Municipal Higher Education: Headwinds on the Horizon
For a considerable number of higher education issuers, strong tailwinds will give way to more challenging headwinds, which include waning pandemic aid, demographic pressures, inflation, wage pressures and higher cost of capital.
For much of the higher education sector, financial performance has trended in a favorable direction over the prior two fiscal years. The confluence of significant federal pandemic aid, conservative budgeting, meaningful expense reductions and strong investment returns has positioned most public and private institutions well for the coming academic year. Longer-term, we expect pre-pandemic sector challenges will continue to widen the credit gap, unevenly affecting institutions more reliant upon tuition and student fees in demographically challenged or competitive markets and with more limited financial flexibility.
Moody’s noted the following in its recent annual medians report for private universities:
- The majority of private institutions rated by Moody’s reported revenue declines in fiscal 2021, leading to a median drop in operating revenue of 1.4%. Positively, most universities budgeted for even greater declines and, as a result, also incorporated considerable expense reductions as an offset aimed at stabilizing operating margins.
- Consequently, the median operating cash flow margin improved to 15.7% in fiscal 2021 compared to the average margin of 13.7% generated over the prior two fiscal years.
- Balance sheet ratios also improved as outsized investment gains strengthened the median ratio of spendable cash and investments to operating expenses to 2.0x compared to 1.4x in the previous fiscal year.
While we expect similar financial results for the fiscal year ending 6/30/2022, we also foresee mounting headwinds that will likely challenge credit quality in the subsequent fiscal year, particularly for smaller, tuition-dependent schools that exist in demographically challenged regions. Federal pandemic aid and stimulus funds will no longer be sufficient to provide meaningful budgetary support and net tuition revenue growth will likely be constrained as inflationary pressures accelerate long-standing affordability concerns.
Public institutions may fare somewhat better in the coming fiscal year as state budgets remain flush with federal aid provided under the American Rescue Plan Act; however, affordability concerns and an inflationary cost environment will have an offsetting effect. Further, enrollment pressures occurring sector-wide are not anticipated to abate; the National Student Clearinghouse Research Center recently reported a year-over-year student enrollment decline of 4.1% for Spring 2022, continuing a long-running trend of incremental, but steadily falling enrollment.
Figure 2: Annual % Change in Spring Postsecondary Enrollment
As credit pressures mount, credit selection in the higher education sector will be increasingly important. Institutions that are more vulnerable to periods of economic downturn and ongoing enrollment pressures will be particularly concerning. These include mid-to-smaller tuition-dependent schools with a limited market niche, especially those located in midwestern and northeastern states where population and the number of high school graduates continue to decline. Conversely, public universities, notably the flagship state institutions located in states with stable or improving demographic trends, and the top-tier Ivy League and larger comprehensive liberal arts colleges with strong student demand and established academic programs should continue along a stable credit trajectory.