Bond Issue(s)

June 18, 2009

Rudy Hasl has no illusions about his luck. If Thomas Jefferson Law School hadn't issued its bond for a new downtown campus precisely when it did --- Aug. 27, 2008 -- the school's president knows he wouldn't be talking about new buildings today.

“This was probably Merrill Lynch’s last higher education financing deal,” Hasl said recently.

As observers of the economic meltdown will recall, Merrill Lynch & Co. – a pioneer of the finance industry laid low by the housing crisis – merged with Bank of America in mid-September. It was only two months earlier that Standard & Poor’s had downgraded Thomas Jefferson Law School’s credit rating from “BBB-“ to “BB+,” moving the school into a class of institutions that face “major ongoing uncertainties” and may have trouble making bond payments, according to S&P’s ratings.

While it was possible for Thomas Jefferson to issue a bond after a rating downgrade last July, investors today would likely have little appetite for such risk. As such, the dilemma is more pronounced for dozens of colleges and universities that have seen ratings decline in recent months.

Much of the impact of a rating change depends on the severity. While a modest drop within the same rating category – say AA+ to AA – may not mean too much, a category shift like Thomas Jefferson's is significant. For institutions that see significant downgrades, borrowing is likely to be more costly or even impossible, and some may be forced to put off capital projects altogether until ratings can be improved.

As colleges and universities have been forced to answer more questions about ratings downgrades, many have downplayed the significance. Doing otherwise, however, could make matters worse, according to Lawrence White, a professor of economics at New York University.

“It’s in their interest to try to brush it off and say for public purposes, ‘Ahh, no biggie.’ They don’t want investors alarmed,” White said. “And ratings agencies are going to tell you it is what it is: ‘We think there’s a somewhat higher probability … that they will default.' ”

Given the variables between institutions, however, it’s difficult to paint with a broad brush and say which colleges are potentially most affected by ratings downgrades, according to John Nelson, managing director of Moody's Public Finance Group. Large public universities that do a lot of borrowing, for instance, might be more affected by increased borrowing costs than small colleges that only issue bonds every five or six years, he said. By the same token, a small liberal arts college that’s rated by Moody’s might be more heavily impacted by a downgrade, simply because the agency’s rating is – for many investors – the only real information available about the college’s financial health, Nelson said.

“There’s likely to be people out there that have diverse opinions [about a wealthy institution],” he said. “Whereas, if you’re a small liberal arts college, there’s nobody following you.”

S&P and Moody’s Investors Service, two major rating agencies for higher education, have both been reassessing the financial stability of colleges and universities. In the last three months of 2008, Moody’s downgraded nine colleges, and upgraded only one, Danville Area Community College District in Danville, Ill. The trend grew starker in the first quarter of this year, when Moody’s downgraded 12 colleges and upgraded none. As for S&P, the agency downgraded 10 colleges and universities in the first three quarters of the 2009 fiscal year.

Among the colleges downgraded by Moody’s was Claremont McKenna College in Claremont, Calif., which dropped from Aa1 to Aa2, a category that is still deemed a low credit risk by the rating agency. Given the fact that Claremont didn’t fall into another investment category altogether, officials say they’re not terribly worried about the shift. Richard Rodner, spokesman for the college, said the rating change likely raised the interest rates on newly issued bonds by less than 1 percentage point.

“We do not have plans for further borrowing in the near future,” he said in an e-mail to Inside Higher Ed. “So, I guess I would say that we do not see a significant impact for CMC.”

For some colleges, however, it’s not just new borrowing that can get more expensive. Many colleges issue short-term debt, which is resold on the market over and over again throughout the life of a 30-year bond. If a college takes a hit in its credit rating, the cost of short-term debt can increase quickly. Furthermore, since some investors simply won’t buy bonds below a particular grade, “you’re automatically removing some of the buyers from the market” when ratings fall below a certain level, Nelson said.

In addition to changing ratings, Moody’s and S&P can also alter the “outlook” for colleges and universities. Outlooks – classified as positive, stable or negative – reflect the agencies’ estimate of where a college’s rating may be headed over the next one to two years.

“Based on my experience, I would say the impact of a rating change is usually somewhat more significant than an outlook change,” Nelson said. “However, the biggest change is going to be when there are surprises.”

A college will often retain its underlying ratings, even when the outlook grows more bleak. Such was the case for a bond issue at Howard University, which saw its outlook altered from stable to negative by S&P earlier this month. The university maintained its underlying A+ rating, however, and as such is thought to still be in a strong position to meet its financial obligations.

“The revision reflects operating losses, declining unrestricted resources and endowment, and long-term strategic challenges for Howard’s hospital,” Liz Sweeney, an S&P credit analyst, said in a news release.

Specifically, S&P cited Howard’s small, aging hospital as an issue. While the hospital has made “great strides” reversing operating losses this fiscal year, it’s still expected to lose money, S&P stated.

Howard officials declined an interview request, opting instead to issue a statement through Kerry-Ann Hamilton, a university spokeswoman.

“The university’s leadership is routinely reassessing its long-range plans to improve our overall financial position,” the statement said. “Howard University Hospital, a teaching hospital, is vital to the community we serve and is an important part of our mission.”

While few can doubt the real financial challenges many colleges face in the current economic environment, the wave of downgrades rating agencies have made in recent months also engender some skepticism. Rating agencies are still subject to critics who say they could have provided more sound information about the troubled mortgage and related securities that sent the economy into a downward spiral, so might they now be erring too heavily on the side of caution?

“Likely there is some overreaction,” said White of NYU. “Put yourself in Moody’s position, and senior management must be saying ‘We can’t let this happen again, better that we’re excessively tough than to be excessively lenient.’ "

Colleges Downgraded by Moody’s this year:


Issuer Current Rating Previous Rating
Alabama A&M University Baa1 A3
Bard College and Simon's Rock Baa1 A3
*California Educational Facilities Authority-Series 2007 (Pool) Ba1 Baa3
Claremont McKennna College Aa2 Aa1
Dartmouth College Aa1 Aaa
Drew University A3 A2
Fresno Pacific University Ba2 Baa3
Georgia Tech Foundation Aa2 Aa1
Hanovoer College Baa1 A3
High Point University Ba2 Baa2
Illinois Institute of Technology Baa2 Baa1
Illinois Wesleyan University Baa1 A3
Loyola University of Chicago A3 A2
Northeastern Illinois University A3 A2
Ohio Northern University A3 A2
Rensselaer Polytechnic Institute A3 A2
Rockefeller University Aa1 Aaa
Sage Colleges Ba2 Baa3
Transylvania University Baa1 A3
University of Central Arkansas Baa1 A3
University of Georgia System's Daniells Bridge Technology Center Aa3 Aa2
Yeshiva University Aa3 Aa2

*Issues tax-exempt bonds to assist private non-profit colleges for construction of facilities.

What the Moody's Ratings Mean

Aaa: Highest quality with minimal credit risk
Aa: High quality and very low credit risk
A: Upper-medium grade and subject to low credit risk.
Baa: Medium grade and subject to moderate credit risk, possess certain speculative characteristics.
Ba: Speculative elements with substantial credit risk.
B: Speculative with high credit risk.
Caa: Poor standing and very high credit risk.
Ca: Highly speculative and are likely in or very near default.
C: Lowest rated class of bonds, typically in default.

Colleges Downgraded by Standard & Poor's (July 1, 2008 - March 31, 2009)


Issuer Current Rating Previous Rating
Cornell University AA AA+
Dartmouth College AA+ AAA
Eastern Michigan University A- A
Illinois Wesleyan University BBB+ A-
Madonna University BBB+ A-
Regent University BBB+ A-
Santa Fe College* C BB
Sarah Lawrence College BBB+ A-
Simmons College BBB+ A-
Thomas Jefferson School of Law BB+ BB-


What S&P Ratings Mean

AAA: The highest rating, indicating extremely strong capacity to meet financial commitments.
AA: Very strong capacity to meet financial commitments, and differing from AAA by only a small degree.
A: Strong capacity to meet financial commitments, but somewhat more susceptible to adverse circumstances or changing economic conditions.
BBB: Adequate capacity to meet financial commitments, but adverse economic conditions or changing circumstances will more likely lead to weakened capacity to meet financial commitments.
BB: Less vulnerable than other lower-rated obligers, but still faces major ongoing uncertainties. Exposure to adverse business, financial or economic conditions could lead to inadequate capacity or willingness to meet financial commitments.
B: More vulnerable than obligers rated "BB," but currently has capacity to meet financial commitments. Adverse conditions will likely impair capacity or willingness to meet commitments.
CCC: Currently vulnerable, and dependent upon favorable conditions to meet financial commitments.
CC: Highly vulnerable to nonpayment.
C: Highly vulnerable to nonpayment and may be subject to bankruptcy.
D: Payment in default.

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