Graduation ceremonies are over and a new freshman class is only weeks away from orientation. As another campus metamorphosis begins, student classes are clear evidence of a university’s realization that building enrollments and promoting graduation rates are only a small measure of their success.
Their true test is how well they can impress Wall Street. Often the least visible sign of a university’s image and academic strength, its bond rating is as much a part of the university as its fight song, school colors and alma mater. More than anything, it is the most telling sign of an institution’s financial muscle.
Although more firms are getting involved in the rating process, the ratings that count the most are issued by Moody’s Investors Service Inc., Standard & Poor’s and Duff & Phelps. Their reports are the most respected. When they evaluate an institution, investment bankers and investors pay strict attention.
Ranging from an excellent AAA to a less-than-investment grade level BBB-, these ratings can significantly affect the cost, value and yield of the general obligation and revenue bonds an institution issues to build that new library, fieldhouse or other capital project. Generally speaking, the higher the rating, the lower the interest universities will have to pay to borrow money through bond issues.
Monitoring Investments
Traded in $1,000 and $5,000 denominations college bonds, like other tax-free municipal bonds, are long-term investments that allow individual and institutional investors to diversify and hedge their portfolios. They pay a guaranteed fixed interest rate 10 to 20 years in the future, investors like them because they are stable investments that offer the same performance rates, despite changes in the economy.
As low-risk debt instruments, higher education bonds are considered relatively safe investments, Wall Street analysts say. Historically, colleges have rarely defaulted. But as more universities are beginning to invest portions of their own portfolios in highly risky investments called derivatives, Wall Street and the Financial Accounting Standards Board, are taking steps to monitor those investments more closely.
The financial ratings firms have developed a sophisticated system to evaluate schools. Standard & Poor’s, for example, examines an institution’s complete financial operation plus such factors as state support and a school’s ability to win government grants.
Endowments Big Factor
Endowments are another prime factor. Harvard and the University of Texas, for example, are popular bond issuers among investors “because they have large endowments,” explains a prominent. Wall Street municipal bonds experts. Declining to be quoted by name because of company policy, the analyst notes that these schools have proud alumni who are big contributors.
“Everybody wants them and it doesn’t matter how much they cost.” Two years ago, when Spelman College wanted to build a new academic center and science facility, Wall Street welcomed the Atlanta-based college with open arms. Standard & Poor’s gave its $22.5-million package an A+ rating and said the college had a stable financial outlook primarily because “the college maintains a high level of liquidity. Unrestricted endowment monies and available resources will cover the outstanding debt by 1.5 times.”
Spelman’s liquidity in part came because of the $20 million gift TV personality Dr. William Cosby and his wife, Dr. Camille Cosby, made to the school. Standard & Poor’s touted Spelman for its market niche as a “high quality liberal arts institution for Black women; a strong management team; above-average student quality with SAT scores of incoming students at 1002 plus strong growth in student demand; and strong fund-raising capability, resulting in endowment growth of 117 percent.”
While ratings are extremely important, there have been some exceptions, especially when a big name university with large endowments are involved. “I’ve seen some lower credits trade better than their ratings,” says a bond trader who asked not to be named. “For example, a BAA rated facility may trade like a [higher rated] A-1 facility because investors feel good about the credit and they feel confident about the institution behind the bonds.”
Other Factors
Mary Peloquin Dodd, a director with Standard & Poor’s public finance group, says that another key factor is whether a school is filling its freshman class by lowering admission standards — a possible sign of declining demand for its educational product.
The firms also watch for matriculation rates and the presence of nationally recognized academic programs. For example, Harvard University holds Standard & Poor’s top rating of AAA. Seven others — Amherst College, California Institute of Technology, Massachusetts Institute of Technology, Stanford, Princeton, Yale and Rockefeller University (NY) — are on that prime list, which makes their bonds attractive investments. A Harvard bond with a 5.50 coupon rate, is expected to pay 6.35 percent upon maturity in 2015.
A long tradition for fiscal strength and public image counts for a lot on Wall Street. But size is not important and the university doesn’t have to be an Ivy League institution to gain Wall Street’s favor. Sometimes private institutions enjoy a slight advantage over some public colleges because rating agencies generally do not rate public institution’s bonds higher than the bond rating of the government agencies in that state.
In New Jersey, for example, Princeton University’s AAA surpasses that of any other high college in the state, while the Rutgers University System is rated AA. Stanford is rated AAA in California, while the University of California System is rated A — with UC-Berkeley and UCLA carrying an A+ rating.
Not all private colleges have a top rating, however. Some small ones, notes Standard & Poor’s analyst Jennifer Neel, are susceptible to small changes in the economy and campus environment. “S&P looks for dramatic swings as well as the ability to support financial aid programs and modify them. If an institution has a large endowment, a tuition discount rate of even 30 percent may not be a problem.”
Scurrying for Favor
A poor rating often sends university officials scurrying to either explain their programs or make changes to gain Wall Street’s favor. During this decade, ratings were downgraded because of:
declines in enrollments;
reduced admissions flexibility;
eroding levels of unrestricted monies;
increasing dependence on tuition revenues; and
deficit operations.
Wall Street has such an influence that college administrators waste no time
implementing changes they hope will gain the favor of the bond raters.
In early May, a month after Standard & Poor’s lowered the rating from an AA
to A+ on a series of Howard University’s revenue bonds, President H. Patrick
Swygert unveiled “A Strategic Framework for Action” — a sweeping cost
cutting reorganization plan.
It calls for the consolidation of 16 departments to 11, placing fund-raising
its top priority and establishing a National Center for African-American Heritage
and Culture. “Increased emphasis on student services, administrative services,
faculty workload, staff performance standards and community service” are new
mandates.
The plan also calls for a Center for Excellence in Teaching and Learning, a
National Leadership Institute and a Technology Center. In making the
announcement, Swygert said, “This plan resonates with our history of being
the national repository of the African-American cultural experience and the
center of African-American thought and critical analysis. He noted the plan
was essential for the university to “fulfill its mission and enhance our heritage
of leadership and service.”
University officials contend the proposals are not in response to their rating
drop but a part of a continuing program to streamline operations and in the
works for a while.
Regardless of the timing, components of the plan coincide with S&P’s
recommendations. The rating agency said, “A new management team, brought
on board over the past year, is assessing a number of options the university
may pursue to improve enrollment trends and curtail operating expense growth
at the hospital. The university has attracted a number of influential trustees
that are working to increase awareness of Howard and protect current levels of
federal support.”
Standard & Poor’s recommended: “To prevent another downgrade from taking
place, Howard must stem enrollment losses, shrink operating deficits at the
hospital, deal with cuts in federal operating appropriations and put forth a
credible strategic plan and implement it in a timely fashion.”
Surviving Downturns
Howard is not alone. Several other universities have seen their ratings drop for
d combination of factors since June 1994. Standard & Poor’s downgraded
Tulane University from an A+ to an A; St. Bonaventure College from a BBB to
a BBB-; and Florida Institute of Technology dropped from a BBB+ to a BBB.
While lower ratings are clear signs that those bonds might be more risky than
higher-rated bonds, they don’t tell the whole story, suggests Joshua Stern, an
S&P analyst. For example, while Rockefeller University has a AAA rating, its
debt has recently “taken a negative outlook.” Not all BBB- institutions have a
negative outlook. They may have a poor rating, but they have performed well at
that level.
Is that a sign of an upcoming upgrade? “Many higher education institutions
have proven themselves to be fairly adaptable and innovative in surviving
demographic downturns and recessionary pressures,” S&P analyst Neel says
in her report. “Some have offset the damage caused by shortfalls in the
number of 18-to-24-year-olds with nontraditional and foreign student
populations. Many have curtailed budget growth and held tuition increases to a
minimum.”
The rating firms are quick to notice improvements. In 1990, Boston College
was upgraded from an A to an A+ and Vanderbilt was upgraded from an A+ to
an AA. Two years ago S&P upgraded the University of Denver from a BBB to a
BBB+. Last year, Carnegie Mellon saw its rating rise from an A+ to AA.
What is the outlook for the future?
Bonds ratings experts believe colleges will have to work harder to maintain
their quality standings. Tuition pressures, dwindling enrollments and heavy
competition from less-expensive community colleges will have their impact.
“While the willingness and ability of parents to pay tuition costs has
diminished, the cost of attracting, educating and retaining students have not,”
says an S&P analyst. “Today, colleges and universities are spending more
money courting prospective students with glossy brochures, videos and
expense-paid weekend visits. Financial aid packages, faculty salaries,
overhead, equipment and vendors costs continue to rise and contribute to
escalating tuitions.”
Standard & Poor’s will continue to monitor profiles and educational niches,
using application, acceptance and matriculation levels as measures of student
demand,” says Neel. In addition, retention and graduation rates, marketing
goals, competitive information, student diversity and financial aid burden and
tuition discounting will be carefully evaluated. In other words, Wall Street will
still be watching.
COPYRIGHT 1996 Cox, Matthews & Associates
© Copyright 2005 by DiverseEducation.com
