Higher Education Sector: A Pandemic Progress Report | Lord Abbett
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Fixed-Income Insights

Overall, the finances of colleges and universities have held up well, in our view, though challenges remain.

Read time: 3 minutes

This article is from the forthcoming edition of the Lord Abbett Muni Quarterly.

The 2020-2021 school year represented one of the worst-case scenarios possible for U.S. colleges and universities with very limited on-campus instruction and many international students unable to enter the United States. Still, the sector held up well, proving its resiliency and strong credit quality, which we think makes it an interesting place to find good investments.

The higher education sector generally entered the pandemic from a position of relative balance sheet strength, benefited from federal and state assistance in the form of CARES (Coronavirus Aid, Relief, and Economic Security) Act receipts, and has capitalized on expenditure flexibility. Operating losses, defaults, and widespread rating downgrades have been averted. Moving into fiscal 2021, while we see pockets of stress, better-than-expected fall 2020 enrollment, imminent additional stimulus, continued distribution of vaccines, and thus-far strong capital market access, limits longer-term negative impact on the sector.

Healthy Balance Sheets Backstop Operations

With some exceptions, four-year colleges and universities are typically well capitalized, and liquidity coming into the pandemic was generally good. Over 190 public and 230 private institutions rated by Moody’s have reported substantial balance sheet growth over the last several years, and the agency’s public and private medians for total cash and investments grew nearly 25% and 21%, respectively, from 2015 through 2019. Resource levels and coverage were strongest for those universities that have large student populations, established endowments, and diversified revenue streams. While annual endowment returns were lackluster through June 30, 2020 (fiscal year end for most institutions), we expect an uptick in performance through calendar year-end. We also note that we have not seen widespread softness in philanthropy and giving, another important avenue for long-term endowment growth. Overall, adequate balance sheet strength backstopped university operations, providing a robust line of defense during the worst of the pandemic.

Fiscal Stimulus and Expenditure Control Tempered Impact in Fiscal 2020

Fiscal 2020 impact stemmed largely from auxiliary services revenue losses – primarily housing and dining – as more than 1,300 institutions moved to remote learning. Further, most institutions offered some form of prorated relief to students for housing and dining charges. The institutions responded quickly with a myriad of budgetary control measures, and they received $14 billion in direct CARES Act funding, which helped to temper overall impact. While fiscal year (FY) 2020 results saw some softness, particularly in operating margins, we expect declines to be manageable.

Looking Ahead

Despite declines, fall 2020 enrollment results were significantly better than initially expected. National Student Clearinghouse data for fall 2020 shows public four-year institutions’ enrollment up 0.2% and private not-for-profit enrollment down only 0.1%.  First-time enrollment was down 8.1% for four-year publics and 10.5% for private institutions – a material change, to be sure, but better than expected. We fully expect across-the-board net tuition revenue weakness as a result of enrollment declines for FY 2021, though we view revenue loss likely to be significantly less severe than originally anticipated

We also expect auxiliary revenue pressure to be temporary. According to data compiled by the College Crisis Initiative, nearly 70% of institutions developed fully or primarily remote instruction models for fall 2020, and those that offered in-person instruction generally reduced housing density and curtailed athletic events. The circumstances around fall 2020 instruction point to lower auxiliary revenue for the sector in FY 2021; however, auxiliary operations typically comprise only a moderate 10%-15% of public and private university total revenue. We expect auxiliary performance in spring 2021 to be stable to moderately improved. As vaccine distribution ramps up through the spring and summer months, we view significantly expanded in-person instruction for fall 2021 as probable, which should alleviate pressure on this revenue stream.

For public institutions, we have found reductions in state support to be less onerous than initially anticipated. While we have seen cuts and expect largely flat appropriations with further reductions in a handful of states, this support typically represents less than 30% of operating revenue and funding for higher education generally remains intact. Finally, an additional $23 billion in aid to colleges and universities approved in December will temper FY 2021 losses.

Summing Up

Higher education faced an unprecedented threat in 2020. The global pandemic curtailed operations across the board and, in some ways, will likely alter the sector’s landscape for years to come. Still, through a combination of prudent management and fiscal stimulus, the sector largely emerged from FY 2020 intact, which speaks to the resiliency of the sector and its value to the nation more generally.

Based on our view of the current vaccine, enrollment, and political trajectories, we expect a robust, albeit gradual, sector recovery over the next several years, with broad financial improvement beginning in FY 2022.

 

IMPORTANT INFORMATION

This commentary may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

This material is provided for general and educational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Lord Abbett product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice.

References to specific securities and issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. The securities referenced may or may not be held in portfolios managed by Lord Abbett and, if such securities are held, no representation is being made that such securities will continue to be held. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be profitable.

A Note about Risk: The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The municipal bond market may be impacted by unfavorable legislative or political developments and adverse changes in the financial conditions of state and municipal issuers or the federal government in case it provides financial support to the municipality. Income from the municipal bonds held could be declared taxable because of changes in tax laws. Certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole. Because many municipal instruments are issued to finance similar projects, conditions in these industries can significantly affect an investment. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state and local taxes may apply. Investments in Puerto Rico and other U.S. territories, commonwealths, and possessions may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems.

The Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act, is a $2.2 trillion economic stimulus bill enacted in March 2020 in response to the impact on the U.S. economy of the COVID-19 pandemic.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in this commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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