Predicting Credit Risk of Colleges and Universities: Brand and Reputation Count

Credit ratings assigned to debt of public and private colleges and universities represent an assessment of credit risk by credit rating agencies. Credit rating affects the interest rate, covenants and other terms of short and long term debt available to a college or university. Not surprisingly, the credit rating agencies use financial information in assigning ratings. But what may be surprising is that they also consider other factors, like market profile, to predict credit risk.

Moody's Investors Service specifically uses "market profile" as one of four broad factors described in its higher education rating methodology. This became an important consideration just two weeks ago, when Moody's announced plans to review Michigan State University's credit rating for a possible downgrade in response to the Larry Nassar sexual abuse cases.

Rating agencies take into account a wide range of financial and operational factors in assessing credit risk. On December 21, 2017, Moody's released an updated rating methodology for assessing credit risk and assigning a credit rating to the debt of public and not-for-profit private colleges and universities. Moody's rating methodology is instructive in highlighting these considerations, some of which relate to reputational and operational factors outside the control of the finance department.

The Moody's rating methodology describes the following four broad factors:

Market Profile: Brand and reputation are used to predict a college or university's ability to compete effectively for students, gifts, grants, faculty and staff.

Operating Performance: Operating results, budgetary flexibility and revenue diversity are used to predict a college or university's ability to pay debt and invest strategically.

Wealth and Liquidity: Financial reserves are used to predict a college or university's ability to withstand changes in its operating environment.

Leverage: Credit profile is used to evaluate a college or university's strength and diversity of funding sources.

The Moody's Higher Education Rating Methodology is available here.

A credit rating downgrade will have broad ramifications for a college or university. A downgrade and even a rating agency's notice of consideration for a downgrade are publically announced.

When a downgrade occurs, it is important to review existing bond and loan documents to determine if they contain covenants relating to credit ratings, such as giving lenders notice of rating changes or maintaining a certain rating level. Violation of a covenant to maintain a certain rating may have consequences that range from a change in interest rate to an occurrence that could immediately be or could ripen into a default.

For a college or university with publicly offered debt, continuing disclosure agreements require filing of a notice of a credit rating downgrade on the Municipal Securities Rulemaking Board (MSRB) Electronic Municipal Market Access system (EMMA).

The attorneys in our Higher Education and Public Finance Practice Areas are available to discuss questions regarding rating methodology and to assist in annual rating agency reviews and in developing reporting and other procedures to manage risks associated with the credit rating process.