Upgraded in Down Economy

A handful of private colleges see bond ratings improve during the financial crisis, crediting conservative budgeting and building reserves.
December 10, 2009

It’s been a rough year for higher education, but there are a handful of colleges where a consistent pattern of conservative budgeting has paid off, according to two major bond rating agencies. At a time when many institutions have seen bond ratings downgraded, which can make borrowing more difficult and expensive, 19 colleges saw bond ratings improve in 2009.

Moody’s Investors Service has improved ratings for seven colleges this calendar year, and Standard & Poor’s Ratings Services upgraded 12 institutions during the first three quarters. Public institutions often saw ratings improved because of consistent state or local support, or unique changes in circumstance -- as was the case with the University of New Orleans' post-Hurricane Katrina enrollment gains. A very small subsection of private colleges, however, were upgraded over the last year because of cautious investing and budgetary management that helped them weather a financial storm, according to ratings reports from the two agencies.

Don Myers, vice president of finance at American University, said he wasn’t terribly surprised to see American among the group of privates whose ratings improved during the economic crisis.

“These agencies tend to follow you for a very long period of time; they are very much into trend lines,” he said. “And we have been operating with a financial management strategy for some time that has taken a very conservative approach that I believe is helping us.”

For years, American has tried to take the sting out of potential enrollment declines by setting aside a substantial sum in tuition reserves to be tapped into if targets aren’t met, Myers said. In 2009, American had $5.2 million set aside in reserves, and for the fiscal year that began in July the fund had grown to $5.6 million, according to budget documents the university provides publicly. American continues to build the reserve, with an eye toward stabilizing it at 5 percent of tuition revenue.That's not say, however, that others haven't suggested other initiatives.

“There is never a lack of dialogue about what alternative things we could do with it," Myers said.

The tuition reserve is critical for American, since its endowment – about $350 million – only funds about 1 percent of the operating budget. That means even small fluctuations in enrollment can have a big impact.

American’s public image hasn’t always been synonymous with fiscal restraint. Benjamin Ladner, American’s former president, was ousted in 2005 when his spending on items like a personal chef and a European vacation was called into question. But Myers says the university’s current financial position is attributable to more than a decade of prudence, which has helped keep the university's budget balanced. That planning has helped the university steer funding toward a series of strategic initiatives, including faculty recruitment, scholarships and marketing, Myers said. Indeed, American plans to spend $41 million over the next two years on these and other programs.

“Many institutions we compete with have frozen salary and decreased staff,” Myers said. “We’re doing just the opposite.”

This year, the university put $3.7 million toward a 3 percent performance-based salary and benefits pool for faculty and staff, and another $3.8 million is budgeted for a 3 percent pool in 2010, budget documents show. An additional $2.6 million is budgeted to hire 23 new tenure and tenure-track faculty over two years.

Vanilla Investments Pay Off

Pieces of American University’s budget strategy are shared by the handful of private institutions that have been upgraded in this downward economy. Ratings reports on Sacred Heart University, Villanova University and Webster University – all of which saw upgrades this year – emphasize conservative financial planning.

“Most of their peers don’t generate surpluses in the way these places do,” said John Nelson, managing director of Moody's Public Finance Group. “Almost all schools that generate surpluses put in a lot of contingencies in case things go bad.”

“Some schools budget exactly on the maximum of what they expect [to generate], and they call that conservative,” he added. “Other schools say here’s what we expect and we’re going to budget for 10 percent less than that. So they are protected.”

Villanova, for instance, has used conservative budgeting to produce operating margins – revenues in excess of expenditures – of 10 percent on average over the last three years, according to Moody’s.

This isn’t to say upgraded institutions were spared from the stock market plunge. Indeed, American, Villanova and Webster all saw investment losses of 20 percent in the 2009 fiscal year, and Sacred Heart lost about 18 percent in that period, according to Moody’s.

Many institutions have struggled in the down economy because they got tied up in complex or longer term investments like real estate or private equity – a category that includes start-up companies. Such illiquid investments left colleges with less cash on hand than they planned for, and a portfolio filled with illiquid assets could provoke ratings downgrades.

With an endowment of $74 million, Sacred Heart’s portfolio is a rather vanilla mix of stocks and bonds, and alternative assets like private equity make up less than 5 percent of investments, according to Phil McCabe, vice president for finance. McCabe notes that the university might be more prone to complex investments if its endowment were larger, but says “we’re not a risky institution by any means.”

When the university was upgraded in October, Moody’s labeled Sacred Heart’s rather standard issue asset allocation among its “strengths.”

“The university reports that almost all of its $70 million in investments could be liquidated within one week,” the report states.

Positioned for Troubled Times

While many colleges expect to struggle for years to come in an unfavorable economy, some express hope that their particular niche in the market has advantages. Such is the argument at Webster University, where an aggressive international online presence has helped spur enrollment growth in the unlikeliest of places. Indeed, soldiers deployed to Iraq are counted among Webster’s students.

“Those are students we would have lost five years ago, that we are able to maintain with our delivery systems,” said David Garafola, vice president for finance and administration.

Webster's main campus is located in St. Louis, Mo., but the university offers graduate and undergraduate programs online to more than 100 campuses across the U.S., Europe and Asia. The model makes the university less subject to the fluctuations of the economy in any one geographic region, Garafola said.

“You may have one area that’s up and one that’s down, but the correlation of the whole is a strength for Webster,” he said. “We don’t have all our eggs in one basket.”

Webster also targets adult learners, a coveted demographic in higher education that many colleges see as part of their growth plans.

The university’s bond rating improved in November from Baa1 to A3. The move is significant, because it raises Webster into a new rating category – from Baa to A. In plain English, that means Moody’s analysts now view Webster as a “low credit risk,” as opposed to a “moderate" one. Garafola expects the rating change to lower the borrowing cost on Webster’s $30 million bond issue by about $3 million.

As with the other private institutions that have seen ratings improve during extremely trying financial times, Garafola says Webster’s management strategy predated the recession.

“The university has been working for a number of years very diligently,” he said. “It wasn’t something we tried to do in a short period of time.”

Moody's 2009 Upgrades

Institution Current Rating Previous Rating
Gordon College A2 A3
Massachusetts State College Building Authority Aa3 A1
Sacred Heart University Baa2 Baa3
Texas Southern University Ba1 Ba3
University of New Orleans A3 Baa1
Villanova University A1 A2
Webster University A3 Baa1

Moody's 2009 Downgrades

Institution Current Rating Previous Rating
Alabama A&M University Baa1 A3
Alabama State University A3 A2
Bard College and Simon's Rock Baa1 A3
California Educational Facilities Authority (Pool) Ba1 Baa3
California Institute of Technology Aa1 Aaa
Creighton University A3 A2
Claremont McKenna College Aa2 Aa1
Concordia University Baa1 A3
Daniells Bridge Technology Center (University of Georgia System) Aa3 Aa2
Dartmouth College Aa1 Aaa
Drew University A3 A2
Fresno Pacific University Ba2 Baa3
Georgia Tech Foundation Aa2 Aa1
Hanover 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
Regent University Baa2 Baa1
Rensselaer Polytechnic Institute A3 A2
Rockefeller University Aa1 Aaa
Roosevelt University Baa2 Baa1
Sage Colleges Ba2 Baa3
Saint Mary's College of California Baa1 A3
Saint Michael's College Baa1 A3
Samford University A3 A2
Transylvania University Baa1 A3
University of Central Arkansas Baa1 A3
University of Science & Arts of Oklahoma Baa1 A3
Yeshiva University Aa3 Aa2

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.

S&P 2009 Upgrades*

Institution Current Rating Previous Rating
Fashion Institute of Technology (State University of New York) A+ AA-
Odessa Junior College District A- BBB+
Oklahoma City Community College A A-
Oklahoma State University AA- A+
Philadelphia College of Osteopathic Medicine A+ A
Washington County Junior College District (aka Blinn College) A A-
Iowa State University of Science & Technology ISU** AA AA-
Laramie County Community College Foundation A+ A-
Vermont State College** A+ A
American University A+ A
University of Toledo** A+ A
University of Northern Iowa** A+ A

*Includes first three quarters of calendar year.

**Rating change attributable to newly applied methodology for "Government-Related Entities," which now factors in the likelihood of extraordinary government support in the event of financial stress.

S&P Downgrades

Institution Current Rating Previous Rating
College of Santa Fe C BB
Cornell University AA AA+
Galveston Community College District BBB BBB+
Dartmouth College AA+ AAA
Eastern Michigan University A- A
Regent University BBB+ A-

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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