Sometimes, we don’t really appreciate what some of our marketing material can do to our fundraising. The NFP world relies on fundraising as its lifeblood but we sometimes don’t pay enough attention to how the world sees us. Let’s look at a case in point: The 2022 Annual Report of the Catholic Diocese of Metuchen. This is the first of a two part blog on things that I quickly picked out from its annual report. For those of you not familiar with this organization, the Diocese of Metuchen (the “Diocese”) is a very large Central Jersey Catholic diocese responsible for 90 parishes, 26 schools and a hospital, among other things. The Diocese does an amazing job in four NJ counties. It has a strong financial condition, with net assets of about $125 million and a strong positive cash flow. Nothing in this article should be construed to be a criticism of how the Diocese operated. The Annual report itself is a very fine piece of marketing material, but was tone-deaf to fundraising concerns. There are several reasons for this, but for this week let’s start with the 800 pound gorilla in the room.
The Diocese reported unrealized investment losses of $51.2 million during the year, resulting in a decrease in net assets of $36 million dollars for the same period. To put this in perspective, the decrease was approximately 18.1% of ending total assets and 25% of the ending total investment portfolio. At the same time, the Diocese reported positive net cash flow. In short, a very creditable performance in managing operating cash flows in a tough economic environment was swamped by what appears to be a cataclysmic decrease in the investment portfolio.
How could this be? Unfortunately, the Annual Report does not disclose the reasons why, nor does it disclose the composition of the investment portfolio. So, let’s make the assumption (and it is only an assumption!) the investment portfolio had a heavy element of fixed income securities. What happened to interest rates over the year? The Fed discount rate (the marginal cost of borrowing for a bank and therefore the rate that drives other other interest rates) was .25% at the beginning of the fiscal year (June 30, 2021) and 1.75% at the end of the period. The prime rate also increased from 3.25% to 4. 75% over the same period. Interest rates were rising as the Federal Reserve was trying to deal with inflation. As interest rates rise the value of fixed income securities fall. Such a large increase in interest rates is presumably the reason why at least part of the investment portfolio took such a beating. The stock portfolio also could have taken a beating in the same time period. For instance, the Dow Jones Industrial Average was 34,292 on June 30, 2021 and 30,824 on June 30, 2022 a decline of about 10%. Again, there simply isn’t enough information provided to see how the various components performed.
Why is this disclosure important? If the investment portfolio is heavily concentrated in fixed income securities there will be no loss if the securities are held to maturity. The loss will turn into unrealized gain in subsequent periods. As the investments securities near maturity the market value of those securities will begin to approach the maturity (par) value of the securities. On the other hand, there is no assurance that a stock portfolio will ever recover its value. It seems to be that any donor would be vitally interested in knowing this information. Financially responsible management of a fixed income investment portfolio will lead to zero unrealized gain or loss over time. However, if the loss was due to a stock portfolio, would you want to donate to an organization that could blithely lose such vast amounts of money? And heaven forbid such a loss could be due to speculative derivative securities…. Based on what I have seen, I find it highly improbable that the investment portfolio includes such problems. I am only using this Annual Report to make a point.
I will readily acknowledge what happened may not be completely the responsibility of the Diocese. For the life of me I can’t figure out why the Financial Accounting Standards Board (FASB) would require fair market value accounting if the NFP organization could demonstrate it has the ability to hold the securities to maturity. Clearly the Diocese does. Even more unfortunate is the fact that a business entity incurring such unrealized losses might be able to mitigate the losses by recording deferred taxes, thereby reducing the impact to the “bottom line”. Since the Diocese is a NFP organization there is no tax effect for such losses. Nevertheless, the Diocese needs to do a better job of explaining what happened.
In the next installment, I’ll examine some of the other issues contained in the Diocese’s Annual Report. Stay tuned.