Earlier this month, Kaufman Hall hosted a webinar on “Beyond the Outlooks: Our Second Annual Conversation with the Rating Agencies.” Our panelists included the higher education sector leaders from the three rating agencies: Emily Raimes from Moody’s Investors Service, Emily Wadhwani from Fitch Ratings, and Jess Wood from S&P Global Ratings; a record of the webinar is available here. Key takeaways from our conversation included the following:
Mixed outlooks
Moody’s has a stable outlook for 2024, Fitch has a deteriorating—or negative—outlook, and the outlook from S&P Global is bifurcated, with institutions with strong demand and financial resources well positioned for the year and less selective, more regional institutions continuing to face negative pressures.
Despite the mixed outlooks, the rating agencies cite common factors driving their expectations for 2024:
- Improved macroeconomic conditions
- Stabilization of labor costs
- Generally soft enrollment trends
- Relatively inflated interest rates affecting the cost of capital
- Some continued strength in balance sheets
- Limited impact of cost reduction efforts now that most of the “low-hanging fruit” has been gathered
All three agencies saw the ratio of rating downgrades to upgrades grow over 2023, with that ratio reaching near or slightly above 2-to-1, especially by the second half of the year. Downgrades were concentrated largely within the lower end of the rating spectrum. As in past years, the preponderance of ratings were affirmed.
The question now is whether the sector is stabilizing at the bottom of the trough, or whether a trajectory of decline will continue, albeit at a slower pace than in 2023.
Growth strategies
The panelists were asked to comment on two strategies to grow enrollments: first, restructuring tuition pricing, typically by rebasing tuition at a lower price, and second, using athletic programs to grow enrollment.
Tuition repricing
The results from tuition repricing strategies have been a mixed bag. There have been examples where initial success has been followed by a slow upward creep in tuition sticker price back toward its original level, and perhaps more commonly, an inability to maintain discounting at a commensurate low level. Others have successfully transitioned to a lower pricing structure. Factors for success include:
- Effectively communicating the mission-focused reasons for the tuition price reduction to alumni who may worry about the sustainable value of their degrees
- Paying careful attention to marketing and branding initiatives around the strategy so that multiple stakeholders, including faculty and current students, feel part of the process
- Carefully managing ongoing tactical variables necessary for maintaining sustainable revenue given the lower tuition price point, including appropriately low discount rates which do not creep upward and the maintenance of the low sticker price over years
There can be a psychological element that limits the effectiveness of this strategy, according to the panelists. Some students would simply prefer to attend a school that charges $40,000 for tuition but offers a $20,000 scholarship instead of a school that charges $20,000 for tuition and offers no scholarship.
In all cases, institutions that pursue a tuition repricing strategy should expect rating analysts to pay close attention to the strategy’s projected and actual impacts on demand, enrollment, and finances.
Athletic program expansion
The analysts have seen considerable movement in college athletics in recent years. Beyond the high-profile shifts of teams in the elite conferences, there has been significant activity at smaller colleges focused on moving their athletic programs from the NAIA to an NCAA Division II or III ranking or from a Division III to a Division II ranking.
The panelists agreed that with very few exceptions, athletic programs are a recruiting tool, not a revenue driver. The analysts have seen some early successes at schools that have expanded their athletic program offerings, and there is clearly demand from students who want to continue participating in athletics at the college level, even if they cannot qualify for an elite team. But the analysts also note that this strategy has a long tail. Because athletics is typically a “loss leader” department, the rating agencies will be interested both in whether enrollment growth tied to program expansion is enough, and whether it is financially sustainable over the long term. Athletic programs are very difficult to unwind once they have been established, and the proof of this strategy’s success is still a few years away.
That said, athletic program expansion can have other benefits, including enhanced alumni engagement and higher donor contributions. It can be difficult, however, to pull apart and quantify these qualitative benefits against the known costs of investment in the programs.
Regardless of which growth strategy is being pursued, analysts want to see detailed information on what the institution plans to gain from the strategy and how the strategy will be implemented. For example:
- What are the funding sources for the strategy?
- What are the annual expectations for results, projected, ideally, over a multiyear period?
- What off-ramps are in place if the strategy does not succeed?
- How does the strategy align with the institution’s mission and its competitive environment?
- What is the track record of the management team and institutional governance in successfully implementing other strategic initiatives?
If this information is not supplied by the institution, the analysts will make their own projections, using their own assumptions. It is far better to come prepared with the information and let the analysts ask questions. Institutions also should remember that the rating analysts are their tale tellers in the rating committee. The more information the institution supplies to the analysts, the more likely that the institution’s voice will be heard in the rating committee discussions.
Mergers and acquisitions
Continued operational and financial pressures at the lower end of the rating spectrum may lead to some increase in merger and acquisition (M&A) activity. At the same time, higher education is a sector that does not do M&A very well, for some very good reasons. More than almost any sector, higher education institutions face “octopus arms” of constituents: students, families, alumni, donors, legislators, regulators, and faculty. The specific identity and brand of a college or university is a far more foundational concern in higher education than in other sectors. And regulatory requirements—including new rules from the Department of Education intensifying oversight of proposed mergers—have added to the costs and time required to complete a merger.
All these factors pose serious hurdles for institutions that may want to seek a partner. By the time these hurdles have been cleared, financials or facilities may have deteriorated, enrollments may have further declined, and the institution may no longer be an attractive candidate for acquisition. All the more important, then, is the implementation of disciplined financial planning that will enable institutions to understand more clearly, and sooner, the runway they have available for decision-making that implements change.
What the analysts are hearing from rating committees
Current concerns in rating committees include the following:
- The impact of the delayed and technically troubled rollout of the new Free Application for Federal Student Aid (FAFSA) from the Department of Education. Colleges and universities are pushing back acceptance deadlines, and in some instances, even creating their own financial aid forms and processes. The ultimate impacts on enrollment, tuition discount rates, and financial aid awards are still unknown.
- Projections for future liquidity, especially at financially stressed institutions that are implementing strategic plans which may or may not be successful. If liquidity projections are not provided, the rating agencies will develop their own projections and there will be significant discussion of the topic in committee.
- Ongoing skepticism over revenue growth opportunities and the ability to squeeze more costs out of institutional budgets. Again, detailed information, projections, and metrics for measuring progress will help address the committee’s concerns.
We are always grateful for the rating agencies’ willingness to engage and share their insights on the rating process and the higher education sector overall. We look forward to continuing our conversation with them next year!
