Episode 80 - Moody's Outlook for Higher Education

Michael Osborn, VP & Senior Analyst with Moody's Investors Service, joins us this week to discuss the credit worthiness, financial liability, and growth projections of higher education.

Full Transcript

Steve Meredith: Hi again everyone, and welcome to Solutions for Higher Education, a podcast featuring Scott L Wyatt, the president of Southern Utah University in Cedar City, Utah. I'm your host, Steve Meredith, and I'm joined today in-studio, as I always am, by President Wyatt. Scott, hello again.

Scott Wyatt: Hello Steve, it's good to be here today.

Meredith: We've got to stop meeting like this. [Both laugh]

Wyatt: That's right.

Meredith: We are in the midst of a run of podcasts about upcoming challenges facing higher education generally in regards to enrollment, and a sense, and a lot of data backing up that sense, that we are entering a new phase of higher education where there are a number of really significant challenges to us. So, we actually are branching out a little bit and we have a guest who can help us understand financially what is facing higher education in terms of significant challenges. And why don't you introduce him?

Wyatt: Thanks Steve. Yeah, we are delighted to be joined today with our podcast by Michael Osborn who is Vice President and Senior Analyst with Moody's Investors Service. And Mike, you're joining us from your office in New York City, thank you so much, welcome.

Michael Osborn: Thank you very much for having me, I'm delighted to participate in the podcast and contribute in any way that I can.

Wyatt: So, we…I think the three of us understand exactly what business Moody's is in and what "investor service" means, but why don't you talk a little bit about credit ratings and worthiness of borrowers and what it is that Moody's is doing for that?

Osborn: Yeah, sure. It's a question that my family constantly asks. [All laugh] "What is it you do?"

Meredith: "What exactly do you do?"

Osborn: Yeah. And for some, I really dumb it down and it's almost a fabrication because I can't explain it easily enough. But, Moody's provides credit ratings for a myriad of institutions. Not for profit, public, sovereign, sub-sovereign and the like. And in my particular space, we work with—we're in the public finance group of Moody's—and we work specifically with…my team works specifically with universities. I should say not for profit universities and other not for profits like cultural institutions, research institutes, foundations and the like and just like we would go out and shop for a mortgage or maybe a car loan, universities do the same. And they borrow for things like dormitories and science buildings and football stadiums and so on sometimes it's a more economical decision and when deciding to finance those projects comes down to borrowing. And so, we're providing investors with a degree of confidence on a university's ability to repay that debt in full. And that's the gist of what we do. And that involves sort of a complex set, a wide degree of analysis, of applying different metrics and so on, both qualitative and quantitative.

Wyatt: What's…what becomes relevant about that for our discussion today is that Moody's has taken a little bit more of a negative outlook in terms of higher education nationally and softened that this year a little bit, but your view of the credit worthiness of institutions of higher education has changed over time. Can you talk to us a little bit about that?

Osborn: Yeah, sure. And it's important to note, too, that our outlook…and so, one piece of what we…one part of what we do is published research, sector specific research, sometimes university or college specific research and try to provide sort of extra intelligence into the market in terms of what we're thinking and what we think lies ahead, and our outlook is an examination of business conditions. And so, while it can have…while those business conditions can directly and indirectly influence credit quality, it's not necessarily an indication of credit quality, but the broader business conditions that affect the sector. So, I just want to establish that first. but…and you're right, we've had a negative outlook on the higher education sector for the last couple of years. If you look at our December publications leading into 2018-2019, that outlook was negative and just recently we moved to stable. And I would say, while we moved it to stable, it's not that we think everything is substantially better and that the challenges are over. In fact, this report doesn't shy away from many of the challenges that are facing the sector. It's that we think that there is stability in this "new normal" of higher education, and by new normal, I mean lower revenue growth and we'll say stability in enrollment. And while the net tuition revenue…and one of the financial indicators that we're looking at when thinking about credit quality would be growth in net tuition revenue. And it also influences the outlook, but the growth in that very important revenue line is growing. It's growing very modestly, what our stable outlook is getting to is that while we think that growth and net tuition revenue will continue to grow modestly, at this point and in point 20, we think it will be nicely offset by pretty solid growth in state funding for public universities, of course. It will be offset nicely by growth in research dollars, largely by the federal agencies that provide most of the support. We think that the investment mark growth in the investment market is providing a nice buoy for endowment spending for the next couple of years, and that has a direct correlation with fundraising. Philanthropy and that support for universities continues to grow nicely, albeit stronger for some…some benefit more than others with that, but by and large that that revenue item is growing at a nice pace. And then for those that have patient-care exposure like University of Utah, for example in the state of Utah, patient care revenues by and large are growing nicely and economic medical centers and healthcare enterprises are contributing favorably to cash flow. So, all those other revenue, those non-tuition revenue items that we see growing at a healthy rate or at least steady rate, that is not a direct offset to direct tuition revenue growth, but a nice compliment to a more challenged tuition revenue environment. That's a very long winded answer, I apologize for taking a couple of minutes there. I'm trying to squeeze it all in and maybe from there we can delve into some more specifics, but I hope that helps.

Wyatt: No, that's good. So, what's interesting is just that we see that tuition costs continue to go up, but the discounting of tuition continues to increase as well and with the declining enrollments projected out in the country generally, that's leading to this challenge of revenue.

Osborn: Absolutely. And the discount rate is something we're paying close attention to. It is a number that can be interpreted many different ways and we think it has a lot of applicability in the private university college environment where it would be hard to…they don't have state funding, for example, that might be funding flat charges, right? Flat tuition growth. Many states are holding back universities' abilities to grow or to charge more. They might be net tuition revenue, or, I'm sorry, a discount rate be affected by that, but then you have that sort of being funded or offset by state funding. Private universities don't necessarily have that and in most cases, the rising discount rate is a function of market pressure and like you said, growing discount rates. And it's interesting because why do private universities continue to increase tuition only to discount it all away? And I'm thinking about a subset of private universities, more so the smaller, more regional private universities and private colleges that don't have a larger national draw and maybe less wealth, and maybe we get into that in another question, but this idea of pricing resets and whether or not that would work. Can the market bear that? Can an institution bear that? What does that say optically about your institutions? And so, that discount rate is certainly something we're paying attention to, and directly related to that would be net tuition per student. And so, some schools are growing enrollment, they have more students in their seats but they[‘re discounting it at a very high rate, and so net tuition per student is declining. And so, essentially, you're growing…and at the same time, you might be growing net tuition revenue, those net dollars, but you're doing that through sort of a volume play and the value that's placed on the institution is sort of less and is evidenced by students' unwillingness to pay more for that same education.

Wyatt: Yeah, the students' unwillingness to pay more or the need to discount is reflective of the competitive world that we're in with a declining number of students. And universities that are built to grow or to be larger than what the market will give them coming into the future.

Meredith: You mentioned, Mike, that there are groups of colleges and universities, and in your summary you refer to this, that have done very well in their, as you have suggested, in their research or they've done very well in growing their endowment and their investments. I don't know if our listeners know this, but colleges and universities generally have funds that they keep on reserve and they invest those just like individuals would invest, and that many universities have done well in their investments and have managed to grow a little buffer around themselves. But, for colleges and universities that are not particularly wealthy and are not especially well situated in terms of being elite or in some way differentiating themselves from the competition, this is going to be a tough era. Is that what you're saying?

Osborn: Absolutely, absolutely. I guess one way to think about that is those schools that are most reliant on those tuition dollars, growth or net, those are the schools that will face the most challenges going forward. And it's that adaptability that we're thinking about right now as schools address it and thinking about, as I mentioned, the net tuition per student, the amount that a student is willing to pay, if that's declining, what is that indicative of? Is it value proposition? And so then why is that value proposition not there? Steve, you mentioned…or Scott, I forgot who said this, but that there just will be a lot of seats to be filled and maybe not enough students to fill those seats. And so, what is a college doing to fill those seats? One thing we're seeing, and this does influence the outlook that moved to stable, is that by and large, colleges are doing a fairly good job at adjusting to this environment. And by adjusting, I mean while revenue isn't growing very strongly, management teams are doing a fairly good job of cutting expenses. They're doing the things they need to do to realign the institution, realign the budget with the size of the institution, and that's difficult to do. I'll pause there because I feel like I might be going down a different road, but…

Wyatt: No, I like the road that you've started down because the best thing about slightly gloomy news or extremely gloomy news…

Meredith: Depending on where you are.

Wyatt: Yeah, is to understand it. And what are you seeing? You just mentioned what road some schools are going down. What are you seeing are the positive reactions to all of these challenges? What are institutions doing that are making them a stronger financial institution? Stronger financially?

Osborn: Yeah, well one thing…I believe you can only cut your way to prosperity for so long. It's hard to cut your way to growth and not every institution is meant to grow, and so enrollment growth for growth's sake isn't always the best task for an institution. But keeping students in the seats, I think that would be mission critical. And so, where we see schools combatting some of those pressures is the schools that are very good at identifying the forward looking or maybe even the current workforce needs of the state they're operating in. and if they're a private, maybe it's just the growing needs of today's student, but for public universities, that adaptability to workforce need, that seems to be sort of mission critical. But what can impede that transition or uploading of new programs can be combative sometimes—I'll say sometimes combative or restraining—shared government model of higher ed and it's hard for colleges and universities to move quickly, at least for most. Those that sort of get it understand the environment they're in and can come together and say, "Well we need to add these programs, we need to take these programs offline," those schools are faring well, or they're at least…they're giving themselves a fighting chance. So, one thing that we're looking for in management is a management team's ability, and really the community at large, their ability to understand what their students, what their environment needs, the university's ability to address those needs and how quickly can they make changes in order to do that? And at the same time, what programs might need to be evaluated for removal? And that's where it can get a little sticky. I think that is an interesting starting point.

Wyatt: Wherever we talk about business kind of decisions on campuses, a lot of people get really nervous and upset because, for the most part, faculty and staff see themselves being in the middle of this grand mission to educate and uplift people as if it's an organization completely independent of the realities of finances, you know?

Meredith: Yeah, a calling more than a job almost.

Wyatt: Yeah, yeah. And whenever we talk about return on investment or jobs, we occasionally get these responses that, "Nah, nah we're above that. This isn't a business, this is not a business."

Meredith: I used to have a guy that was our old CFO at the place where I used to work who would always respond to that by saying, "It is every two weeks, buster." [All laugh] "Every two weeks it's a business because you've gotta make payroll."

Wyatt: You've gotta make payroll.

Meredith: And it's a…in your summary Mike ,you indicated this. You said governance is going to be a key factor and not only the willingness of the universities to change but the willingness of the governing teams, the management teams, to make hard decisions, which as you suggest, are hard for a variety of reasons. They are hard personally and hard professionally and hard academically, but they're also just hard because of shared governance and other things that we deal with in higher education. But you're thinking that those institutions that are adaptable more quickly will be able to buffer themselves better against this rising tide, is that right?

Osborn: Yeah, it is. I think those institutions that rely on students who are seeking a very career specific outcome need the education to get into those jobs. And so, I think that's absolutely going to be critical. And it can be difficult for…I mean, there's sort of the operational side of things, there's the internal politics that might be at play that can impede on a university's ability to make programmatic changes. Even if you have the structure to do that, to make those changes, you want to make sure that you're not alienating other constituents like alumni, and this is where boards can get…maybe boards are an impediment to some of that growth in that if they attended that institution, a particular institution, and that institution started to change or evolve in a direction that doesn't look like the place they attended. I mean, there are other factors at play, and maybe it creates…ruffles some feathers at the board level and maybe that's taken out in evidence through the lack of or reduction of, say, philanthropic support, right? And so, there are other ways that that can come to bear and may limit an institution's ability to make those types of changes, those changes that can maybe change the tradition of a place or the optics of an institution.

Meredith: You mention in the summary, again—I'm sorry, I'm talking about the document here that Moody's put out.

Osborn: Yes.

Meredith: In the summary, you mention that there are a number of social factors at play and that those social risks are going to continue to transform the sector. And workforce needs we've already talked a little bit about, one of the things you mention is expanding online programs that give access to new types of learners versus, and we've talked about this part in other podcasts, the dip, and some would say a cliff, the demographic cliff, for traditional-aged high school seniors coming into college, for lack of a better term. The 18-22 year old. And do you see that pursuit of the non-traditional is what we call them, non-traditional student through online programs, is that another way that universities can buffer themselves against difficulties in the demographic shift?

Osborn: Yeah, I think so. It's working for some. It's working for many, and we haven't seen online education be as transformative as it was thought of in the beginning, but it's certainly growing and a number of institutions regularly are communicating to me and others here maybe a decline in the traditional-aged student, as you mentioned, but solid growth in this online component. And we're seeing various structures in terms of how that's tailored. Some that are building the infrastructure in house, they have their university's platform, or maybe it's some other platform, but they're creating the content in-house, they're using university faculty, the students are being recruited by university staff. And then there are other models, sort of an outsource model, where an organization sort of invests in an institution and takes on that liability, the financial liability…

Meredith: Right.

Osborn: And they share in the growth and they share in the tuition revenue that might come down the road. So, there are different…and I'm sure there are other structures in between, but these are working for some, certainly. And that gets to, again, this ability to adapt to that demographic as you mentioned, the adult learner or those that are coming back into the education market to further their career or maybe compliment what they already have and it's a nice way to do that.

Wyatt: You've got some understanding—limited about Southern Utah University—but you have some understanding of other institutions in Utah such as the University of Utah…give us kind of your sense about the intermountain states area? Utah and our little region? What's…any particular insights about our part of the world unique from this country?

Osborn: Yeah, sure. And I'm sort of going off memory here and I know you live and breathe it every day so you'll know more than me. [All laugh] But I think one thing that we've found impressive about the environment in Utah is really a couple of things, and that is we hear demographic environment, right? And in the Midwest and the Northeast you hear it the most in terms of the declining number of high school graduates, and conversely in Utah, demographic environments seemed quite vibrant for that traditional college age students. And the universities we work with in the state and just others we observe seem to be doing quite well, in stark contrast to many others. And that's coupled with a very supportive state. We talked about credit quality in the beginning, you have the state of Utah that holds our highest rating of AAA and it does a very good job of supporting, in our mind, supporting higher ed through a couple of ways. And one is through growth and operating appropriations and another is through new capital support, paying for various buildings and so on. And so, it's a combination of those two things that compliment growth in students quite nicely and so it sort of culminates in this very healthy environment. Do you feel the same or am I off base?

Wyatt: No, no.

Meredith: No, exactly right.

Osborn: Yeah.

Wyatt: WE feel very fortunate to be here. The state's economy is booming and we're the beneficiaries of that. And we've seen a lot of growth in students coming out of high school coming to our school. SUU has grown 51% in the last five years, so we've seen incredible growth. But we've also been increasing our discount rate so that it's more affordable for students. That's been a big question in Utah. Not just the question of discounting tuition, but the question of, "What can students afford?" And there's a couple of ways to approach that. One is to just reduce your tuition; another way is to increase scholarshiping for need-based students or for academic achievers. But what we've seen in Utah is similar to around the country, the birth rate has dropped in Utah.

Meredith: That's right.

Wyatt: But we're behind…

Meredith: Even we are now under replacement rate, I think, in Utah.

Wyatt: Yeah.

Meredith: For the very first time.

Wyatt: One of the advantages we have is that our economy is really charging forward. And another advantage is that we are able to watch what's happening around the country with the declining enrollments before affects us.

Meredith: Before it hits here.

Osborn: Hmm, yeah.

Meredith: Mike…

Wyatt: But then also one of the challenges we've got with this booming economy is that a lot of people will graduate from high school and then just take off to work.

Osborn: Absolutely.

Wyatt: Rather than getting a degree.

Meredith: That's right.

Osborn: Yeah, we're seeing that around the country. As you mentioned, it's that tradeoff between a dollar now and a dollar later.

Wyatt: That's right.

Osborn: And in this strong economy, students are making that choice. And it will be interesting to see…it can be cyclical, so if we approach a downturn, that may reverse. It could.

Wyatt: Yeah, it could. In Salt Lake County, we're seeing a decreasing…along the whole Wasatch Front which is our main population center in Utah and we draw a lot of students from there, we're seeing a decreasing percentage of people going to college. Which…and if they can jump in and get a great job, that's awesome for them because there's a lot of jobs available for now. But when the economy changes or where there's a recession, those with a bachelor's degree fare much, much better. So, we're still selling what we've got and we feel very positive for the next number of years. But we're keeping our eyes open and making sure that we are prepared for whatever may happen.

Meredith: And Mike, since your job as an analyst is, at least in some respect, to forecast what the future may be, is…as I look at your "What could change the outlook" summary, is the biggest fear nationally that we've been riding a bubble here? We haven't had a really major correction; we haven't had another big recession. Is that the primary thing that could really set things tumbling if market…if you were going to change from stable to negative, is that the thing that would most likely tip us from one to the other? Or what do you think?

Osborn: I wouldn't say most likely. I mean, it certainly is a…it would be a big component of it, but we've seen the resiliency before. And it's interesting because at the outset, we talk about those that are…the very wealthy institutions and it's really those institutions that will feel the pinch more than others. We published some research, I believe it was earlier this year, maybe it was late last year, and we conducted some sensitivities around this and so, if we took the wealthiest 30 schools or so and they took, let's say, a 30% haircut on their wealth, what is the trickle down effect of that and could they survive that? And by and large, most would survive it. We think most would survive it without having to make any sort of drastic changes to their business model. That's assuming that eventually there's a rebound at some point. But if that were to sustain for a long period of time, I'm sure it would. But yeah, that certainly could because there are other effects to that. If that happens, if that predates a recession, then what does that do to income in a state and the taxes associated with it? And now you're talking about state budgets and do states now start holding back on those nice appropriation increases that we were talking about earlier? So, it's sort of the direct and indirect effects of something like that. So, that's what we'd be looking for. The…sometimes agencies of the state can be the first to take a hit if state budgets go south, so we'd be paying careful attention to how that affects higher ed. And then I would say in addition to that investment market pullback, the net tuition revenue growth, it's certainly modest. Something we're going to be paying…that we always pay close attention to. But interesting, as you just mentioned, Scott, if we approach this recessionary environment, it could actually have then a benefit on the enrollment side.

Wyatt: Right.

Osborn: And so that could be a nice boost. So, how that would…

Meredith: Right.

Osborn: How that would manifest itself on a university's budget remains to be seen because now it's an affordability question, and now something that's in greater play, and the states now funding and…you get my drift.

Wyatt: Yeah, yeah. It's…

Meredith: No…

Osborn: It's a big puzzle.

Meredith: It is.

Osborn: And so, it's really sort of how all the dots connect in that environment. But yes, that certainly would not be a good support mechanism for a stable outlook if the market were to…you know, it's such a volatile investment market right now and we don't know…I don't think anyone knows what it will do. But there is certainly no shortage of opinions. And we think that the risks of a recession are there, we're not projecting one, but I think the market is certainly doing well and it's been a long stretch.

Wyatt: Yeah, it's been a long stretch.

Meredith: It has.

Osborn: Yeah.

Wyatt: And when you think of what happens during recessions and then less jobs and people choose to go to college rather than work because the jobs aren't there and they want to do something meaningful, productive that can prepare them. For the institutions that are very heavily dependent on tuition dollars for their budgets, that has a more positive effect on them. For those institutions that are more dependent on state appropriations for their budgets, when you hit these recessions, there's less tax revenue being collected.

Osborn: Mhmm, that's right.

Meredith: Yeah, that's…

Wyatt: What's good for us in one time…

Meredith: That's right.

Wyatt: Is not so good for us in another time. And…

Meredith: For 20 years, I was in the community college system in Arizona and when the economy would roar in the Phoenix area, we would all shrug our shoulders and say, "No students are showing up." And then when the economy there, which was driven largely by building, construction and all that stuff, when that would flag, all of the sudden we had all of these students, but there were no property tax to collect which is how we survived. So, it was always there was plenty of bad news to go around and it didn't matter what the economy did.

Osborn: It's a challenge, that's right.

Wyatt: It's very complicated. Well, what would be your…what is the biggest takeaway for us? What would you suggest to us? For our financial health?

Osborn: Well, where…unfortunately we can't give…we're not in the business of giving advice, but I would…

Wyatt: Oh, make it just…

Osborn: When…I guess what I would say is what we're looking for and what we're seeing and that is…and I sort of hearken back to what I said earlier about business adaptability, business flexibility…what's interesting is when we think about your institution in a potential recession environment. Let's say that has a positive impact on enrollment but you haven't, let's say you don't have the…you have to ramp up the infrastructure for that enrollment growth. And I don't necessarily mean buildings, but people.

Meredith: Right.

Osborn: And so, I think one…we haven't talked about this yet, but one thing that we think is interesting as we think about location is those universities that are located in an urban environment, so they're capitalizing in a lot of different strengths, but one of those is access to maybe adjunct faculty, right?

Wyatt: That's right.

Osborn: And those that can teach in sort of a temporary capacity and sort of limit the university's exposure to employment contracts and so on. And so, it's one example. I want to bring back what I said earlier about program and curriculum flexibility and the ability to…one thing that we're looking at is a university's program review assessment period. How often are they assessing or reviewing programs and what is the schematic for assessment and maybe taking programs offline, adding programs? So, all of that…really that flexibility And this is probably through the broader slots of universities out there. And so, the…to use the word again, it's that organizational flexibility, that responsiveness to expand and contract, to understand its environment, to be proactive rather than reactive and sort of make those changes maybe even before they come and sort of seeing a little bit into the future. And so, it's really those things that we're keeping a keen eye one.

Wyatt: Thank you very much, it's been enjoyable talking to you.

Osborn: Thank you, I appreciate it. It's been nice speaking with you as well.

Meredith: You've been listening to Solutions for Higher Education, a podcast featuring Scott L Wyatt, the president of Southern Utah University in Cedar City, Utah. We've had as our guest today Michael Osborn. Mike is a Vice President and Senior Analyst for Moody's Investors Service and he joined us by phone from his office in New York City today. We thank Michael for joining us and we thank you, or listeners, for tuning it. We'll be back again soon, bye bye.