Opening Keynote

During his keynote address, University of California CFO will discuss some of the compelling issues in California higher education, many of which -- housing, as an example -- will be relevant to other sectors of public finance leadership.


Transcription:

Chris Mukai (00:10):

Thank you Chas, and on behalf of my Raymond James colleagues in the audience and the 25,000 associates throughout the country, it's an honor to be here today to help kick off the 34th annual conference, I can't believe, 34 years. It's wonderful seeing so many old faces and new faces when the industry comes together on this time of year, but I was reminded a few minutes ago outside in the hallway that after attending this conference for over two decades, that I am one of those old faces. I actually prefer seasoned, but I am one of those old faces. Nonetheless, public finance gets us together here at this time of year every year, and public finance is an essential business at Raymond James. We are one of the top three senior managers in the industry in terms of number of deals, and we are focused on growing our business, particularly in California in the Western US where we now have 18 public finance bankers.

(01:00):

That is why it's such a privilege today to be able to introduce our keynote speaker, Nathan Brostrom, the Chief Financial Officer of the University of California. Many of the audience here today have either attended or have family and friends have attended UC, Berkeley, San Francisco, Davis, Santa Cruz, Merced, Santa Barbara, San Diego, Irvine, Riverside, and not last, but not least, my Alma Mater, UCLA. Go Bruins, or maybe you've received care at one of the university's five academic medical centers, or maybe you all have maybe not realized it, but benefited from some of the research conducted at the Lawrence Berkeley National Laboratory. It's hard to overstate the impact and importance of the University of California to the state and even the nation. It's the largest higher education institution in the nation with cutting edge research. It's a forefront at the forefront of innovation and change in technology, medicine, agriculture, manufacturing, commerce, and even intercollegiate athletics, and as many in this room, care deeply about. The university is also one of the largest issues of municipal bonds in the Western US.

(02:01):

Our keynote speaker today is responsible for overseeing the finances of the university. Aside from being just a good dude, Nathan has his roots as one of us. He too sat in the audience where you're all now sitting. He too roamed the hallways and the exhibit halls as a public finance banker and then the head of his firm's western region public finance practice for over a decade. He then went on to become the CFO at UC, Berkeley, and then took greater responsibility as a COO and CFO of the entire UC system. He also served as the interim chancellor for UC, Merced, and there he succeeded in making UC Merced, the number one university in the country for exceeding projected graduation rates. He also presided over a $1.3 billion public-private partnership to double the size of the campus in 2020. He's one of the few people who has intimate knowledge of the inner workings and is impacted at all levels of the UC system. That's why we're all fortunate to have such a talented and seasoned leader like Nathan, guiding the finances of such an important institution to our state and economy, particularly as we push forward and face new challenges in an evolving landscape. So with that, I'd like to introduce our keynote speaker for the day. Nathan Brostrom, Chief Financial Officer for the University of California.

Nathan Brostrom (03:16):

Thanks so much Chris. And I would also like to welcome you all here. It has been really great just being in the hallway and seeing so many old, I guess I should say longstanding friends. I like your story about 1995, Andy, but Cody Press and I worked together in 1985, and I was actually an analyst, and Cody was a summer associate, so I don't know if it's still the same, but Cody would be going off to a Dodgers game and say, could you finish this up for me? But anyway, it's really, really wonderful to be here. And I also want to welcome my team, Megan Gut Kunst and her team from Capital Markets Finance, who really know inner workings of debt markets.

(03:59):

So it's a gross understatement to say that the past several years have been a disruptive period in higher education. The pandemic brought huge displacement in students, many dropped out. We had issues with retention. Many chose not to enroll For those who enrolled, we saw big learning gaps both from those who were already in college and those that were entering. And then there was a surge in reports of anxiety and depression among our students. I was at UC, Merced when the pandemic broke out and had daily calls with students who were really, really just wanted to be back on campus and did not want to have to learn at home. But even prior to the pandemic, there are already signs of a big disruption in higher education. We've had a steady decline in college aged kids across the country since 2010. California has actually seen an increase, but it's mostly because we have higher completion rates of our A to G requirements, which you need for UC and Cal State system, much higher costs of college and university, and that's led to higher levels of student debt.

(05:03):

And that's become a national and regional political issue. And it's been particularly hard on smaller tuition dependent colleges, many of which have been have closed or threatened to close. I looked last night and already this year over 20 colleges have closed or announced closure, and it's not just affecting small private colleges. The Pennsylvania state system of higher education consolidated six campuses into two universities, and they've still seen declines in enrollment. The signs of disruption are also not helped by the divisive political environment that Chas was referencing. The gap between the views of the parties on higher education has never been greater, and given the cost and perceived biases, many more Americans are questioning the value of a college degree. We have been pummeled by the War in Gaza at all of our campuses. We've had political activity, we always have political activity in our campuses, but this is one of the first times in my memory where you actually have students pitted against students and faculty against faculty instead of all of them pitted against us as the administration.

(06:10):

And just this last week, we saw dueling political protest at many campuses, particularly at UCLA, Chris, which has tested our protocols on protests and also what are the appropriate provisions for time, place, and manner. So as you can see, there's a lot to cover in a talk on current issues in higher education. We could spend a whole session on the impact of artificial intelligence on the sector or the implosion of college athletics. And Chris, I'm thinking 1990 was probably Russell White who still holds the Cal rushing record outperforming Marshawn Lynch and Java Best and others. But I'm going to focus on a few of the key things, the real world issues as Chas calls him that will also have some resonance for you and your work. So before I move on, any guesses on what that slide, where that is? No. Ann Eaters in the house, UC, Irvine.

(07:08):

So this is actually a big story, not only in California, but across the country. Academic medical centers are having a significant impact in higher education, one that's particularly pronounced in California just over the past nine months. As you can see on this chart, we have purchased eight hospitals, increasing our overall bed capacity by 50%. This is being driven by several factors. First of all, there's considerable uncertainty in the medical compensation programs, Medicare and Medicaid, and even more given the looming election, which could pose a huge risk to our Medi-Cal programs. There's a big growth in demand for academic medical centers and the tertiary quaternary care that they provide. If you went into any of our hospitals now Mission Bay or Parnassus, they'd be well over a hundred percent capacity. You may be forced to wait in a gurney for your procedure, and we are actually forced to turn away thousands upon thousands of transfer patients a year just for lack of capacity.

(08:05):

And overall, you can see the contrast on this slide. Our existing occupancy is 86% while those of the hospitals that we acquired is at a capacity of 42%. The final factor is the state requirement for seismic upgrades for all hospitals and acute care facilities. This has to be done by 2030. There was legislation this year that was going to extend that to 2037, but Governor Newsom vetoed it, and it's no coincidence that most of the sellers of these hospitals we acquired are for-profit and did not want to make the capital investment necessary to keep the hospitals open after the 2030 seismic date. So overall, I would say that this is a very positive development and it does increase access to high-end UC quality care across the state. However, as you start thinking about us as a credit, it affects many of the key drivers in the university.

(09:00):

You can see here, and this goes all the way back to 1980, the change in revenues at the University of California, and I'll start at the far end. You can see that revenues from UC Health, which includes both the hospitals, but also our clinical practice plans now exceed 50% of our overall revenues. When I joined the university nearly 20 years ago, it was less than 25%, and that really does change the nature and the credit profile of the university. This has led to a commensurate decline in the percentage of state funding at the university, and it now hovers about 10% of our overall funding. When we combine it with tuition and non-resident tuition, which make up what we call our core funds, it's still under 25%. This has been a growing trend across the country, and the state of California has actually been one of the more reliable partners of among states in funding higher education.

(09:51):

However, as all of you know better than I do, the state budget fluctuates in a boom and bust cycle, and we have few protections in the budget process. So on the revenue side, the revenues of the state of California are inherently volatile. More than 70% of our revenues come from personal income tax and from those of the highest income tax brackets leaving us very, very dependent on capital gains. And then on the expense side, they're largely hardwired driven by voter initiatives like Prop 98 or sentencing mandates and federal requirements on healthcare and other needs. So we become part of the increasingly dwindling discretionary part of the state budget in good times, maybe 20 to 25% of the state budget. We have benefited in the past several years with a funding compact that started with Governor Newsom has extended to the legislature. However, in the coming year, because of this boom and bus cycle, we are looking at a budget cut of nearly 6% in our state funding.

(10:49):

So as you can see, the overall diversification of our revenues has been a very, very positive development at UC and leaves us much more resilient to downturns in the state than we were, for example, in 2007, 8 9 during the Great Recession. How even there, I have to point out that there's significant differences between our campuses and their level of diversification. UCSF, for example, less than 2% of their revenues come from core funds, meaning the state and tuition. Whereas at UC, Merced, where I spent the year, we drive more than 70% of the revenues from those sources. And a lot of our campuses without medical centers, Santa Cruz, Santa Barbara, Riverside, all depend for about half of their revenues on core funds. It's also true that our sister sectors, the community colleges and Cal State universities do not benefit from this kind of diversification that has given us much greater resilience, and yet our enrollment continues to grow.

(11:48):

As you can see, we've added over 50,000 students just over the past decade. This growth is counter to what we're seeing across the country where overall undergraduate enrollment was at 15.4 million in 2023, which was a 7% decline from before the pandemic, and down over 15% from its peak in 2010 when it was over 20 million undergraduate students. We have seen this trend in California as many of the Cal State campuses suffered enrollment declines both before and during the pandemic and community colleges saw large decreases that they're just starting to rebound from across the board. CSU is down about 7% from its pre pandemic highs, mirroring these national figures. And the community colleges just surpassed 2 million students last fall after seeing large V-shape declines of over hundreds of thousands of students in the pandemic. Our campuses, all of them continue to remain very attractive. I was just telling Chris with UCLA ranking as the number one university in the whole country for the most applicants with over 150,000 unduplicated applications a year vying for freshmen or transferred admission, it just came out that their admission rate for public university is below 10% first university there. So be glad you went there when you did.

(13:07):

So this slide lays out our most significant challenge with state funding. If you see on the far left, state funding has largely kept up with inflation over the past 25 years, growing by 11% on an inflation adjusted basis. However, it has not kept up with our growth in enrollment. You can see we've added over 120,000 students during that time, a 71% increase, all told that means a 35% decrease in core funding per student. So one of our big efforts, and one of the things that Meg and her team and I work on is really trying to enhance this core funding the state and tuition by leveraging all of our other non-core revenues, investment income, indirect cost recovery, philanthropy, real estate, ground leases to support our core educational mission. But this trend has also unfortunately resulted in some declines in student experience, higher student faculty ratios, impacted majors bottleneck courses that delay time to degree. So this is a strategy that will play an increasingly a significant role in all of our plans going forward. The state's been a reliable partner, but we can't count on it either State funding or tuition to grow at levels needed to maintain both the excellence of the campuses and the access for all Californians. So we must draw in the other revenue streams, which now constitute 75% of our overall revenue to support this core mission of teaching and learning.

(14:30):

This slide tells the same story in a slightly different way. It shows that the overall decline in core funding per student, again down by about 35%, but it also shows how dramatically the split between who pays has also changed. In 2000, nearly 80% of a student's education was funded by the state. And the most recent data, as you can see on the far right, it's a fairly even split between the state and tuition, including non-resident tuition, which has grown quite dramatically in the last 15 years. The state, of course, continues to support us through financial aid, and they have fully funded Cal grants, but the overall appropriation has declined dramatically. Student something near and dear to all your hearts, we face the same challenge in state funding for capital. We used to receive a fairly consistent stream of capital from both state general obligation bonds and state lease revenue bonds, roughly 200 to $250 million a year to both UC and CSU.

(15:27):

We have not had a general obligation bond since 2006, and we were not included in the education bond this year on the ballot. You're still welcome to vote for it, but we were crowded out and we have not had a lease revenue bond since 2011. We did, as you can see in the far right in the green bars, negotiate with a state to issue bonds backed by AB 94 funding. But all this, and we've actually issued over $2 billion of bonds with this structure. However, this simply enables us to pledge a certain amount of our appropriation to support the debt service and it's operating funding that could have been used to hire more faculty, pay for graduate support or other pressing needs in our operating budget. So as with the operating budget, we've had to look to other revenue sources to support our capital program. One of the areas that has risen dramatically has been philanthropy and that we're very, very appreciative of it. However, it's mostly for new buildings and new initiatives rather than the maintenance and renewal of many of our old buildings. So deferred maintenance and seismic upgrades remain two of our most pressing and critical priorities as a system.

(16:37):

And just to piggyback on what Andy was saying, the need for capital is particularly acute in the area of housing. We have added, as you can see in the dark blue and all shades of blue, we've added over 35,000 beds across all of our campuses since 2011. And yet as a system, we still house less than 40% of our students largely driven because of the enrollment growth that we've seen. The cost of housing and access to housing remains one of the key barriers to recruiting undergraduate and graduate students. Some campuses like UCLA and UC, San Diego are building to where they can offer a four year guarantee of housing for their undergraduates. We've been helped at UCLA because it will be the Olympic Village in 2028, and so that's helped us fund some of that housing. But we still hear horror stories every fall of the inability of students to find affordable or satisfactory off-campus housing.

(17:29):

And we get increasing resistance from many of our host cities concerned that our growing student enrollment will crowd out their residents. Because of this, we have substantial plans to add even more beds in the coming five years. That's the tan part of the bar charts currently projected to add 25,000 more beds over the next five years. The cost of housing has also become a barrier to recruiting faculty and staff. And so we're working on models where we can finance and control more housing on or near the campuses. Meg runs a in-house mortgage program, which has never been more popular to offer below market mortgage rates to help incoming faculty buy into our expensive communities. One area that has been promising, what we have benefited from the disruption caused by the pandemic has been in real estate. Given the dislocations in the commercial real estate market, we have been able to buy real estate around our campuses, and we've also benefited from two other factors.

(18:28):

One, our current cost of capital remains very low thanks to the introduction of a central bank, and we've seen widening gaps with comparable commercial rates. And second, we have a much longer time horizon when we're looking than commercial buyers. The UC has been here from over 150 years, and we will be here for another 150 years, and this enables us to make long-term strategic investments without the need for an immediate near-term return. Most of these acquisitions have been for student, faculty and staff housing, and you'll see a couple of additional transactions at our upcoming regents meeting. However, we've also seen opportunities for acquisitions, supporting research and other educational activities. For example, the UCLA campus bought the former West Side Pavilion in LA. You may have gone to movies there when you were a student that was redeveloped by Google. And then when they went to hybrid work, they were willing to sell it, and we were going to launch a new research center, which will host the Center for Immunology and Immunotherapy, as well as a new center on quantum science in an old shopping center.

(19:32):

So in closing, I did want to return to a question posed at the start, is college worth it? The labor market certainly thinks so. The Public Policy Institute of California produced a report earlier this decade, which cited that the state would need over 1.1 million additional college graduates by 2030 to support the industries and growth sectors in California. And this figure was far greater than the four segments, the three publics and private universities were projected to produce. So we have looked at ways to both increase our enrollment but also take steps towards reducing time to degree and getting more students through a more recent study projects that 84% of newly created jobs will require some level of higher education. And again, this may not always mean full fledged four year degrees or graduate degrees increasing. We are seeing our campuses offer certificate programs and stacking degrees as a way to meet industry needs in certain disciplines.

(20:24):

But the next question, the one I'll close on is does it make sense for individuals to go to college? One of my favorite economists on this topic is Raj Chetty, a Harvard Economist who runs a center called Opportunity Insights, which uses big data to study economic opportunity. Often his findings are quite depressing, as we as a society are far less socially mobile than we like to think of ourselves. The gray line there on this chart shows the correlation between a parent's economic ranking and a child's, and it's largely a 45 degree angle, meaning that your parents' income largely predicts where yours will be. However, the single greatest factor, greater than any other factor in changing that outcome in leveling that curve is a college education. So regardless of whether your parents are from the highest quintile of income or the lowest a college education ensures that you'll benefit from social mobility.

(21:14):

This is true for the most elite colleges, which is the line at the top, but also for other four year colleges and for our community college graduates, which is the line at the bottom. So it's increasingly important that we have to make sure that our colleges are ready for all these students, of all the statistics, and Chris cited some great ones of why we are very proud of UC. The one that makes me most proud is that over 40% of our undergraduate students are first generation students. They're first in their families to go to college, and that ensures that a transformation like this will happen not only for them, but also for their whole families. So thank you for your attention. I'm happy to take questions and have a discussion.

Chris Mukai (21:57):

Phones set up there for folks who want to pose any questions to Nathan?

Audience Member Max Adler (22:10):

Hello, I'm Max Adler from Bloomberg. I was wondering if the law that was recently passed by California limiting legacy admissions at UC and the ongoing war in Gaza have depressed donations over the last year?

Nathan Brostrom (22:28):

The question is about legacy admissions and we do not have legacy admissions at UCA. We haven't had them for 20 years, and no admissions that are tied to donations at all. We have seen, we'll report at this at the next REGENS meeting. We've seen a very, very strong year in fundraising across all 10 of the campuses, $4.3 billion. I should have said, a lot of that is going to the medical centers. So Parnassus, we're doing a complete rebuild of Parnassus and UCSF is also rebuilding the children's hospital in Oakland and some more projects under admission bay. About half of that funding is going to come from private philanthropy. So that has been a big boost in our overall philanthropy. Some of our smaller campuses are still struggling below $50 million or so.

Audience Member Chris Birn (23:15):

Thank you. Hey, Nathan, Chris Brin from RBC, I know that we're here at a California Bond Buyer conference and you are the University of California, but they're also a global academic institution. And I'm wondering if you could speak about trends in international enrollment and how that is impacting the operations of the university?

Nathan Brostrom (23:33):

Yeah, it's a great question. The question is about international enrollment and what we have seen. We continue to attract a lot of international applicants. As part of the compact with Governor Newsom, we agreed we have an 18% cap on non-resident students. This is just at the undergraduate level, so 18% on any campus and 18% overall. Some of our campuses, UCLA, Berkeley and San Diego had vaulted past that, and they were close to 25%. So as part of the compact, we negotiated a buydown of the non-resident students and replacing those with in-state students. Across the board our non-resident undergraduates are pretty much split 50-50 between international students and domestic non-resident students. The largest country by far has been China, and that has not everyone else. Is that abated? No, we continue to see strong demand, especially on the undergraduate side. When we get into some of the graduate programs, there tend to be more restrictions on whether we can have certain foreign nationals on research grants and things like that. But China and India continue to be our strongest, and I think that will continue, especially given our location on the West coast.

Audience Member Gary Hall (24:55):

Nathan.

Nathan Brostrom (24:56):

Anyone else? Sorry,

Audience Member Gary Hall (24:58):

Nathan. Gary Hall, first of all, thank you so much for allowing me to escape Chicago and come to California work for you years and years ago. But quick question for you. You mentioned public private partnerships, especially that you did at UC, Merced. Is that a method that you might finance other infrastructure projects in the system going forward?

Nathan Brostrom (25:19):

Yeah. The question is about public-private partnerships, and we have used them quite extensively. We did the 1.3 billion at UC, Merced, which was the largest public private partnership in higher ed, or I think in all social infrastructure. And we've used them quite extensively on housing projects. A lot of Irvine's undergraduate housing was done through p threes. The only thing I would say there is what we do, and Meg has been very creative in doing this, is we tend to, a lot of public private partnerships are D-B-F-O-M, design, build, finance, operate, and maintain. We do the F part, the finance, because that is where there's a big golf. We have a couple projects now where we have stepped in as the financier for projects that would not have been viable or would've been unaffordable if we had used commercial rates. And we're stepping in as a construction lender on a project in Santa Cruz, which we need desperately for the housing, but would not have been done without us inserting our financing into that. So I think we'll see them, but it'll probably be more on a selected basis given the widespread between commercial rates and our cost of capital.

Audience Member Hank Levy (26:32):

Nathan? Hi. Over here. Hi, Hank Levy, county of Alameda. How are you doing? So you and I have worked with the city of Berkeley on affordable housing. It's interesting about all the students coming into the city of Berkeley, putting pressure on the city of Berkeley and Berkeley is changing. For those who don't know, what can you see, can the UC system get involved at all with affordable housing? From an institutional point of view? I mean, I know you personally are involved in it, but with the money finance, the power that the system has and what ideas have you got for the city and maybe can help others too?

Nathan Brostrom (27:15):

Yeah, that's a great question, Hank. And there's a couple of routes to do that. One is we can do it through master leases. Hank and I were working on potential housing for North Berkeley, BART and Ashby BART, and we were looking at ways could we provide a master lease for graduate student housing there that would make it more viable for a developer to come in and get financing on it. So we can work with private developers there. We can also develop it ourselves. And we are looking at this for lots of different opportunities. UC, Santa Barbara for faculty housing, UC, Irvine for staff and workforce housing where even for our nurses or respiratory technicians, they can't live anywhere near the hospitals they're working at. So if we can often, we won't develop it ourselves, we'll do a ground lease with a developer and then use the ground lease revenues to help subsidize, subsidize the housing. But it is increasingly important that we do this because oftentimes when we interview faculty or even graduate students, their biggest, they'll go to Harvard or Yale because it's less expensive to live there than it is to live in Hoya or Westwood or even Isla Vista. So you're going to see us looking at a lot of different projects and especially where we have land to do that.

Chris Mukai (28:46):

Okay. Well, if there are no more questions, we'd like to thank our keynote speaker, Nathan Brostrom, Chief Financial Officer.