SNW maintains its outlook for the municipal not-for-profit higher education sector as stable with negative lean after tax reform passed at the end of the year. This is consistent with the ratings agencies – one views the sector as stable and two have negative outlooks. Large, wealthy names dominate our index, which influences our stable outlook. But the negative lean is because of secular population trends and cyclical affordability headwinds that may influence the performance and credit quality of the sector over the next 12 to 18 months. Tax reform added another layer of cyclical challenges to the sector.
To recap, the secular trend in high school population is marginally positive but growth is not evenly distributed. While attracting students was relatively easy in the past, colleges and universities face a stiffer and more competitive market environment today. In addition, affordability issues are challenging the cost/benefit analysis for some students. The new cyclical risks in the sector are due to tax reform, possible immigration reforms and investment cycle.
End of year tax reform added new elements that could impact the sector going forward. The first issue is the implementation of a new 1.4% endowment excise tax on endowments larger than $500,000 per full time student. Yale Divinity says:
“The exact calculation is not totally known since not all investments in endowments are liquid. But assuming the government elects to consider everything, for Yale Divinity School this would amount to a tax of 1.4% on the return of our $362 million endowment. We consider a return of 8.25% to be break even since we distribute 5.25% of the earnings and allow 3% for inflation. If we use the 8.25% as a figure, the return on $362 million is $29,865,000. The tax would be $418,110 at 1.4%.”
More clarity is needed to measure the final impact from the excise tax. Overall, the tax will not be material to the sector but targeted at private wealthy universities.
All-in, we a seeing better relative value opportunities in other sectors of the market and will look to evaluate how these trends ultimately play out.
Source: OFI / SNW Team Research, Yale Divinity