Cash flow problems in higher education
There have been endless stories about the massive student loan problem. One in six borrowers are now late in their payments. It’s a crushing burden for college graduates who can’t find a job or don’t have one that pays enough. We also hear about colleges and universities that are struggling with debt loads that they took on to finance new construction. The New York Times reported in December 2012:
But some colleges and universities have also borrowed heavily, spending money on vast expansions and amenities aimed at luring better students: student unions with movie theaters and wine bars; workout facilities with climbing walls and ‘lazy rivers’; and dormitories with single rooms and private baths.
Instead of funding better instruction, the borrowing mainly addressed campuses and housing. More from the Times:
Spending on instruction has grown at a much slower pace, studies have shown. Students end up covering some, if not most, of the debt payments in the form of higher tuition, room and board and special assessments, while in some instances state taxpayers pick up the costs.
Several well-known schools have been downgraded to junk or speculative-grade debt for problems related to cash flow problems (spending faster than money comes in).
In December, Moody’s downgraded the liberal arts college Bard to junk (Ba1) from investment grade (Baa1); a four-notch downgrade. Here is the scathing analysis from Moody’s:
The downgrade to Ba1 reflects razor thin liquidity and weakening cash flow from operations combined with an entrepreneurial operating model that continues to grow the college’s expense base and exposure to philanthropy. Bard’s continued reliance on operating lines of credit to support operations underscores the college’s growing dependence on cash gifts and pledges to fund its expanding operations, a willingness to fund operations and projects prior to payment on pledges, and the uncertainty of the timing of the receipt of pledge payments. The Ba1 rating also factors the college’s high leverage and ongoing capital needs and incorporates limited documentation and transparency of policies, practices, and long-term planning.
When Moody’s writes “a willingness to fund operations and projects prior to payment on pledges,” it is essentially saying the school is throwing a party and donor pledges need to be paid more quickly to keep the punch bowl filled. Moody’s also wrote that Bard did not have enough money to cover debt payments in 2013:
Operating performance has weakened, and the college’s limited annual operating cash flow in 2013 was insufficient to fully cover debt service requirements.
On the plus side, Moody’s congratulates Bard for a “superior” donor base and global brand:
Superior but concentrated donor support that is a crucial part of ongoing operations, a strong market position with an increasingly global brand, and recent actions that could bolster sources of liquidity support the rating at the Ba1 level.
Moody’s also downgraded Yeshiva University deep into junk (B1) from investment grade (Baa2); a five notch downgrade. Moody’s downgraded the school three times in the past year over losses to investments in Bernie Madoff’s funds. From the Moody’s analysis:
The magnitude of the downgrade to B1 reflects the depth of operating and cash flow deficits concurrent with extremely thin unrestricted liquidity and lack of a clear strategy to regain financial equilibrium. Minimal headroom, if any, expected under covenants exacerbates risks of limited liquidity and heavy reliance on external bank lines. Extraordinary reliance on the endowment to fund operations and cover debt service, likely to continue for the near-term, will erode or, at best, prohibit growth of financial reserves in line with peers.
And what does Moody’s suggest for Yeshiva?
The rating reflects the immediate need for an operating and financial turnaround that is sustainable and transparent throughout Yeshiva’s consolidated businesses. Ongoing exposure to potentially negative reputational and financial impacts from pending litigation as well as organizational restructurings constrains the B1 rating.
The current weak financial conditions in universities are painful to correct. But operating expenses are easier to adjust than over-building facilities to attract students. Cash flow problems will likely cause more headwinds down the road for higher education institutions.