Decoding campus credit
The U.S. economy has been through major changes in the last several years, and the effects are being felt on campus. In many cases, this turmoil shows up publicly in the form of a credit-rating downgrade. On some campuses, a change in the credit rating has no effect on the day-to-day operations; on others, it can be devastating.
What the rating agencies care about is whether an institution can pay back its debts in full and on time. Each of the major firms—Moody’s, Standard & Poor’s and Fitch—look at revenue, expenses and sustainability to assess an institution’s unique financial situation.
The rating is issued after a decision to borrow has been made, not before. It influences the interest rate paid, and it comes with a detailed analysis that lists both positive and negative factors that have an impact on the rating. The dynamics affecting a university with a medical center, for example, will be very different from those affecting a commuter college, and the ratings will reflect that.
Following are three questions campus administrators—even those not in finance—may have about institutional credit ratings and their impact.
1. How are the ratings made?
Moody’s, Standard & Poor’s and Fitch each have different approaches to credit ratings. But they all issue an alphanumeric rating—the configurations may be different, but A is always better than B and plus is always better than minus. The agencies also offer a positive, negative or stable outlook.
The institution being rated pays for the analysis to help price and market a new debt issue, such as when plans are being made for a new building on campus. The audience for the rating is the investors who would buy the bonds.
A rating may also be called for when an institution is implementing a risk management program or if the institution has significant outstanding debt. The companies do reports on entire industries to help investors evaluate the investment case for the sector, as well.
Meet the (debt) press: Higher ed rating organizations
In the United States, the Securities and Exchange Commission maintains a registry of nationally recognized statistical rating organizations (NRSROs)—these are private companies that analyze debt issues to help investors judge risk and return.
There are 10 NRSROs, with the three largest in the higher education sector being Fitch, Moody’s and Standard & Poor’s.
They all view higher education as a sub-sector of public finance, as the bonds issued are almost always tax-exempt.
The ratings process has been controversial because the issuers, not the investors, pay for the ratings, and better ratings lead to lower costs for the issuers. Hence, these companies have had faced increased oversight from the U.S. Securities and Exchange Commission.
For more information about the role of these agencies in the financial markets, see www.sec.gov/ocr.
For individuals, the factors that go into credit scores are standardized nationally. For campuses, each rating is custom, so there is no set of simple steps to raise a credit rating.
Institutions are facing issues that can’t necessarily be solved with simple cost-cutting, says Joanne Ferrigan, senior director at Fitch Ratings in New York City. Some private colleges located in regions experiencing a population decline, for example, are now competing against public universities in other states, as marketing to out-of-state students for the higher tuition revenue ramps up.
When determining a credit rating, Ferrigan and her team examine the mix of an institution’s revenue from students, state appropriations, research, healthcare facilities, endowment and donations. She looks closely at the rate of net tuition revenue (gross tuition less financial aid)—which has been going down at many colleges in recent years.
At Standard and Poor’s, ratings are based on current information and two-year trends. A “negative outlook” is assigned if there is a one-in-three chance the rating could be reduced in the next three years. The emphasis is on long-term trends, not a short-term blip.
“The higher education sector, in our view, has been historically stable,” says Jessica Wood, director of Standard & Poor’s Rating Services in Chicago.
Edie Behr, vice president and senior credit officer at Moody’s in New York City, says the firm issues most of its bond ratings on construction projects, particularly stadiums, dormitories and classrooms. Colleges competing for students use new buildings as leverage.
State-level financial difficulties are having an impact on the credit ratings of public institutions. “There’s not an explicit relationship between the two, although it’s very much a part of our thinking,” Behr says. The state’s budget affects college appropriations, capital spending, student financial aid programs and pensions.
A public university can’t be rated higher than its state, unless its leaders have demonstrated demand and access to independent resources, Wood says. In Illinois, the state which has the lowest credit rating (A- by S&P), four public higher ed institutions have a credit rating lower than the state’s, and three have ratings that are higher.
Not all higher ed-revenue news is bad, Behr says. “There has been a very robust stock market, and investment returns are good. We find that gifts are correlated with investment returns.”
Liberty University in Virginia is one of the few universities, public or private, that has received a credit upgrade in recent years. In upgrading Liberty to A1 (the fifth highest rating) with a stable outlook in 2012, Moody’s noted the school’s strong online programs, brand recognition as a Christian college and flexible staffing with no tenured faculty members outside of the law school.
As challenges, the report listed that 90 percent of revenues come from student charges. Moody’s also noted, as concerns, modest fundraising, capital spending on residential facilities and governing power vested in one person, the president, rather than the board.
2. Are credit-rating downgrades ever ok?
Increased borrowing can lead to a decreased credit rating, but borrowing isn’t always a bad thing or a sign of weakness. Even campuses with huge endowments borrow money.
The University of Chicago has an Aa1 rating with a negative outlook from Moody’s because of the institution’s high debt level. The university has been borrowing money for new construction because the interest rates it pays are less than the returns it earns on investments, at least for the time being. With a $6.7 billion endowment, it is not considered to be in danger of a financial crisis any time soon.
There are two types of downgrades, says Robert Spencer, director of the Huron Consulting Group. The first is intentional—the result of the institution taking on more debt in order to invest in projects that support the strategic plan. The second is due to operational issues officials at no campus want, such as declines in enrollment or drop-offs in donations.
“If you’ve got a downgrade with a negative outlook, that’s when you have a fundamental structural problem,” he says. But if a university is building a new institute or program or research facility, and the growth trend and the strategy fits, it can be justifiable to have a negative credit outlook.
Higher education’s core problem is that there are fewer incoming students—and fewer willing or able to pay full price, Spencer says.
“Fundamentally, [colleges] need to have a sustainable structure,” he says. “They are not corporations that can just release a new product and repurpose facilities. Higher education is not an industry that traditionally has had shakeups.”
At the same time, colleges are competing more on costs and trying to be more transparent—middle-class students are demanding that, notes Behr of Moody’s.
Colleges “need to work harder to show individual students what the value of their education is,” she says. As that happens, many institutions are seeing lower growth in revenue and higher costs, at least in the near term—and cost-cutting isn’t easy. About 60 percent of the budget on a typical campus goes toward personnel, and it is especially difficult to change the faculty line-up, Behr says.
Because rating agencies take a long-term view of an institution’s financial strategies, there is no neat list of Suze-Orman-style steps colleges can take to improve their credit rating. On some campuses, it’s a matter of improving revenue. On others, it’s a matter of spending less. And for still others, it’s a combination.
Likewise, downgrades don’t happen overnight. “Unless there’s an extreme situation, it typically takes a little bit of time for a downgrade,” says Wood. Normally, there are a few years between ratings changes unless there’s a major event, such as a natural disaster. That also means an institution’s rating won’t be upgraded for a few years.
Boston University—which, like Liberty, has received an upgrade in recent years—has been working on a strategic plan since 2007 that includes stronger marketing to prospective students in the U.S. and overseas, increased emphasis on research, and a comprehensive fundraising campaign. Officials also cut spending to generate budget surpluses. “The upgrade is one of several external validations of Boston University’s progress,” says Colin Riley, a university spokesperson.
3. Do downgrades impact work being done on campus?
A downgrade is not necessarily a bad thing, if the borrowing occurred in the implementation of a good strategic plan. A campus may be spending money now to position itself for long-term growth. If this is the case, the campus will benefit in the long run. In fact, Huron’s Spencer says campus leaders need to concentrate on operations and strategy rather than become enslaved to maintaining a certain financial ratio. A change in credit rating means business as usual on some campuses.
On other campuses, the downgrade is a sign of trouble, and administrators should respond with cost-cutting and attempts to raise revenue. Spencer says downgrades are often a sign that an institution needs to make fundamental changes.
Furthermore, a downgrade can be particularly problematic for an institution’s development office if donors are a key source of revenue—as they are on most campuses. “Downgrades do affect philanthropy,” he says. “Donors want to give to an institution that has a strong future.” If they see the credit rating and outlook as signs of future trouble, they may choose to give money elsewhere.
Public resistance to tuition increases, rising healthcare costs and falling state funding has created a tough credit situation for colleges and universities. This is forcing many institutions to pay closer attention to expenses. “We have an industry outlook that is negative for the higher education sector,” says Behr of Moody’s.
Despite all these challenges, there is, of course, a fundamental need for higher education. And officials would do well to remember that a credit rating is a fallout of the strategy, not the strategy itself.
Ann C. Logue is a Chicago-based writer and a lecturer in finance at the University of Illinois at Chicago.