ࡱ>  BHbjbj "BDl.......BXXXXl$B|fffffff@BBBBBB$= ]f.fffffff..ff{ffff.f.f@ff@ffFrT..f gkUBXf0ffBB....From the issue dated February 7, 2003  INCLUDEPICTURE "http://chronicle.com/icons/space.gif" \* MERGEFORMATINET Junk-Bond Colleges Declining fiscal ratings reflect the struggles many small colleges face By MARTIN VAN DER WERF The long-predicted decline in the fortunes of small private colleges is  ALSO SEE:  HYPERLINK "http://chronicle.com/weekly/v49/i22/" \l "fall" Fall in Value  HYPERLINK "http://chronicle.com/weekly/v49/i22/" \l "pess" Growing Pessimism  beginning to show up in the bond market. Since the beginning of 2002, six colleges have been downgraded to "below investment grade," or "junk bond" status. The number now rated in the junk category, 17, has nearly doubled in the last two years. The reasons are familiar. Investments are performing poorly, which has hurt endowments; the sinking economy is causing parents to question the worth of the higher tuition at private institutions; and debt that was taken on during the flush years of the late '90s is now proving to be a drag on already thin balance sheets. To lure students, smaller colleges have been doling out more financial aid and building new facilities to match those at the college down the road. The result is that many colleges are operating year after year with deficits, further depleting their resources. Once colleges have their bonds downgraded to junk status, it creates uncertainty about their financial strength, and, in most cases, it forces colleges to pay higher interest rates to the holders of their bonds. Nonetheless, investors, particularly those who make purchases for mutual funds, remain interested in bond issues from low-rated small colleges. The bonds are a staple of tax-free high-yield municipal funds. Only one college, Bradford, has defaulted on its bonds in recent years. The Massachusetts liberal-arts college closed in 2000 because of financial problems. The possibility that more small liberal-arts colleges might follow that same path, however, and fears that Life University, a Georgia institution primarily known for its chiropractic program, will default on its bonds, too, have sent the first shivers through the higher-education bond market. Barnet Sherman, who buys small-college bonds for Van Kampen Funds, says he is focusing less on liberal-arts colleges, and more on specialized colleges that he thinks will remain popular. "We look for schools that have a very important market niche," says Mr. Sherman, a vice president and fund manager for the New York-based mutual-fund company. "Liberal-arts schools? I would say more generally that they have a harder sell. People are looking at them more carefully, and wondering what their long-term chances of success are." Van Kampen is still buying bonds of some liberal-arts institutions, like Bennington College, in Vermont. But it is spreading more of its money to places like Daniel Webster College, in New Hampshire, which specializes in aviation careers, and the Boston Architectural Center and Montserrat College of Art, in Massachusetts. Terry J. Goode, a senior municipal credit analyst for San Francisco-based Wells Capital Management, says, "We are keeping an eye on [college bonds] we do own to make sure they will be able to continue to perform. If this anemic economy continues, they do risk further declines in credit quality. I think 2004 will be a critical time for them if the equity markets do not come around." Financial Pinch The bond markets offer an incomplete picture of the financial health of all of American higher education. Only about 500 of the 4,000 or so colleges and universities in the United States carry a public bond rating. But on an individual basis, the struggles of colleges with ratings offer a glimpse into the serious financial pinch being felt around the country, particularly in the Northeast and Midwest, where most small private colleges are located. Many are in spirals of accumulating debt and diminishing resources. Eastern Nazarene College, in Massachusetts, for example, has financial resources of about $4-million, but debt that exceeds $22-million. At the University of Findlay, in Ohio, the debt is $28.5-million, far more than the institutions' total financial resources of less than $17-million. At Clarke College, in Iowa, total financial resources have slipped below the college's overall debt of $12.3-million within the last two years. All are now rated one notch below investment grade. Colleges that have been downgraded to "junk bond" status wince at the implications of the rating, but say it is not unusual in a bad economy, and reflects what is happening with corporate bonds and some government bonds. The report with the downgrade decision "is a good tool for usit's interesting and important to look at it," says Eugene T. Kirschbaum, vice president for business and finance at Clarke. "But it shouldn't be taken as a sign that the college is falling apart because it isn't falling apart." Clarke used an $8-million bond issue in 1998 to build a new student union and a student apartment complex. Both have been open for three years now. They were added to a campus that is made up of comparatively new buildings, since about half of Clarke's campus was destroyed by fire in 1984. The Roman Catholic college, which has about 960 students, has been cutting costs by, among other things, reducing cafeteria hours and negotiating new purchasing contracts. "Unless something unforeseen happens, we will have a balanced budget this year," says Mr. Kirschbaum. That would be a marked change from recent years. According to a review of the college's credit by Moody's Investors Service, published last month, Clarke has averaged an operating deficit of 6.4 percent for the last three years. The college's saving grace has been fund raising. It has raised an average of $3-million a year for the past three years, but the college endowment is only about $10-million. That is because some of the money given to the college is diverted straight to the general operating budget, or to pay for building projects, says Mr. Kirschbaum. At Findlay, the drop in ratings is meaningful, but no reason to panic, says Martin Terry, vice president for business affairs. The financial problems "have really brought this university together as a team to see what we could do, rather than just cut positions and cut programs," says Mr. Terry. "We'll just get in there, and do the things we need to do to straighten this out, and in two years, we'll reapply" for a rating review. Findlay, however, appears to be in worse financial shape than it was three years ago, and Moody's "believes that the recent erosion of balance-sheet resources is unlikely to be reversed over the near term," according to a credit report released in November. The college has been running deficits for five consecutive years, and total financial resources have plummeted by more than 40 percent since 1999. How the Ratings Work Colleges are rated on the same scale as other bonds. The highest rating, AAA, goes only to the wealthiest colleges and state-university systems. The AAA institutions include five of the eight Ivy League members (Dartmouth College and Columbia, Harvard, Princeton and Yale Universities), other large national universities, such as the University of Notre Dame and Stanford University, and smaller institutions with extraordinary financial resources, such as Amherst and Grinnell Colleges. In descending order from AAA, there are three categories of AA ratings, three of A, and three of BBB. Below BBB, in the case of Fitch Ratings and Standard & Poor'sor Baa3, as Moody's expresses ita college is considered "below investment grade" or "speculative." That category, made popular by such traders as Michael Milkin and Ivan Boesky, became known as "junk bonds" in the 1980s. The ratings continue: Three BB ratings, then three B ratings, and there are also ratings at CCC, CC, and C. If a bond drops below C, it is marked D, for "default." In addition to a rating, a bond issuer is also assigned an "outlook"positive, stable, or negative. All of the colleges now listed as below investment grade are at the upper end of the junk-bond scale. Of the 17 institutions now rated in the "junk" category, all but one are BB. Only Life University is below that, at B. Analysts of college bonds say that while a drop into "junk bond" status is not a death knell, it marks the existence of financial problems so fundamental that recovery would be arduous. "It is more typical than not that they don't come back to investment grade," says Joshua Stern, a higher-education credit analyst at Standard & Poor's. "The erosion of resources is difficult to restore." Mr. Stern wrote a report in November predicting that colleges and universities might "consolidate in large numbers or close as they struggle against stagnant levels of financial resources and substantially higher levels of debt." In 2002, Standard & Poor's upgraded the bond ratings of seven colleges and downgraded the ratings of nine, the first time downgrades have outnumbered upgrades since the mid-1990s. From 1990-95, Standard & Poor's upgraded the ratings of 80 colleges, and downgraded 178. But the trend reversed from 1996-99, when the ratings agency upgraded 120 institutions and downgraded only 14. Now the pendulum is swinging back again. It was predominantly lower-rated colleges that were downgraded in the last year. "That is pretty much in line with what we expected," says Mary Peloquin-Dodd, who heads the higher-education-rating division at Standard & Poor's. "What we are asking ourselves now is how long the downturn will be in the sector, and how long it will be before it begins to affect colleges that appear to be more insulated from financial concerns." Moody's had more upgrades of colleges, 29, than downgrades, 18, in 2002. But for private colleges, the number of upgrades and downgrades were the same, 18. Analysts at Moody's say the colleges most likely to be downgraded are those losing students they used to be able to attract. "When things are going bad, there is sort of a chain reaction, and it often begins with declining enrollment," says Naomi Richman, the head of the higher-education analyst group at Moody's. "Declining enrollment leads to declining tuition revenue, which leads to operating deficits and poor liquidity. Colleges can cut, but they can't cut everything, because their quality will suffer, and then even more students won't come." Turning Things Around Before all of the low-rated colleges are written off as goners, however, consider the case of Dowling College, on New York's Long Island. As of June, Moody's had tagged it with the lowest bond rating of any college in the country, four steps below investment grade. In September, just as many colleges opened their doors to another year of red ink, Moody's upgraded Dowling by one category, and announced that it has a positive outlook on the college's finances. This, even though Dowling sold $10.9-million worth of bonds late last year, adding to the $37-million in debt it was already carrying. Moody's analysts were impressed that the college has a growing enrollment, and, after years of deficits, it has balanced its budget for three consecutive years. That came after a disastrous investment of more than $26-million in the late 1990s in what was to be an international center for the study of aviation and transportation. The project failed, and the center has been turned into a branch campus of Dowling. How is the college turning itself around? In late 1999, the college's new president, Albert E. Donor, and the new chief financial officer and treasurer, Susan E. Williams, began meeting every Monday at 7 a.m. with six of the college's trustees to set an agenda for what had to be accomplished that week. Every step was designed to nurse the college back to financial health. "We called all of our vendors, and we said we really need your help," says Ms. Williams. "'How can we work with you to maintain ourselves and have it cost less, but still make sure you get paid.' We talked with them often. So if they didn't get a check from us, they got a phone call from us, explaining the situation. Those phone calls have meant a lot." The college slashed advertising costs for recruiting students, focusing instead of rebuilding relationships with local high schools. It reduced executive salaries across the board, froze hiring, and beefed up collections on student accounts. Tuition makes up 86 percent of the college's revenue. No costs were considered too minor to escape attention, says Ms. Williams. And, slowly, the situation has improved. A Flood of Bond Issues Like Dowling, a number of other colleges in relatively weak financial condition are going further into debt, reasoning that they need new science centers, residence halls, recreation centers, and other facilities sought by students. It's either that, or close for sure. D. Scott Gibson, a managing director for Advest Inc., a Hartford-based investment bank, says the market is being flooded with bonds from small colleges. Temporarily, at least, the economy is working in the colleges' favor. Interest rates are at historic lows. Even colleges with lower-level bond ratings, such as BBB, are getting interest rates of around 5.5 percent. Rates at that level are, in some cases, even lower than the interest rates on AAA-rated college bonds sold at a time when the economy was much stronger. "That's an incredibly low borrowing rate for BBB schools," says Mr. Gibson. "Yes, it means more debt, but who's to say that isn't the best deal going right now?" But there is a downside, too. Rates for bond insurancewhich allows a college, or any bond issuer, the chance to buy a higher credit ratingare up by more than 25 percent in the last two years, says Mr. Gibson. And underwriters of college bond issues and the bond-insurance companies are asking for much more in bond covenantscollateral, stipulations, or other requirementsthan they used to. In 1999, the College of New Rochelle, for example, did not have to offer any covenants, other than a pledge that its debt would not exceed 15 percent of its annual expenditures. Now, the discussions begin with colleges offering a mortgage on the buildings being built. At Salve Regina University, the bond insurer took a mortgage on the core of the Rhode Island campus when the college's $40-million bond issue went to market late last year. At Western New England College, in Massachusetts, there will be a mortgage on the residence hall being built with a new bond issue, meaning bondholders would have preference over other creditors if the college or the dormitory itself goes bust. It is just another indicator that investors are looking to protect themselves, even when buying into colleges, which up to now have been considered one the safest investments going.  FALL IN VALUE A growing number of colleges have low bond ratings. The following institutions have been downgraded since December 2001 to "below investment grade" ("junk bond") status, which means that bond-rating agencies believe they have significant financial problems: Clarke College (Iowa) Eastern Nazarene College (Mass.) Lasell College (Mass.) Ohio Dominican U. Texas Wesleyan U. U. of Findlay (Ohio) The following institutions were "below investment grade" before 2002: Bennington College (Vt.) Daniel Webster College (N.H.) Dowling College (N.Y.)* Eckerd College (Fla.) Franklin Pierce College (N.H.) Life U. (Ga.) New England College (N.H.) Nichols College (Mass.) Southern California U. of Health Sciences Touro College (N.Y.) Tougaloo College (Miss.) These colleges are currently being reviewed for a downgrade to "below investment grade": Polytechnic U. (N.Y.) Saint Peter's College (N.J.) Bond-rating agencies also state whether colleges' financial outlooks are stable, positive, or negative. The following colleges are still considered to be above junk-bond status, but they have the lowest investment-grade rating, and negative outlooks: Bloomfield College (N.J.) Christian Brothers U. (Tenn.) College of Santa Fe Delaware Valley College (Pa.) Dowling College* Lewis U. (Ill.) Regis College (Mass.) U. of Louisiana at Monroe * Dowling College is rated "below-investment grade" by Moody's, and carries an investment-grade rating with a negative outlook by Standard & Poor's. 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