Muniland: Toga! Toga!

It’s that time again, when SNW analysts make weighting recommendations for a specific sector in the municipal bond market. Each month a specific sector is the subject of an in-depth review, which includes an analysis of the sector’s relative credit quality, issuance trends and pricing relative to other sectors in the muni market. This month we reviewed the higher education sector. There are two notable trends in the sector: (1) a secular decline in the high school population, and (2) a cyclical trend of waning affordability. Overall, the public and private higher education sector earns a neutral credit outlook. 

The major secular trend impacting the higher education sector is slowing high school matriculation rates. The U.S. Department of Education projects the high school population will only grow 1% between 2011 and 2022. That rate of growth is four times slower than the robust 1992 to 2005 growth period. While we continue to see overall growth in the high school population, this growth is not geographically equal. Generally, the Upper Plains, Great Lakes, Northeast and Mid-Atlantic regions will see declining high school populations. Regions garnering a disproportionate share of the high school population growth are the Southeast, Texas, Southwest and West Coast. This secular trend is a credit negative for smaller colleges (<2500 students) and less selective liberal art colleges in regions with a declining high school population because there will be greater competition for fewer students. However, public flagship state universities are bucking this trend due to more attractive offerings and relative affordability. Nationally, fewer graduating high schoolers mean a much more competitive market environment for students. 

The major cyclical trend in higher education is declining affordability. There is significant regional variability in the cost of tuition and room and board, but on average one year at a public four year institution costs about $20,000, and one year at a private university is $43,000 (see figure 2). In nominal terms, tuition growth for both public and private schools is trending along at its historical rate of ~3.0% over the last 10 years. But in real terms (adjusted for inflation), we see a totally different story, where tuition is growing, but median family incomes have declined about 2% over the last 10 years. The result is a mismatch between what families can afford versus the real cost of a higher education. Affordability is always a credit concern, but if a high cost provider has elite status or strategically important market positions, then affordability becomes a lesser concern. We know how well an institution is competing by measuring net tuition revenue growth, which is total tuition revenue minus total scholarship and financial aid. If credits have sufficient net tuition revenue growth, they demonstrate pricing power and typically have excellent credit fundamentals. If credits have declining net tuition revenue growth, they lack pricing power and the institution cannot raise tuition or may have to subsidize tuition by providing more financial assistance.

In all, SNW has a neutral credit outlook for the higher education sector, even given the secular and cyclical headwinds. This is because credits that have a large scope of operation (universities with large enrollments, teaching hospitals and research facilities), and with sizable endowments and wealth, dominate our benchmark. These credits have a competitive edge and strategic market positions to attract more students from a shrinking population. These are the credits where we are focusing our investments. Our benchmark has a small allocation (<1%) to liberal arts schools, but these credits face a highly competitive environment, and if they are located in states with declining high school enrollments and lack large endowments, they could be on a fast track to credit downgrades. In turn, we are avoiding exposure here. 

Source: U.S. Department of Education, The College Board, Creditscope and SNWAM Research