Minneapolis, MN | March 24, 2022 | Ben Pietrek, Analyst
In a welcome change from recent years, this year all three rating agencies have assigned a “Stable” outlook to the higher education sector for the first time since 2017. Moody’s maintained its Stable view from last year, and S&P and Fitch improved their outlooks on the sector from “Negative” to “Stable.” Despite the sector’s return to stability, all three rating agencies identified significant challenges that remain for higher education in 2022. Most notable among these are continuing shifts in student demand, the impact of escalating inflation, and volatile financial market conditions that have been further destabilized by the outbreak of war in Ukraine. The consistent theme from all three agencies seems to be that, while the sector appears to have the worst of the pandemic behind it, short- and long-term pressures on the sector remain that will test higher education institutions going forward.
Moody’s: Outlook Remains Stable as Students’ Return to Campus Drives Revenue Growth
Moody’s outlook remains “Stable” for 2022, with the rating agency citing projected revenue growth as students return to campus along with record investment growth as strong positive factors for the higher education sector.  With students largely returning to on-campus learning in Fall 2021, Moody’s projects 4-6% growth in operating revenue over the next 12-18 months, driven largely by increases in revenue from auxiliary activities and supported by modest increases in net tuition. Government financial support will also contribute to revenue growth – according to a National Association of State Budget Officers (NASBO) survey, state spending will increase by 5% in 2022. With state funding comprising a large chunk of public university revenue (for context, the median percentage of revenue from state appropriations for Moody’s-rated public universities is 25%), this projected spending increase should bode well for university budgets in 2022 and going forward. Federal relief funding allocated to mitigate the financial effects of the COVID-19 pandemic will continue to offset revenue losses and expense growth in 2022 and 2023.
In addition, Moody’s highlighted that the significant investment gains achieved throughout 2021 will increase institutional wealth and liquidity in the new year. They estimate that income from invested assets should rise by approximately 15% in 2022 and 2023. This increase in financial resources at the disposal of higher education institutions also has the potential to drive a parallel improvement in philanthropic activity and a reduction of unfunded pension liabilities. Offsetting negative factors include inflation and labor shortages, both of which will cause spending to increase and operating margins to tighten. These factors will be a particular challenge for higher education institutions since salaries typically comprise more than 50% of operating expenses. Moody’s also noted that conservative budgeting in the aftermath of the pandemic will present a challenge to allocating funds for social responsibility priorities and cyber risk mitigation. Cyber risk is likely to increase throughout 2022, as colleges seek to adopt new technologies to assist with remote instruction and thus become more susceptible to ransomware attacks or data breaches. In general, remaining budget constraints will make it more difficult for institutions to address other priorities, such as affordability and inequality of access.
S&P and Fitch: Outlooks Revised to Stable as Colleges and Universities Weather Pandemic Challenges
After maintaining a “Negative” outlook on the higher education sector for four consecutive years, S&P has revised its outlook to “Stable” in 2022.  However, the improvement in outlook does carry the acknowledgement that the sector still has significant obstacles to overcome this year. S&P cited record investment gains averaging around 25% in fiscal 2021, coupled with emergency government funding and increases in tuition and auxiliary revenues associated with students’ return to campus as the strongest factors driving the improved outlook. Despite these favorable elements, S&P views the success of health and safety measures as of the upmost importance to ensure the persistence of financial improvements resulting from the return to on-campus learning. They also highlighted the expectation that the sector’s recovery from the pandemic and other pressures will not be uniform across the country. The strength of each state’s response will likely contribute to how quickly its colleges and universities recover. Another challenge that the sector faces in 2022 is high inflation; when coupled with labor shortages, this could drive up personnel costs and impact the ability to attract and retain staff. Furthermore, S&P identifies demographic shifts as a long-term pressure on higher education. College enrollment has been falling across the country and high school graduation numbers have remained flat, partially as a result of a lower birth rates two decades ago. S&P expects these trends to continue and forecasts a “big drop-off” in the number of high school graduates in the mid-2020s.
Similarly, Fitch has also revised its higher education outlook for 2022 to “Stable,” citing returns to campus across the sector, stronger financial flexibility stemming from federal stimulus, and large investment gains.  The agency also noted that it was closely monitoring funding sources, describing reliance on tuition and fees throughout the sector as a “meaningful constraint.” Fitch also focused on enrollment, noting that enrollment at four-year institutions was resilient throughout the pandemic and especially so with undergraduates already in college and graduate students. However, they also identified long-term regional and local trends will play a large part in shaping enrollment, and that changes in student demand will add a degree of volatility.
All three rating agencies have shifted or affirmed their view on the sector to “Stable” based on fairly similar rationale. Each has also identified challenges that will persist into 2022. Despite the return of most students to campus in Fall 2021 and a highly successful year of investment returns, the changing demographics and student demand patterns will continue to impact issuers in the sector for the remainder of 2022 and beyond. Additionally, the credit climate remains challenging overall – although rating agencies upgraded more colleges and universities in 2021 than in 2020, the three agencies still assigns “Negative” outlooks to a considerable number of institutions. All three agencies noted the challenges faced by the sector will likely be felt more acutely by small- and medium-sized institutions as well as those who rely heavily on tuition as the primary source of revenue. For these institutions in particular, it will be crucial for their leadership teams to be proactive in the face of these challenges.
Given the volatility emerging in the current municipal market, with credit spreads widening significantly, credit ratings and underlying credit profiles are as important as ever for borrowers looking to access the capital markets. If your college or university has an upcoming rating review or is considering issuing new debt, we encourage you to contact Blue Rose to discuss analyzing your potential rating, planning how to articulate your institution’s credit strengths, and engaging with the rating agencies in the current market environment.
 For additional information on Moody’s outlook for the U.S. higher education sector in 2022, see “Higher Education – US: 2022 Outlook Stable as Emergence from Remote Learning Supports Revenue Growth,” published December 7, 2021, by Moody’s.
 For additional information on S&P’s outlook for the higher education sector in 2022, see “Outlook for Global Not-For-Profit Higher Education: Out of the Woods, But Not Yet In The Clear,” published January 20, 2022, by S&P.
 See “Fitch 2022 Outlook – U.S. Higher Education,” from February 3, 2022, for additional information on Fitch’s outlook for the U.S. higher education sector in 2022.
Comparable Issues Commentary:
Shown below are the results of two public higher education issues from the State of Michigan that sold in the month of March. Michigan State University (“Michigan State” or “MSU”) priced its taxable century bond (i.e. 100 year bullet maturity) on March 2nd. One week later, the University of Michigan (“Michigan” or “UM”) priced its Series 2022A taxable bonds on March 9th. This series included a century bond, as well as a 30-year bullet maturity. Michigan State’s bonds were issued for general corporate purposes such as new capital projects, improvements to existing university facilities and infrastructure, and other multi-year strategic initiatives to be approved by the board of trustees. The University of Michigan’s Series 2022A bonds were similarly issued for any general corporate purposes and capital projects that the university’s board may approve. Michigan also issued a concurrent taxable series in the form of its Series 2022B Green Bonds, as well as a tax-exempt Series 2022D issue. The Series 2022B bonds will be used for various capital projects associated with the university’s goal of achieving carbon neutrality by 2040, while the Series 2022D issuance was a $55 million issue serving to current refund the University’s 2012E Bonds.
Both schools’ bonds carried strong credit ratings from S&P and Moody’s. MSU’s bonds were rated “Aa2” by Moody’s and “AA” from S&P, while UM carried ratings of “Aaa” from Moody’s and “AAA” from S&P. Each deal was highlighted by the “century bond” component, with both universities issuing large taxable bullet maturities in 2122. The University of Michigan’s 2022A bonds, markedly larger at $1.7 billion in size compared to MSU’s $500 million Series 2022A, also incorporated a $500 million bullet maturity at the 30-year point in addition to their $1.2 billion century bond maturity. These bonds are notable in that they were the second and third century bond transactions to be sold by higher education institutions since the onset of the COVID-19 pandemic, the first coming from Claremont Mckenna College (rated “Aa3” by Moody’s) in January of this year. Given the market volatility that has taken hold in the weeks leading up to and following the pricing of these two issues, it may be challenging for other issuers to successfully price century bonds in the short term until the interest rate and credit spread environment begins to moderate.
As mentioned above, both of these transactions priced into a relatively choppy market in early March. Interest rates continued on an upward trajectory for both tax-exempt and taxable indices and credit spreads rose relative to their levels seen at the beginning of 2022. 30-year Treasury rates peaked at a high of 2.29% in the week leading up to Michigan State’s pricing and experienced intraday movements of as much as 11 bps over that same period. MSU faced challenges on its pricing date as well, with the 30-year treasury rate rising by 14 bps on March 2nd. Coming to market just a week later, the University of Michigan priced into a market that was similarly difficult. The 30-year treasury rate continued to rise steadily from March 4th through UM’s pricing date of March 9th, with a net increase of nearly 20 bps in those four business days culminating in an 11 bps increase on the day of pricing itself. The pricing differential between these transactions is further evidence of the increasingly challenging environment facing issuers; each new week has brought both higher benchmark rates and wider credit spreads. MSU’s final cost of capital on its century bond was 4.165% (with a spread to the 30-year treasury of +195 bps). The University of Michigan’s final rate on the century bond maturity of its financing was 4.454% (with a spread of +210 bps to the 30-year treasury).
Meet the Author:
Ben Pietrek, Analyst | 952-460-5776
Ben Pietrek joined Blue Rose in 2021 and works as an Analyst. In his role Mr. Pietrek is responsible for providing analytical, research, and transactional support to the lead advisory team serving higher education, non-profit, and government clients with debt advisory, derivatives advisory, and reinvestment advisory services. He is also responsible for credit and debt capacity analyses.
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