Municipal Debt and the Changing Landscape of Private Higher Education

The Coming Higher Education Enrollment Cliff Creates Openings

While the Global Financial Crisis might be approximately 16 years in the rearview, it produced lasting effects, including the “enrollment cliff.” Birth rates declined given economic uncertainty from the peak in 2010. In the United States, the number of 18-year-olds (typical college entry age) is projected to peak lower around 2026, leading to a cumulative 23% decline in college freshmen enrollment over the projection period to 2031 and increasing competition between schools. Tertiary institutions of higher learning must balance the population decline with competitive responses focused on the upcoming demand reality. The chart below portrays historical and projected estimates of 1) number of 18-year-olds in the U.S., 2) college freshmen enrollment, and 3) total enrollment. It is notable that the projected enrollments are increasing after a multi-year decline as COVID-19 enrollment recovery continues. This recovery is expected to level off as enrollment catches up with changing demographics starting in about 2030. As this enrollment cliff approaches, it creates opportunities for municipal bond investors.

The Coming Higher Education Enrollment Cliff

Public vs. Private Colleges

Higher education can be split into two broad subsets: public and private. While public entities face the same demographic headwinds, they benefit from greater relative affordability and state funding.

The broad theme of improving financials at the state level has played out with federal emergency response funding coming to an end. Some states that are primarily dependent on income taxes are starting to see glimpses of future deficits requiring revenue increases and/or spending reductions, from which educational spending could feel the pressure. Even with these headwinds, generally, public higher education faces less financial pressure than private, given state support.

Private higher education is where fundamental analysis is critical for municipal bond investors. Astute investors can identify healthy schools at compelling relative values. The subset currently has a negative skew on the aforementioned value proposition coupled with the enrollment cliff.

Highly selective schools maintain strong demand profiles and often robust fundraising and endowment support. These schools are performing well but offer less relative value for municipal bond investors due to high demand for the bonds.

It seems that not a week goes by without a (generally smaller) private school facing a bond covenant violation, debt service reserve draw, missed debt payment, or worse, a closure. Such an environment creates opportunity for municipal bond investors.

The real value is finding lower to moderately selective schools able to fight the headwinds and maintain/grow enrollment while successfully passing along steady tuition increases without increasing discounts. Their moderate selectivity and reliance on tuition solidifies a credit rating ceiling towards the lower end of investment grade, where many challenged schools reside. This presents relative value opportunities for municipal bond investors who can identify these schools and purchase them at attractive levels, delivering a positive relative risk/return skew.

Once a moderately selective private school is identified, key points of focus are enrollment trends, net tuition revenue per student (is the school able to successfully pass along education costs?), operating margins, and endowment usage (is the school running a sustainable spending policy?).

Many schools, feeling the financial pressure, face tough decisions regarding their own value propositions compounded by strained statements of revenues and expenses—the non-profit version of an income statement. Discerning which schools are both likely to outlive the coming enrollment cliff and offer relative value to municipal bond investors can benefit from decades of experience in muni markets and careful bottom-up investment analysis.