I recently listened to a Breckenridge Podcast on the topic of university bonds, and here are my notes on what you should consider before investing in this type of municipal bond.
One of the primary things to look at when evaluating any type of bond is where the revenues used to pay bondholders are coming from. Universities primarily get revenues from tuition and fees. If they rely on endowment returns and investment returns that can be a big problem, because there is much more uncertainty involved.
With University Bonds in addition to revenue composition you should look at:
Student Demand which is measured by using two different metrics.
- Acceptance Ratio – The number of students accepted vs. the number that applied. With the acceptance ratio the lower the ratio the better.
- Matriculation ratio – The percentage of students who are accepted which actually enroll. Here, the higher the ratio the better.
Student demand ratio analysis is especially important for small private universities that are highly reliant on tuition. The ratio gives us a good feel for the university’s ability to raise tuition without reducing admissions.
Liquidity which is a measure of the university’s financial resources. How well can they weather a storm with cash on hand?
Operating margins which is their ability to generate revenues to cover expenses and add to their capital base.
Debt, which is the the leverage of the system. This is broken down into several components:
- Look at the financial resources and compare to the total debt outstanding.
- Debt service coverage.
- Debt financing structure of the university meaning the amount of debt they have outstanding in fixed vs. variable rate debt. If a large amount of outstanding is in variable then that can be concerning.
Public universities have state appropriations which gives the a broader basket of revenues that they can tap into. Generally they are stronger credits as a result. The negative with public universities receiving state appropriations: If they are in a state where cuts need to be made, higher education can be a cut.
With private universities student demand is where its at. Endowments and fundraising are more of a private university issue. They need to raise money through fundraising as well as have very solid investment returns that they can tap into for their annual operating income. Public universities do some of this as well.
Two other risk which could affect both public and private university bonds are:
- Federal budget cuts and the spillover effect that will have into grants. which is especially problematic for public universities.
- Healthcare reform, the universities that have hospitals associated with them will have to adjust.
Learn More
- 4 Strikes Against Municipal Bonds? (Wait, aren’t there only 3 strikes per out?)
- The Safety of State Bonds: A Historical Perspective
- How to Choose a Municipal Bond for Income
- Municipal Bonds
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