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Bond Rating: Beyond the Balance

An institution's financial stability is determined by many factors. Understanding the process is key to earning a better rating.
University Business, Jan 2006

Ask an admissions, financial aid, or enrollment management officer about their institution's "ratings." The conversation will likely turn to how the school stacks up in college guidebooks or U.S. News rankings.

The college's bond rating will not be top of mind. Yet enrollment trends and other measures of demand comprise one of four core areas reviewed by Standard & Poor's when determining the financial health and stability of an institution. As Richard Miller, president of Hartwick College (N.Y.), notes, "Bond rating agencies care not only about the institution's current financial state; they also want to know how solid the underlying revenue streams are."

Therefore, demand trends are especially important when rating private institutions with low endowments, where the tuition revenues generated by student enrollments drive the budget. In short, the success of an institution's enrollment management effort not only affects direct revenues to the institution, but can also have a major effect on the cost of borrowing.

In evaluating demand, rating agencies focus on overall enrollment trends, as well as trends in applications, selectivity, yield, and student academic profiles. Schools with stronger demand positions can more capably handle year-to-year fluctuations and longer-term changes in demographics, competition, and other market factors.

For example, if the size of the applicant pool allows an institution to be selective, and student quality is high, enrollments (and revenues) could be maintained during a downturn in demand by adjusting admission requirements.

Bond rating agencies also care about the mix of students, seeing diversity as a buffer for the vagaries of the market. For example, greater geographic diversity is generally preferred, as it protects from regionalized economic or demographic downturns. Similarly, comprehensive institutions with a diverse, well-balanced set of both undergraduate and graduate program offerings are less likely to be vulnerable to a fall-off in demand for a particular program area.

Of course, competition is also considered, so a focused institution that has found its niche could be viewed more favorably than an unfocused institution trying to be all things to all people. And then being able to demonstrate a position of prestige, relative to top competitors, is viewed favorably by the rating agencies.

Attrition trends are considered evidence of student satisfaction (or dissatisfaction). Moreover, a rising attrition rate can sometimes foreshadow future declines in demand if an institution's value proposition is seen as diminishing. With respect to pricing and financial aid, rating agencies review the school's ability to raise tuition by comparing tuition rates to those of competitors. A heavy commitment to financial aid is seen as limiting financial flexibility, along with things like faculty commitments, health care costs, and debt-service payments.

A look at Standard & Poor's report Fiscal 2004 Ratios for U.S. Private Colleges and Universities (published in July 2005) sheds still more light on the role played by enrollment management in influencing a bond rating. The chart below highlights some key differences between institutions with AAA ratings versus BBB ratings in Standard & Poor's pool. Most of the differences between triple A and triple B ratings are what one would expect. Those institutions given the highest bond ratings:

Are highly selective;

Yield well, even among highly qualified admits; and

Are less reliant on tuition revenue.

The higher discount rate for top-rated institutions may initially be a surprise. However, that's most likely because more prestigious, selective institutions typically can charge more, and higher-priced institutions, almost by design, will have higher discount rates, other factors being the same.

For an extreme example, take two schools, one charging $30,000 annually for tuition, the other charging $15,000. Assume both are in the same state; both have similar socio-economic profiles; and both meet the same percentage of need with grant. Even with a higher discount rate, Institution A is generating significantly more net tuition revenue per student than Institution B and is therefore in a stronger financial position.

The bond rating criteria used can vary somewhat for public versus private institutions. When evaluating public institutions, especially community colleges, the rating agencies rely more on overall enrollment trends and less on measures like acceptance rates; they recognize that the public mission of these institutions often mandates more liberal admissions requirements.

In addition, given the importance of state allocations in the budgets of public institutions, it is quite common for a public institution's rating to simply mirror the "credit worthiness" of its state. Nevertheless, Moody's Investors Service reports that 38 percent of the private IHEs in their rating portfolio were given B ratings, compared to only 5 percent of their public IHEs. In contrast, 95 percent of public institutions rated received A ratings or higher, compared to only 62 percent of the private colleges rated. The rating agencies take a particularly skeptical view of small private institutions in the Northeast, where heavy competition, demographic trends, and size make them particularly vulnerable.

For both public and private institutions, however, the review goes beyond trends and statistics. Strong, effective leadership in enrollment management as well as other key positions at the institution is also seen as important to future financial success. Consequently, Standard and Poor's also considers such factors as management's:

Ability to anticipate and address future challenges;

Ability to adopt realistic and attainable goals and policies; and

Past effectiveness in navigating market changes.

Clearly, demonstrating effective, data-driven enrollment planning and management can give an institution an edge in the rating process. As Standard & Poor's explains in its 2005 public finance criteria, "The choices made by different schools in very similar circumstances can mean the difference between ongoing viability and financial distress, even closure."

Given this, enrollment managers should know as much about bond rating criteria as they have come to know about the U.S. News ranking process. They need to be involved in compiling data for any bond rating review process, and their ability to demonstrate skills in managing enrollments in a volatile marketplace can help the institution achieve the best possible rating.

However, as Miller puts it, "You can be overly attentive to the ratings. You can't run the institution to please the rating agencies." Hartwick College has strengthened its demand position recently by paying attention to students and sound management principles rather than its ratings. Nevertheless, Miller says, "Bond ratings can be a good gut check on the condition of an institution."

In fact, he invited John Nelson of Moody's Investors Service to a recent board meeting to give Hartwick's trustees information on how the outside financial world generally views colleges. His rather sobering presentation pointed out that "size, market power, and wealth are all highly skewed" in the higher education sector, with about 1 percent of U.S. IHEs showing significantly more financial resources per student and much higher selectivity than the other 99 percent.

Given these statistics, we'd agree that worrying too much about bond ratings can be an exercise in frustration. Nevertheless, ratings are a fact of life, and senior management should ensure that key staff members know about the factors considered.

Kathy Kurz and Jim Scannell are partners in the enrollment management consulting firm Scannell & Kurz. They can be reached via their website,

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