In January, we brought together the higher education sector leaders from the three major rating agencies: Emily Wadhwani from Fitch Ratings, Jess Wood from S&P Global Ratings, and Susan Fitzgerald from Moody’s Investors Service. A recording of the webinar is available here: this blog summarizes five of the key takeaways from our conversation.
1. Outlooks on Higher Education
Although descriptions of the higher education sector outlook vary among the rating agencies, the underlying rationale is similar. Highly selective institutions with strong demand are doing well, but many smaller regional and private institutions are struggling. This has resulted in a negative sector outlook from Moody’s, a deteriorating sector outlook from Fitch, and a stable but bifurcated sector outlook from S&P.
The published outlooks identify various factors underlying the perspective of the agencies regarding higher education. In the webinar, our panel participants highlighted the following as being key determinants:
- An end to pandemic-related relief funding. The flow of non-recurring, pandemic-related federal dollars that have propped up operations at many institutions has ended. While the panelists expect a sector-wide impact, they agreed that this will have the greatest impact on smaller, more volatile institutions that were experiencing difficulties before the pandemic began in 2020.
- Capital markets volatility. As the Federal Reserve has tightened its monetary policy, increased volatility in the capital markets has had an adverse impact on investment portfolios that support, among other things, pensions and endowments. Efforts to contain inflation have had mixed results—prices of some goods have stabilized, but other areas, especially service-related industries, continue to experience strong inflationary headwinds. The panelists described their expectation that markets will likely remain volatile until inflation is brought under control.
- Uptick in operating expenses. Panelists further cited the fact that inflation has also affected operating expenses; colleges and universities are spending more to maintain core services. Inflation is also affecting affordability concerns in higher education, with heightened scrutiny on the value proposition of higher education.
2. Efforts to Contain Expenses
Our panelists agreed that the pandemic demonstrated the ability of colleges and universities to make meaningful efforts to reduce expenses. Emily Wadhwani noted that higher education was second only to the hospitality industry in reducing expenses in the early years of the pandemic through travel bans, hiring freezes, and furloughs.
3. Alternative Programming
Interest in adding alternative programming—including online or hybrid course offerings and certification programs—was growing in the years before the pandemic. The pandemic underlined the value of these programs, including in the eyes of faculty; Jess Wood noted that offering some form of remote learning is now expected and that this expectation is here to stay.
In terms of the impact of alternative program offerings on credit ratings, the devil is in the details, according to the panelists:
- Is the institution taking on alternative programming on its own or in partnership with another organization (e.g., an online program manager, or OPM)? If a partnership is involved, how are the revenues allocated?
- Is there a risk that alternative programs might cannibalize existing programs, or are they a supplement to existing programs? Institutions that have maximized the value of alternative programming have been strategic and thoughtful in not putting existing franchises at risk.
- How is the institution balancing the need to maintain traditional programming while investing in alternative programming? Traditional students still see value in an in-person, campus experience. How are institutions managing to maintain the quality of that experience while building out new, alternative programming?
If done well, alternative programming is generally seen as a credit positive. Susan Fitzgerald noted that vocational or certification programs might have particular value at small liberal arts colleges: there are still vast benefits provided by a traditional liberal arts education, but vocational and certification programs might give students added value in the career marketplace.
Our panelists are seeing consolidation in the sector but are seeing it more among public institutions than among privates: consolidation is often easier with public institutions because of the involvement of state coordinating functions.
While many correlations between higher education and healthcare can be made, our panelists believe that higher education will not follow the same trajectory as healthcare with regard to consolidation. In part, this reflects the panelists’ perspective that colleges and universities are committed to the uniqueness of their vision, and do not want to alienate their alumni and donors. Absent consolidation, closure will be the more likely route for struggling institutions: by the time they reach a decision to partner, they may no longer be attractive to potential partners. That said, our panelists do not anticipate closures to accelerate at a rapid pace.
A more significant trend is consolidation of internal programmatic offerings. Programs with weak student demand, poor student outcomes, or poor contribution margins are increasingly under scrutiny. In some instances—particularly when other institutions are in close geographic proximity—programmatic partnerships provide a potential option.
There was unanimous agreement on the statement that rating agencies hate surprises. If a major issue emerges, the agencies expect the institution to reach out to them before it becomes public: they will always be respectful of confidentiality concerns but need to know about issues before investors start contacting them.
With respect to rating agency presentations, our panelists appreciate an emphasis on forward-looking, strategic conversations. A detailed presentation on historical and current operational and financial performance is welcome but is best submitted several days before the actual meeting and should not be the subject of the presentation itself. The agencies are not interested in a slide-by-slide walkthrough of where the institution has been; they will have already spent time looking at the institution’s actual performance. Rather, the real value of the rating meeting is generated by a focus on future plans and forward expectations. What is the runway for new strategic initiatives? What are the off-ramps if a strategy does not work out? What are the major challenges the institution is facing and how are they being addressed?
Most importantly, colleges and universities should be focused on the long-term relationship with the rating agencies. If there is new information—good or bad—that might affect the rating, reach out to the agencies. If the agencies reach out to you, make sure that someone promptly responds. Investors have committed to bonds that often have a term of 30 years or more. Building a relationship of trust and transparency will ensure that both issuer and rating agency are best positioned to respond to investor questions and concerns.