Midwest colleges face headwinds in a challenging time for higher ed

Nearly half of America’s private colleges and universities reported negative operating margins in fiscal year 2023, and the situation was even worse in the Midwest, according to preliminary data compiled by Merritt Research Services.

Within the Midwest region, roughly 50% of colleges in the east north central states had negative operating margins, while 67% of those in the west north central states (located west of the Mississippi River, like Missouri, Iowa, Minnesota and the Dakotas) were in the red.

Merritt’s data set includes half the sector’s total issuers; the rest have yet to report their 2023 results. But already, the numbers show a significant decline year-over-year.

Richard Ciccarone, Merritt’s president emeritus, said he expects that when all the data is in, the preliminary trend will persist: “All but the elite private colleges face the same headwinds for fiscal year 2023 related to demographics, operational expenses to cover higher personnel expenses and the already prohibitive cost of tuition and fees,” he said. 

Enrollment declines in the west north central states, of negative 3.4%, were the greatest of all regions in the country, according to Merritt, with east north central schools down 2.2%.

Most private schools rely on student fees to fund operations. With headcounts already declining and with an enrollment cliff looming for colleges of all stripes, the higher education sector will have to adapt.

Christopher Brigati has been following the sector for several years. The director of strategic planning and fixed income research for San Antonio-based SWBC, a financial services company, Brigati has been trading credits of small private schools in the secondary market.

He said he’s noticed a divide between haves and have-nots in higher ed, which he traces to differences in rankings and enrollment issues.

The initial months of 2024 have brought a steady drumbeat of bad news for some Midwest colleges. On Feb. 6, Moody’s Investors Service revised the outlook on Baa2-rated Maryville University to negative from stable, citing the Missouri school’s “constrained financial operations and student market risks.” 

Maryville, with about 7,600 full-time equivalent students and $63 million of outstanding debt, has continued to invest in strategic initiatives despite lower net tuition growth, on which it relies heavily, Moody’s said.

On Jan. 23, Moody’s revised the outlook on Kenyon College’s A2 issuer rating to stable from positive, pointing to expected “narrowing operating margins” in the short term at the Ohio college, given decreasing enrollment after a stretch of over-enrollment.

On Jan. 22, Moody’s revised its outlook to negative from stable on junk-rated Augsburg University. The Minnesota school, with 2,998 full-time equivalents, is rated Ba1 and has $63 million of debt issued through the Minnesota Higher Education Facilities Authority. Moody’s highlighted Augsburg’s recent softening operating performance, which could imperil its ability to meet debt service coverage covenants and which lowered its unrestricted liquidity. 

Kroll Bond Rating Agency, in a May 2023 report, cautioned against over-relying on “vanity” metrics like rankings and acceptance rates, instead of financial metrics, in evaluating the credit quality of colleges and universities.

The report noted that most private nonprofit colleges and universities have strong track records of repaying debt obligations in a timely manner.  

“Such a track record suggests that credit ratings assigned to some private colleges and universities by the other large rating agencies are too low, especially when compared to other municipal asset classes,” the report said. “In KBRA’s view, the overreliance on certain ‘vanity metrics’ like student selectivity leads to a rank-ordered competition where ratings are detached from the historical default and recovery risks they are supposed to reflect.”

Kroll analysts told The Bond Buyer they saw room for higher ratings in some situations — for example, if two schools with similar financials received different ratings because one of them had an 8% acceptance rate and the other had a 15% acceptance rate.

The analysts also acknowledged a phenomenon that Brigati highlighted: the trade-off that investors are making in the higher ed space given a move toward covenant-light or no covenants at all.

From a credit standpoint, the Kroll analysts said, higher education has shifted over the last 10 or more years toward a loosening of deal structure: looser covenants or none at all; no mortgage; and unsecured general obligation pledges.

As schools have moved away from issuing debt secured by revenue streams, gross tuition or a basket of revenue, investors are looking for better pricing to compensate for the lack of structure or ability to come in and take control in the event of a problem, the analysts said.

“Despite decent credit ratings (single-A, for instance), portfolio managers and buy-side accounts were overly dismissive of the offerings without a significant price concession from what I would expect for single A-rated credits,” Brigati observed of smaller private colleges’ debt. “Thus, liquidity of the issuers appeared to be much poorer than I expected.”

And the credit risk is real. Last March, Iowa Wesleyan University, a 181-year-old private college in Mount Pleasant, Iowa, announced it would shutter due to an enrollment shortfall, its debt burden, inflation and a decline in philanthropic donations. 

The school had $26 million of debt either guaranteed or held by the U.S. Department of Agriculture.

Iowa Wesleyan University

Merritt’s Ciccarone noted that roughly 10% of Midwestern private colleges now face both negative operating margins and low liquidity. “Debt repayment becomes highly problematic if negative margins are repeated,  liquidity is weak, and the debt burden is high for the size of the college,” he said.

Additionally, tuition-dependent private colleges have to make the case their higher prices are worth it. 

Ciccarone said “some students and parents balk at the value proposition” of private colleges. “Tuition levels of colleges reported to date in the Midwest grew at a pace that surpassed the [national average] in fiscal year 2023,” he said. The tuition rates in east north central states in particular outpaced the national average.

Barring a shift in the way nonprofit schools do business, “I expect challenges to the credit quality of such issuers,” Brigati said. “I would anticipate more credit downgrades in the sector in the next several years.”

The Federation of Independent Illinois Colleges and Universities is a Springfield-based trade group for the state’s nonprofit colleges and universities. President David Tretter acknowledged that recent data reveals some schools are struggling.

“It’s certainly a challenging environment. If we were to drill down to the Midwest, competition for students is pretty intense, and then there’s the demographic cliff,” he said. “High school grad numbers are tapering off. If you look at the data, it’s not super aggressive, but even small changes make a difference.”

Illinois has lost some nonprofit private colleges over the last six years, he said, and other schools have combined to survive. In Chicago, Robert Morris University Illinois became part of Roosevelt University. In Romeoville, Lewis University merged with St. Augustine College.

“I think that’s probably one of the first things you’re going to see, is some mergers or blending of schools,” Tretter said. “Some of those are good partnerships based on student populations and the kind of programs they offer, and they probably made sense. But I think it’s less likely to happen in smaller communities… For many private colleges, they’re small institutions and kind of an anchor in the community they’re in. So when they close, it’s going to be a big deal.”

Adding to the strain on colleges are competitive pressures around meeting the demands of modern college students — high-quality facilities and dorms, for example, and comprehensive student services. And while some larger universities are also struggling, they have an advantage over smaller colleges in that they can be more efficient per student.

“If it’s a very small institution, those economies of scale aren’t there,” Tretter said. 

The Kroll analysts cautioned against a sky-is-falling mentality, noting that institutions can run a deficit for a year or two without being in grave peril. The sector as a whole is largely investment-grade, they said, and any credit rating or outlook changes are likely to be around the margins, affecting only the weaker institutions.

And the news hasn’t been all grim. On Feb. 8, S&P revised Taylor University’s outlook to positive from stable, citing an improved balance sheet, enrollment growth, new programs likely to boost student numbers further, and recent fundraising success. The Indiana school’s Series 2021 economic development revenue bonds, supported by the school’s general obligation pledge. Taylor has about $28.7 million total debt outstanding.

On Jan. 31, Fitch revised Roosevelt University’s outlook to stable from negative and affirmed its speculative-grade B rating on $35.4 million of outstanding Series 2007 Illinois Finance Authority revenue bonds. The Chicago school notched enrollment increases in 2023 and undertook expense control measures, a pairing likely to diminish its structural deficits and allow it to preserve cash flows despite steep debt obligations, Fitch said.

And on Jan. 29, Fitch upgraded Iowa’s Wartburg College, to BB-plus from BB-minus affecting $73 million of outstanding Series 2015 private college facility revenue refunding bonds. The rating outlook is stable. 

Wartburg, enrollment 1,439 full-time equivalents, increased its retention rate by 9% in recent years. It also partnered with community colleges and a private college consortium to improve its transfer processes and it has a strong track record of donations and a sustainable endowment spending policy, Fitch said.

Tretter conceded that his members and their colleagues in neighboring states will have to evolve to survive current trends. But he said in his 34 years in the industry, his organization has only lost a handful of colleges.

“Don’t count us out,” he said. “I think higher ed is going through another pivotal change here, and history shows that the nonprofits have been pretty good at adapting.”

Paraphrasing Mark Twain, he added, “Rumors of our demise have been greatly exaggerated.”