College Bond Market Hits Rough Patch

When it comes to college expenses, it’s not just parents who are strapped for cash. Thanks to the still-fragile credit market and wobbly economy, some colleges are experiencing difficulty issuing bonds.

In general, colleges and universities issue bonds to help pay for long-term large capital projects, like building a dormitory or a new academic building or improving on-campus technology. Before going to market with a bond, a school—often via investment bankers—will try to gauge investor interest (typically pension funds and mutual funds) and weigh factors like market conditions and interest rates. In today’s world, that can equal some setbacks.

On June 29, for example, the board of trustees at the West Valley-Mission Community College District in California decided not to put a bond measure on the upcoming November elections ballot. Instead, the district postponed the bond issue—which could have been up to $400 million—until 2012. That missing money will be felt on campus, says John Hendrickson, chancellor for the West Valley-Mission Community College District. The money was supposed to go toward remodeling and restoring aging campus buildings, purchasing equipment and improving technology—projects which are now on hold and will likely remain that way for another two years until the bond is issued, he says.

Other schools are encountering hurdles refinancing existing bonds. In July, Muhlenberg College, a private liberal arts college in Allentown, Pa., canceled plans to refinance nearly $23 million of bonds, which it wants to convert from a variable interest rate to a low fixed rate. The decision was made in part because paying off the outstanding bonds could have left the school carrying more debt than it currently is, says Kent Dyer, the college’s chief business officer and treasurer.

Many factors help a college or university determine whether they should issue or refinance a bond, including market supply and demand, yields and whether inflation is looming. “Normally, this isn’t an area that’s hard to sell bonds in because, depending on the institution, it’s usually of high credit quality, reasonably well managed, and defaults are very rare,” says Eric Jacobson, director of fixed-income research at Morningstar. On the refinancing side, “this part of the market is among the most liquid and easy to operate.” But at the core of some colleges’ difficulties with bonds could be their credit quality, he says.

To a large extent, credit quality is determined by credit ratings. Shifts in ratings reflect changes in a rating agency’s long-term opinion of the financial health of the school. “In most cases, all else being equal, a lower rating tends to correlate with a higher interest rate that they need to issue the bond,” says Roger Goodman, vice president of higher education at Moody’s Investor Service.

So far this year, Moody’s has downgraded 16 colleges’ and universities’ debt compared with 22 for the same period a year ago. Most downgrades have hit smaller institutions that have lower ratings, in the Baa range. (Among the schools Moody’s has downgraded are Franklin Pierce University in Rindge, N.H., Birmingham-Southern College in Alabama, Hartwick College in Oneonta, N.Y., and Central College in Pella, Iowa.) When determining whether to downgrade a college, the ratings agency looks at several factors, including the school’s ability to sustain enrollment in an environment where parents’ willingness to pay higher tuition may decline, as well as absorb losses in investment portfolios and a decline in fundraising, says Goodman.

For now, the biggest impact that college students may see resulting from bond-related obstacles is the postponement or complete cancellation of new academic or dormitory buildings or improvements in other parts of a school’s infrastructure. “Whether a rating change goes up or down, it’s not likely to directly impact the quality of the student’s experience,” Goodman says.

Instead, the challenges that schools are facing with issuing bonds could present an opportunity to college boards to look for ways to be more productive, says Anne Neal, president of the American Council of Trustees and Alumni, an independent nonprofit that works with college and university governing bodies. “Is this really the time for an expensive new building project —or are there other things that can enhance revenue streams?”