Minneapolis, MN | February 1, 2024 | Erik Kelly, President
It is with great joy that our Blue Rose advisory team serves organizations across the country with the goal of improving their financial health.
In 2023, we had the opportunity to positively impact numerous higher education institutions, non-profits, and governmental entities advising on matters related to long-term capital planning, capital markets access, interest rate hedging programs, alternative financing solutions, the investment of bond proceeds, budget process improvements, and many other unique projects. Each engagement allowed us to utilize our skills in service to our clients’ missions. In addition, our team came together in-person in both September and December of last year to serve two non-profit organizations, the Ann & Robert H. Lurie Children's Hospital of Chicago and Feed My Starving Children in Minnesota. It is with this dedication to service that we helped others overcome some of last year’s unique challenges.
For example, on June 30, 2023, LIBOR cessation was completed. Variable rate bonds and notes, lines of credit, and derivative products that were once reset off a LIBOR index (including all its permutations) were converted to or assigned a new or different index, often SOFR. Whether fallback protocols were adopted, proactive amendments were made, or refinancing transactions were executed, LIBOR faded into the sunset mid-last year. From the very beginning of the anticipation of LIBOR cessation, our team was attentive to the challenges that LIBOR transition would bring to the market as a whole and to our own clients’ circumstances. We analyzed scenarios, advised on a best approach, and assisted in efficiently executing various LIBOR transition strategies. In the end, our clients overcame the LIBOR challenge that was years in the making.
Similarly, the interest rate markets proved challenging in 2023. The Federal Reserve’s swift increases of the Fed Funds rate led to a significant inversion of the yield curve. Later in October of 2023, interest rates, as measured by the 10-year benchmark treasury rate, reached 15-year highs. Refinancings dissipated quickly and higher borrowing costs hindered capital improvement budgets. As we have articulated recently, the markets are not all doom and gloom, as opportunities exist to utilize the current interest rate environment to achieve positive arbitrage on refunding transactions and new money projects, when permissible. Fortunately, both tax-exempt and taxable rates are meaningfully off their highs from October as we hit the new year.
As we move into 2024, many challenges are already upon us, and likely more are to come. From an interest rate perspective, uncertainty and, possibly, significant volatility is anticipated. The Fed continues to combat inflation, though recent inflationary statistics suggest that inflation has moderated significantly since its highs of 2022, even if not yet to the Fed’s 2% target (with the Personal Consumption Expenditures (PCE) price index at 2.6% in December 2023). Despite the Fed’s significant rate increases that one would expect to cool the economic climate, robust labor and spending statistics perpetuated through the end of 2023, creating wonder about whether a forecasted recession would in fact materialize.
As a result, there remains significant uncertainty about whether the Fed’s December forecast for three rate cuts in 2024 will happen, even more so now given the Fed’s written statements on Jan. 31st that it needs “greater confidence that inflation is moving sustainably toward 2 percent” before considering any rate cuts. Economic indicators will factor into the direction of rates this year, but so, too, will the political landscape - including a forthcoming presidential election later this year. Therein lies the greatest concern about interest rate volatility, particularly as we approach Q4 2024.
Within the higher education sector, the challenges facing our nation's colleges and universities are anticipated to persist particularly as the long-anticipated demographic "cliff" comes upon us. Not all higher education institutions will feel the squeeze from a declining high school graduate population, but many will. This challenge and others are well articulated within the sector outlooks published in December by each of the three major rating agencies that are summarized below.
Credit Rating Agencies: Higher Education 2024 Outlooks
Moody’s: Stable (revised from negative in 2023)
Moody’s believes revenue gains and moderating expense growth will improve operating performance, while financial reserves and gift revenue will support budget gaps in the short run.
S&P: Bifurcated / Mixed (consistent from 2023)
&P suggests the higher education sector is stable for institutions with strong demand and financial resources while the sector is negative for less selective institutions without financial flexibility.
Fitch: Deteriorating (the Credit Gap is widening in 2024 compared to 2023)
Fitch anticipates a deteriorating credit environment for the higher education sector due to labor pressures, elevated interest rates, and a very uneven enrollment recovery.
As if the stressors noted by the rating agencies aren’t enough to overcome in 2024, recent news related to the Free Application for Federal Student Aid (FAFSA) presents the higher education sector with yet another significant challenge. Specifically, on January 30th, the Department of Education notified colleges and universities that FAFSA information would not be released until March. Typically, this critical information that is necessary for colleges to finalize financial aid packages for prospective students is made available as early as October. This year, due to the Department's delay in rolling out a simplified FAFSA form as well as more recent changes to the mathematical formula behind the FAFSA aid calculations, a substantial delay in the typical enrollment cycle is unfolding and sure to cause headaches if not significant disruption to both families and colleges alike. You can read more about the FAFSA delay here.
Whether the challenges are capital markets-related or industry specific, leadership in guiding your organization is more critical than ever. With our growing team, we're here to help you even more and look forward to being of service to you in 2024.
Comparable Issues Commentary
Shown below are the results of two higher education financings that priced before the holiday break. On November 17th, Gwynedd Mercy University (“GMU”) of Pennsylvania priced its tax-exempt Revenue Bonds, Series 2023 VV1. Roughly two weeks later, on December 5th, the South Dakota Board of Regents (“SDBOR”) priced its tax-exempt Housing and Auxiliary Facilities System Revenue Bonds, Series 2023. Gwynedd Mercy’s transaction was purely a new money issuance which served to finance various improvements to its campus, including a new Health Innovation Center, athletics facilities, and residence halls. SDBOR’s Series 2023 was a dual-purpose issuance which refunded its outstanding Series 2014A Bonds in addition to financing an expansion of the wellness center on the University of South Dakota’s campus.
One of the most notable points of contrast between the two deals is their bond ratings. GMU’s bonds carried a “BBB” rating from S&P, while SDBOR’s bonds were rated the equivalent of five notches higher at “Aa3” from Moody’s. These institutions themselves are also quite different – Gwynedd Mercy is a small private university, while SDBOR is a public university system covering multiple universities and campuses. GMU’s transaction was slightly larger, at just under $17 million of total par amount, though nonetheless the two transactions were similar overall in issue size with SDBOR issuing just over $14 million. SDBOR’s transaction featured a standard 10-year par call provision in 2033 while Gwynedd Mercy’s deal featured a 9-year par call provision in 2032. These two transactions were very different in terms of their structures. Gwynedd Mercy’s Series 2023 VV1 has only two term bonds maturing in 2038 and 2048 while SDBOR’s Series 2023 features exclusively serial maturities from 2024-2039. The two deals also differed in coupon structure. Gwynedd Mercy’s 2038 and 2048 term bonds featured a 5.25% and 5.75% coupon, respectively, while SDBOR utilized exclusively 5% coupons.
Both transactions priced amid a fall in rates that began in November and stretched through the end of 2023. From November 1st through the 16th, the day before GMU went to market, MMD dropped by 47-55 bps across the curve. On GMU’s pricing day, the index fell another 0-4 bps. Gwynedd Mercy was ultimately able to achieve spreads of 219 and 229 bps on its two term bonds, respectively. From November 17th through December 4th, the day before SDBOR priced, the index continued its downward trajectory, falling 25-35 bps across the curve. On SDBOR’s pricing day, MMD decreased by another 4 bps across the curve. SDBOR was ultimately able to price its bonds at final spreads of 34-69 bps. While there are no directly comparable coupons between the two deals, we do gain some insight into spread differentials across the credit spectrum by comparing the 2038 maturities from each transaction. Gwynedd Mercy’s 2038 maturity features a 5.25% coupon, while SDBOR has a 5% coupon in that year. The spread differential between the two is 150 bps, which equates to roughly 30 bps per rating notch. On a yield basis, the difference becomes even more pronounced, with SDBOR’s 2038 maturity coming in 193 bps below that of GMU’s 2038 maturity. While not a perfect comparison, this highlights the pricing challenges that institutions rated in the BBB range and lower can face in the current market when compared to higher-rated borrowers.
Meet the Author:
Erik Kelly serves as President of Blue Rose, providing leadership, coordination, and oversight of the firm’s advisory services since 2011. Mr. Kelly contributes to the strategic direction for the firm, oversees compliance with the changing regulatory environment, and ensures the quality of professional advice provided to the firm’s clients.
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