Downgrade leaves a San Francisco Bay-area college teetering above junk

A Moody’s Investors Service downgrade leaves St. Mary’s College of California with no breathing room above the speculative-grade rating category.

Friday’s downgrade to Baa3, the lowest investment-grade rating, from Baa2 affected $53 million of debt issued through the California Educational Facilities Authority, a state treasurer’s conduit.

The rating agency also maintained a negative outlook.

Saint Mary’s is a moderately sized private, Catholic not-for-profit college in Moraga, a town of 16,870 east of Oakland. The more than 150-year-old university was founded in San Francisco, but relocated to Moraga in 1928, according to its website.

The U.S. higher education sector as a whole is pressured by declining enrollment and inflation-adjusted tuition revenue declines, according to reports published by Moody’s and Fitch Ratings last year.

Small private colleges and regional public universities will endure greater enrollment losses, said the Moody’s team.

Private and public university net tuition is projected to rise by a median 2% in the current fiscal year, said Moody’s report on the entire sector. That is well under the 7.7% annual inflation level reported by the U.S. Department of Labor in November for the 12 months that ended in October.

In fiscal 2022, Saint Mary’s generated operating revenue of $119 million and enrolled 2,229 full-time equivalent students, according to Moody’s.

“The downgrade of the college’s issuer rating to Baa3 is largely driven by heightened student demand challenges contributing to weak operating results, lower debt service coverage, and increasingly thinning liquidity,” Moody’s analysts wrote. “Social considerations are a key driver of this rating action, with highly competitive market conditions, challenging regional demographics and shifting student preferences contributing to significant declines in both undergraduate and graduate enrollment.”

Officials from the college were not immediately available for comment.

What Moody’s called the “student market headwinds” will continue to strain pricing flexibility and growth in net student revenue for St. Mary’s, which typically accounts for over 80% of total operating revenue, according to the ratings agency.

While the college has implemented various expense management measures, deficit operations are likely to continue through at least fiscal 2023, potentially driving further erosion in unrestricted liquidity. The college’s exposure to demand debt, financial covenants, and collateral posting requirements introduces additional credit risk.

The rating “reflects Saint Mary’s good wealth and scale, with approximately $212 million in total cash and investments and $119 million in operating revenue in fiscal 2022,” Moody’s said.

The college also has a solid regional reputation as a Catholic liberal arts education provider with good donor support underpinning its weak brand and strategic positioning, Moody’s said.

“The college’s ability to successfully execute its articulated strategies to improve student demand, strengthen operating performance, and gradually build up liquidity will largely determine the trajectory of its credit quality,” according to the ratings agency.

The college’s Baa3 revenue bond rating is based on the issuer rating and the broad nature of pledged revenues.

According to the notes of its audited financial statements for the year ending June 30, 2021, posted on the Municipal Securities Rulemaking Board’s EMMA website, St. Mary’s outstanding debt, which has a 2043 maturity, has a monthly interest rate reset under terms of a five-year direct purchase agreement with Bank of America Public Capital Corporation.

The negative outlook reflects “expectations of continued student market difficulties, operating deficits, and weak liquidity into at least fiscal 2023. The outlook also incorporates the liquidity risks introduced by its exposure to demand debt and associated debt structure risks,” Moody’s analysts said.

Meaningful strengthening in brand and strategic positioning, reflected in improved student demand, philanthropy, and revenue growth trends combined with significant and sustained improvement in operating performance and growth of reserves while maintaining strategic investments in academic programs and capital improvements could lead to an upgrade.

The inability to strengthen student demand and sustainably restore net student revenue growth could lead to a downgrade, as could failure to make significant progress in restoring fiscal balance by fiscal 2024 or to remain in compliance with the various financial covenants.