of debt financing through the University, maintaining a strong unrestricted reserves balance will continue to be one of the School’s most important financial goals.