Colleges as a Credit Risk

Struggling to Stay Afloat

STUDENTS piling on debt to go to college might attract all the attention, but colleges have been on a borrowing spree as well, nearly doubling the amount of debt they’ve taken on in the last decade to fix aging campuses, keep up with competitors and lure students with lavish amenities.

In January, Moody’s Investors Service put a negative outlook on the entire higher education sector, even at major research universities, which had been spared in previous forecasts. And that came after a year in which the agency downgraded the credit ratings of 22 colleges, including Alabama A&M, Wellesley College and Morehouse College. At the same time, Standard & Poor’s Ratings Service downgraded 13 institutions, including Amherst College, Tulane University and Yeshiva University. Combined, both agencies upgraded only eight colleges in 2012.

Bond ratings aren’t scoured like the U.S. News and World Report rankings. But if you’re a parent preparing to start the college search with your son or daughter, the negative financial outlook raises plenty of questions to ask the college tour guide: Will outdated buildings be renovated Will more part-time instructors replace retiring professors Will classes get bigger or will students end up in partly online courses Will the school even be in business by the time your child graduates in four years

“There is a major problem in that the industry has an inability to grow revenue in a way they have for the last 20 years,” says John C. Nelson, managing director of the higher education and health care practice at Moody’s, which examines the finances of more than 500 colleges and universities that issue bonds through public markets.

A handful of colleges have closed, merged or been bought by for-profit colleges in recent years â€" mostly small, tuition-dependent private colleges, which remain at most risk. While few financial experts foresee mass closings in the years ahead, only 500 or so of the 4,000-plus colleges and universities in the United States seem to have stable enough finances to be truly safe. The remaining colleges, where a vast majority of Americans attend, can no longer hold off the technological, demographic and economic forces quickly bearing down on them.

One-third of all colleges and universities in the United States face financial statements significantly weaker than before the recession and, according to an analysis released last July, are on an unsustainable fiscal path. Another quarter find themselves at serious risk of joining them.

“Expenses are growing at such a pace that colleges don’t have the cash or the revenue to cover them for much longer,” says Jeff Denneen, head of the higher education practice at Bain & Company, the global consulting firm that, along with the private-equity firm Sterling Partners, performed the analysis. “A growing number of colleges are in real financial trouble.”

Other forecasts are equally pessimistic. The number of higher education institutions on a Department of Education watch list, for instance, has grown by more than a third since 2007 to include institutions like Long Island University and Pace University.

“We’re seeing prolonged, serious stress,” says Karen Kedem, an analyst at Moody’s. What is significant about the negative outlook is that Moody’s typically rates only colleges and universities with strong balance sheets to begin with.

Reading a college’s bond-rating report is like reading a person’s credit report: it is a financial checkup that gives insight into strengths and weaknesses that you will never find in any college guidebook, but probably should.

Take this line from a Moody’s report when it downgraded Drew University in New Jersey in 2012: “The rating is based on persistent operating deficits and thin cash-flow driven by a decline in enrollment and net tuition per student coupled with rising debt service payments and transition of several key members of university leadership.”

Translation: the private college is operating in a hole (though, Moody’s also notes, it’s helped by having an endowment); it is discounting tuition too much, and it is not attracting enough students, especially those who will pay more in tuition.

Michael Groener, Drew’s vice president of finance and business affairs, who arrived on campus last fall, says the financial decline is largely the result of discounting the $42,000 sticker price too often and too much â€" sometimes by 50 percent. “That is pushing it about as far as we can go,” Mr. Groener says. In the years ahead, he says, Drew needs to bolster revenue through other means, mostly fund-raising, and look more closely at expenses by prioritizing what really matters in a good liberal-arts education.

A version of this article appeared in print on April 14, 2013, on page ED8 of Education Life with the headline: A Matter of Ballast.