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Fixed-Income Insights

Here, we examine the factors informing the sector’s current investment profile.

by Yeida Reyes and Joshua Levine, Research Analysts

Note: This article is from the forthcoming issue of The Muni Quarterly.

We remain neutral and cautious about the higher-education sector of the municipal-bond market—although there are many identifiable, attractive opportunities therein that we believe will continue to be strong investments in the sector. The credit themes underlying the sector in 2017 continue to hold in 2018, with wealthier institutions that have established brands extending their advantages over smaller and regional entities—especially liberal arts-focused institutions—that are experiencing reduced demand within their student markets.

These credit themes include: 1) ongoing concerns about affordability, leading to high discount rates among some tuition-dependent institutions; 2) national demographic shifts, leading to shrinking student markets (although still large) in the Midwest and Northeast and expanding markets in the Southwest and West Coast; 3) stable giving/donation trends and strong investment returns, boosting the balance sheets of larger institutions (though this trend is potentially affected by market conditions and tax reform); 4) ongoing innovation within the sector to adapt learning models to diverse student needs, with universities looking to expand their enrollment pools through retention efforts and niche programming; and 5) strong demand for college graduates in the low unemployment-rate economy.

Against this credit backdrop, we also expect three new developments to affect the sector in a moderately negative way in 2018.

1) Assessing the Value
First is the accelerating discussion around the value of higher education as a whole, particularly given increasing national political polarization. A recent Pew study revealed that 58% of Republicans believe that higher education has a negative impact on American society. The concerns reflected in the study include the core challenges of affordability and employment outcomes, as well as perceptions of bias in the curricula. The extent to which increasingly negative feelings around higher education translates into lower participation rates among future students will dictate the credit impact for investors. Despite these concerns, we expect ongoing evidence of the economic value to higher education will preserve the majority of the enrollment pool for institutions. A recent Georgetown University study, for example, showed that since 2010, 99% of new jobs went to people with at least a two-year degree.

2) Regulatory Changes
Second, the potential reauthorization of the Higher Education Act (HEA) introduces uncertainty around the regulatory regime governing the sector. The last full-scale update to the HEA occurred in 2008. Some of the proposals on the table in the current draft bill could have, in our opinion, a negative impact on enrollment. Key changes up for debate include the elimination of loan-forgiveness options for students in income-based repayment plans for their student debt as well as new caps on federal loan amounts for graduate students. Both of these shifts could limit the ability of lower- and middle-class students to pay for their education, which in turn would affect enrollment.

Some proposed changes that may have a positive impact on access to higher education include the simplification of the federal student-aid application (Free Application for Federal Student Aid, or FAFSA) and increased distribution periods for Pell Grant recipients. (Federally sponsored Pell Grant funds currently are distributed at a specified amount annually.) Overall, as with most instances of large-scale regulatory change, we expect the pending amendments to the HEA to create uncertainty for students and higher-education institutions.

3) Immigration Policy
Finally, the third development we are monitoring for 2018 involves the way changes to immigration policy will continue to affect international enrollment. In aggregate, international enrollment fell 4% between fall 2016 and fall 2017. This is important because international students are more likely to pay full, un-discounted tuition rates, and they have been an essential growth market for numerous institutions. This particularly is worrisome for institutions that expanded their graduate programs in response to softening demand at the undergraduate level.

Conclusion
Although the higher-education municipal-bond sector as a whole is facing some headwinds, we will continue to invest selectively in bonds issued by colleges and universities because there are many attractive credits in the sector. Among the investment opportunities are those institutions that have strong demand metrics, maintain sizable endowments, offer programs that are highly valued, and, in the case of public universities, have steady state support. Institutions that have weak balance sheets, high tuition-discount rates, low demand metrics, and limited program offerings will be avoided. 

 

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