In Debt, Making New Promises

Colleges with distressed debt are making new promises to delay financial ramifications from investors.

February 23, 2015

In largely unnoticed side deals with investors, several colleges have promised they will raise prices on students, force students to live in dorms and even increase class sizes as they lay off faculty.

These are not for-profit colleges. Instead, they are nonprofits running into trouble with their debts. Unable to fulfill promises made when the colleges borrowed money years earlier, these colleges have struck deals to head off severe penalties, including foreclosures of campus property.

The debt was borrowed in the form of bonds, usually for campus construction. These bonds come with a host of financial conditions colleges must meet. Colleges agree to make timely payments, of course, and also to set aside a certain amount of money to cover their debts.

But, as colleges struggle to find enough students or run into unexpected market conditions, they may not be able to fulfill all these promises. To avoid penalties, at least a handful of colleges have promised their bondholders they would do things that could substantially affect student life. 

These agreements -- which are usually publicly available but largely unknown to students -- could eventually raise questions about who is in charge of the institution: the college’s governing board members, administrators and faculty, or the people who hold its debts?

“To a banker, to an investor, it doesn’t matter if you’re a nonprofit or a for-profit. The bottom line is you owe them money,” said Kenneth Hartman, a senior fellow at Eduventures and a former president of Drexel University’s online operations.

Others take a more subtle view: debt holders want nothing less than to run a college, and what is good for the college is also good for investors. 

Perhaps the most noted case of a college running into trouble right now is Thomas Jefferson School of Law, in San Diego. It signed an agreement with investors to restructure itself and promised to meet a series of financial conditions. While that agreement goes into financial details that are forcing significant changes in operations, other agreements lay out requirements for colleges that clearly touch on academics.

Take a deal Iowa Wesleyan College struck last fall with Wells Fargo -- which acts as a trustee on behalf of the college's bondholders. The college promised the bank that the college would enroll a certain number of students over the next several years. It is now contractually required to have 446 full-time students on campus in October 2017. Last fall, it had 361 full-time equivalent students. The college cut its workforce by a third, prompting questions last year about how it can continue to offer thorough instruction in some basic subjects. Now, it’s promised to take on more students.

Florida Keys Community College, a public institution, fell behind on promises it made when it borrowed money to build new dorms. After investors scrutinized its operations, it promised its bondholders it would raise student room fees “to the highest level the market will bear” starting last fall. That meant up to a 12 percent increase for students.

The college also promised that its officials would lobby state lawmakers to expand student housing on the campus.

A spokeswoman for Florida Keys said the price increases for rooms were “logical and prudent” and that the dorms were still less expensive than other housing in the area. The spokeswoman, Amber Ernst-Leonard, also said the college will need legislative approval to expand student housing, which college officials need “in order to reach healthy economies of scale.”

Iowa Wesleyan’s president, Steven Titus, said his college in southeastern Iowa is changing to adapt to a new economy.

“Restructuring operations and its financial position last year have quickly resulted in a renewed academic program, dramatically improved student retention and a dramatic increase in student applications,” he said.

The trouble Iowa Wesleyan ran into with its debt -- "trouble" is a term Titus objects to -- was not failing to make payments. Instead, it did not have an agreed-upon amount of cash set aside for payments.

Upper Iowa University, another private institution in the state, ran into the same trouble, though it got out of it after a year and is no longer under mandatory heightened scrutiny from bondholders. While they're not quite similar, both Upper Iowa and Iowa Wesleyan have laid off faculty and looked for ways to increase enrollment. Both have also begun to force students to live on campus. At Iowa Wesleyan, this was clearly a financial move. A consultant’s report noted that Wesleyan, as part of efforts to increase revenue, “changed its residence hall policy so that students must live on campus all four years,” instead of for just two, as it had in years past.

At Upper Iowa, the university began to enforce a three-year residency requirement, up from two years, a change mentioned in a report by its consultant. A university spokesman, Andrew Wenthe, said the change was for a variety of reasons, but one of them was the college had taken on debt to build new dorms and needed to fill them.

The university is also intentionally increasing class sizes so that the student faculty ratio will move from 14 students per professor to 19 students per professor by next year. The college also increased the number of students in each section of its online classes from 15 to 20.

The university also reduced its use of discounting, in the form of scholarships, meaning some students might be paying more, although that is a healthy sign for a tuition-dependent college.

These are all things a college might do anyway in the face of financial obstacles, but to see the decisions spelled out in black and white in papers prepared for investors is unusual, especially at a private college. It's also unusual to see financial interests peering into colleges' operations and making suggestions about how they should operate.

Upper Iowa is considered a success story. It needed to meet three financial conditions and had failed to meet one. With the help of an outside consultant, hired at the behest of bondholders, the college executed a turnaround plan of sorts.

“Really what the bondholders do is they provided the university with a new perspective, a way for us to look ourself through a different lens,” said Upper Iowa’s chief financial officer, Leslie Anderson.

She said the consultants and the bondholders are not trying to control the college but to get an understanding of what is happening.

“They are not interested in owning property at universities across the country,” she said. “They are more interested in trying to prevent institutions from getting to that point.”

Most students are likely to have little if any idea about what is happening behind the scenes. 

At Upper Iowa University, officials have begun talking with students about the college’s finances, mainly to tell them what their money is going to. But the university did not tell students about the process it was going through with its investors, even though those decisions would affect how students lived their lives.

Titus said Wesleyan has made new deals with investors but that had “not led to heightened scrutiny by bond trustees.”

But the college now has to file more frequent financial reports and retain Longhouse Capital Advisors, the same consultant Upper Iowa uses. Colleges hire consultants all the time, but they are often required to hire a consultant as part of their bond agreements when their debt becomes distressed. Iowa Wesleyan also last year borrowed from several banks another $5.75 million through a loan program. To secure those loans, Iowa Wesleyan has put up 11 campus buildings that were not already collateral for previous debt, as well as part of the college’s endowment.

The decisions a college makes to get out of financial trouble may be made, formally, in an effort to make sure bondholders recoup their money, but the same decisions may also benefit the whole campus if it keeps the doors from closing.

“It may benefit the current students,” said David Bliss, the executive director of the New Hampshire Health and Education Facilities Authority, which helps finance nonprofit bonds in the state. “The fact is, they’re trying to keep this place alive, is what they’re trying to do.”

A number of colleges that have municipal bonds, which nonprofits can use, have to make public details about their bonds and their operations as part of financial disclosures required by the Securities and Exchange Commission.

Franklin Pierce University in New Hampshire has not made a key document related to its distressed debt public and will not talk about its troubles, which Moody's Investors Service has warned could result in a default. That makes it impossible for the public to tell what promises the university has made with its bondholders, what conditions those investors might have set and what changes the college might have made to its operations because of its debts.

Sandra Quay, the university’s chief financial officer, said the college was not making the information public. The bond’s trustee, BNY Mellon, did not provide the information, though the agreement is on file there. A spokesman for the university, Jim Wolken, did not comment.

One question without any clear answer yet is whether bankers and investors can come in and control so much of a college’s operations that accreditors might raise questions. For instance, the Higher Learning Commission, which accredits Iowa Wesleyan, has a standard that colleges must be "sufficiently autonomous to make decisions in the best interest of the institution and to assure its integrity."

The accreditor is supposed to look at whether a college’s financial situation confines its governing body's ability to make choices.

Barbara Brittingham, the president of the Commission on Institutions of Higher Education of the New England Association of Schools and Colleges, which accredits Franklin Pierce, said the accrediting agency also has a way to keep its eye on colleges’ financial conditions and also looks at institutions’ autonomy. There is no bright line, she said.

“A lot of the times if the banks are a local bank, they will go out of their way, in particular, to work with the institution, because it’s usually important for the economy,” Brittingham said.

Hartman, the senior fellow at Eduventures, compared colleges with debt troubles to Greece, which adopted widespread austerity measures to receive bailouts from other European countries led by Germany. 

“What are you going to do with a bunch of dormitories in Mount Pleasant, Iowa?” Hartman said, naming the town Iowa Wesleyan is in. “So [bondholders] will work with an institution, but it will oftentimes require an institution to make significant changes to the way they operate the institution -- on a global scale, we see what is happening with Germany and Greece right now.”

The involvement of the bondholders may increase depending on the conditions of the college. And, at times, it seems, the wishes of the bondholders may not get memorialized, but the colleges get the idea. This means that even colleges that make public their agreements with bondholders may not be telling the whole story. The true scope of colleges with distressed debt is also largely hidden, in part because colleges with weaker finances may not even turn to the public bond market, which requires the colleges to disclose their operating conditions. These other colleges' troubles, then, may be between the institution and a bank, perhaps a local bank. Students, professors and local media may never know if things are going south until it's too late.​

Still, while bondholders may be able to force drastic changes at a college, including dumping senior management, it doesn’t necessarily mean they can or should.

“That just alienates the people who care about the institution the most,” said Lee White, the manger of the education and nonprofit finance group at George K. Baum & Company, an investment banking firm that specializes in public debt. “You want to keep the people who care about the institution the most in place.”


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