First, let me say that I hope everyone is safe and healthy and making the best of these unprecedented times. From what I’ve experienced, Higher Ed institutions are adjusting as efficiently as possible. I have been impressed with the universities my daughters attend, and at how quickly they have responded. An almost seamless move to the on-line classroom is keeping them engaged and learning.
From a financial view on the Higher Education sector, after a short stint of Stable outlook last year, not surprisingly, the COVID-19 virus has prompted Moody’s to change their outlook back to Negative. Why the change? The immediate impact of lower revenue, higher expenses, and increased uncertainty for not only fiscal year 2020 but also 2021 have obviously initiated this move. In their base case scenario, it is assumed that there will be some level of recovery in the second half of the calendar year and warmer weather will weaken the spread of the virus.
Expenses hit hard
For some background, approximately 30% of universities already have operating deficits, and 5-10% could see much more credit stress if Moody’s downside scenario plays out (i.e.: the outbreak lasting longer and causing more economic and financial turmoil into the second half of the year).
The quick shift to online education options and other emergency measures that have been taken will likely increase expenses, coupled with some refunding of room and board revenues and other reduced revenues (think no March Madness) can cause even tighter operating performance.
Add in the financial market impacts on reserves, endowment income, potential for reduced fundraising, state support uncertainty, and disruption in research grants and we’ve got the ingredients for a negative outlook.
A few other noteworthy observations from the full research report:
- State support going forward could be a savior, or could worsen as pressures from other sectors such as healthcare demand more dollars. The median contribution to revenue from state support for Public institutions is about 25%. Private institutions rely more heavily on endowment income and philanthropy, also subject to disruption.
- International students, which typically pay full tuition and represent 5% of the sector’s enrollment, may continue to decline.
- Enrollment challenges will heighten, as accepted students delay decisions and returning students may change course due to health concerns and reduced financial ability.
- Reserves and liquidity will immediately be impacted by the poor investment environment, as will longer term endowments that may have spending limitations to keep them from going under water.
- Potential for "financial exigency," an extreme mechanism that allows institutions facing severe difficulties to quickly address fixed costs, including tenure.
- Debt considerations, such as interest rate swaps and short term issuance, could get more expensive as investors continue their flight to safety in Treasury and related securities. Debt covenants may be breached, causing additional financial pressures.
- Pension obligations could see additional pressures on the balance sheet and budget concerns.
I’d like to offer some ray of hope. As with any challenge, we learn how to increase creative thinking for solutions and learn to be more effective. Work with your investment partners to hear what their view on the financial markets might be. Often times, especially for long term investors, there are validating statistics that can be shared to keep focused on the governance policies we have in place for these very reasons. And we will be stronger for navigating through these turbulent waters together.
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Information provided by SEI Investments Management Corporation, a registered investment adviser and wholly owned subsidiary of SEI Investments Company.
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