Underwater Endowments: How COVID-19 Could Affect Your Funding

It’s difficult enough for higher education to face the existing challenges of COVID-19. Now, losses on endowments in the tens of billions of dollars add another threat—potentially lower spending allocations from the funds so vital to university budgets.

On Feb. 12, 2020, the Dow Jones Industrial average closed at a record high of 29,551. This was up roughly 10% from July 1, 2019 (the beginning of most higher education institutions’ fiscal year). Fast forward less than two months, however, and markets have fallen at a historically fast rate. The prognosis for a solid year of investment earnings for college and university foundations has now vanished.

Foundations should be particularly aware of underwater endowments, especially if the fund was recently established. With recent market conditions, many endowment funds at will likely have a lower fair value at the financial statement reporting date than the original gift amount (or the amount required to be maintained by the donor or by law).

How does this affect financial reporting?

It depends upon whether your institution reports under Financial Accounting Standards Board (FASB) or Governmental Accounting Standards Board (GASB) framework.

Under FASB reporting, accounting for underwater endowments recently changed with the adoption of ASU 2016-14. Before this standard, FASB required underwater endowments to be reflected as a reduction of unrestricted net assets. This left the original amount of the endowment gift as permanently restricted net assets.

Under ASU 2016-04, the classification of net assets drops from three categories to two: with donor restrictions or without donor restrictions. Under this new classification method, underwater endowments now are reflected in the “with donor restrictions” category. Organizations are required to disclose the following with respect to underwater endowments:

• Policies related to appropriations from underwater endowments
• The organization’s ability to spend from underwater endowments
• The fair value of underwater endowment funds
• The amount by which the original endowment amount exceeds the fair value of the endowment fund (i.e., the “underwater” portion)
• The original gift amounts or level required to be maintained by donor stipulations

Under GASB reporting, the net position of an organization falls under one of three categories: net investment in capital assets, restricted, and unrestricted. The restricted portion is further broken down between the expendable portion and nonexpendable portion.

The original gift amounts for endowments (the corpus) is reflected in the nonexpendable portion. Earnings and losses, on endowment funds are reflected in the expendable portion. So while the underwater portion of endowments falls under restricted net position, the original gift amount is preserved as nonexpendable restricted net position.

What can we do in the face of underwater endowments?

The lack of investment earnings, combined with likely drops in donor contributions, suggest lean times ahead for higher education. But as with any setback in investing, the key is to remember the big picture.

As your foundation seeks to raise and invest funds during a probable recession, look at long-term projections to determine spending allocations, capital campaigns and more. You might need to make difficult decisions on cutting costs to find the funding you need. This can include re-evaluating your workforce to look for bloat or outdated personnel structures. You might also review operations, processes, vendor contracts and facilities use (and their resulting costs).

James Moore’s higher education team can be a critical partner in times like these. After serving your industry for over 50 years, we understand the needs of university-related entities like yours. Now more than ever, our expertise can help you make these and other important decisions for your institution’s future.

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