College and university board members have recently been inundated with reminders of the importance of upholding their fiduciary responsibility to provide oversight of institutional finances. That governing board members understand these complex finances has never been more essential, trustees are being told. There is one tool providing valuable information in this area, however, that board members and senior administrators may have overlooked: the grading and analysis of the university’s debt, often referred to as the “bond rating.”
That rating, conveyed via a letter grade, can be an extremely useful way for board members to better comprehend their institution’s finances. The bond rating often includes analysis of the factors that result in a good or bad grade of debt and can be a window into the financial management of a college or university. Each board would be wise to become more familiar with the process of bond rating.
One benefit of the bond rating and accompanying financial management analysis is that an impartial third party does all the work, providing an independent, outside analysis of the institution’s financial management. Several private companies rate the debt of private and public higher education institutions. Commonly referred to as the “bond-rating agencies,” those companies include Moody’s, Standard and Poor’s, and Fitch Ratings.
When an institution plans to issue debt, it often pays one or more of these bond-rating agencies to rate, or “grade,” that debt. As part of its service, the bond-rating agency provides some analysis as to why the debt has been rated high or low. To oversee university finances, the bond rating and analysis should be used along with other sources of information such as the university budget, financial statements, and audits. Board members should be examining all of those sources of information, but the bond rating alone can be a helpful tool for learning more about the financial health of the institution.
How Should Board Members Use the Bond Rating?
First, trustees should know whether the college or university—if an issuer of debt—has been rated by a rating agency. Bond ratings are not legally required, but are often necessary for investors to feel comfortable purchasing the bonds. While there is plenty of unrated debt issued in America, many higher education institutions ask a rating agency to analyze the financial situation of the institution and provide a rating for its debt. The analysis and rating are almost always a part of a specific sale of bonds. Assuming a bond rating has been done, the analysis and the bond rating should be provided to board members; if it is not, trustees should request the university administration provide the bond ratings and analysis of the most recent university debt sales. Board members should also ask for the bond rating for prior debt, even if it was issued many years ago.
If the college or university has never received a bond rating, the board should ask senior administrators why there are no bond ratings. Is it because the institution doesn’t sell bonds? Board members should seek to understand the debt-issuing history of the institution. The finance and budget officials of the institution should have that information about debt and bond ratings. While bond ratings are not always required to be public, trustees have fiduciary responsibilities overseeing the institution’s finances and therefore should have access to such information.
In addition to the specific bond ratings for the individual institution, the bond-rating agencies regularly publish information about the financial situation of the higher education sector as a whole. The Web sites of the major bond-rating agencies have that broad information about the sector and, in many cases, individual institution ratings can be found there too. At the very least, board members should regularly refer to the information about the sector. For instance, rating agencies have recently rated the outlook for the higher education sector as “negative.” For the most part, bond-rating agencies rate an overall sector as improving (positive), stable, or weakening (negative).
Perhaps not surprisingly, while some college and university debt has been upgraded recently, many more university debt downgrades than upgrades have occurred in the previous year. As the economy improves, sectors such as state and local government have seen some overall increases in their bond ratings, but that has not yet occurred in the higher education sector. The bond-rating firms have raised concerns that political, economic, and statutory factors have contributed to declining revenues within higher education, and they note competitive and demographic pressures on institutions, as well. They also observe that states and the federal government have significantly decreased their aid to the higher education sector.
Second, board members can use the bond rating as a starting point for questions directed to the president and university officials about the financial management of the institution. If the bond rating is high, the board should not rest easy, but rather it should be always cognizant of and ready to question any institutional actions or outside factors that might endanger the bond rating and its imprimatur of good financial management. This line of inquiry forces those responsible to consider the implications of any and all actions on the overall financial health of the institution. State legislators and other officials often ask how a proposal may impact the state’s bond rating. They are, in effect, using the bond rating as one proxy for good financial management. Board members should do this, too, as part of their fiduciary duty to ensure that the institution is being managed well financially. If the bond rating is low or average, board members should ask detailed questions about the institution’s financial practices. For example: “Our last debt issuance was rated low several years ago. Will this new proposal impact future debt ratings?”
If no debt is being issued, any time the board would like an outside analysis of an institution’s financial management, it can have a bond rating company do a financial analysis of the university as if it were rating the debt. A separate bond-rating analysis—independent of a debt issuance—obviously costs money, but it may, at times, be worth procuring. This is particularly true when board members have strong concerns about the institution’s finances. Even the threat of requesting an outside analysis of the financial management of the institution may be a good tool for board members. Board members may wish to have an outside financial analysis if they have concerns about the financial management of the institution, or if they do not feel the administration is providing adequate information, or in cases of concern over malfeasance. Those may be rare instances, but having a bond-rating analysis as if debt were to be issued can be extremely useful in providing additional information as board members exercise their fiduciary responsibilities.
It is important to note that the bond rating is not a grade of the overall management of the institution and that many factors impact its financial health. As we all know, colleges and universities are quite different, and things happen over long periods of time, so that a poor bond rating is not necessarily an indicator of current poor administration, financial or otherwise. The goal of any board discussion should be the continual improvement of the financial and administrative management of the institution. The benefit of a conversation focused on reviewing the bond rating is that it can be had without being in any way accusatory or critical of the institution’s senior leaders.
Another important way to use the bond rating and the analysis of the debt or issuer is to compare the university with other institutions that are similarly situated. That provides board members with the ranking of the financial management of their institution vis-a-vis other colleges and universities to which they wish to be compared. The rating agency may point out financial management issues that others have overlooked or have not been comfortable highlighting. Board members are rightly focused on their own institution, but being aware of how it stacks up to its peers can be enlightening and educational, and serve as the basis for important conversations within the boardroom.
Playing Out in the Real World
There are some recent examples as to how bond-rating analysis can play an important role in raising questions about university finances. In 2014, for example, a very unusual thing happened: Georgetown University was downgraded by Moody’s from a “positive” outlook to “stable” but upgraded by Standard and Poor’s from “negative” to “stable.” Both agencies now grade Georgetown as “stable,” but from different perspectives. Moody’s believes the university has too much variable debt, and Standard and Poor’s believes that because Georgetown will have plenty of well-qualified student applicants for years to come, it will have the ability to raise tuition and have sufficient future revenues. This presents an opportunity for Georgetown’s board of trustees to carefully reflect on its financial management practices.
There are many other good examples. Iona University was recently upgraded, and its good financial management acknowledged. Its cash-flow position was praised, as was the university’s desire to upgrade residence halls and improve the reputation of the institution. Boston University and the University of La Verne in California have received upgrades, as well.
One Tool among Many
Ultimately, the purpose of a bond-rating agency is to rate the debt and risk for investors. Therefore, governing boards should keep in mind the limitations. The bond-rating agencies were heavily criticized for their controversial high ratings of mortgage-backed debt that contributed to the Great Recession of 2008. The Financial Crisis Inquiry Commission in 2011 stated that “the three credit rating agencies were key enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval. Investors relied on them, often blindly.” Keep in mind, however, that the bond raters have made substantial changes since then, and bonds issued by higher education are often rated by different sections and individuals than those who rated the mortgage-backed debt several years ago.
Bond ratings are not necessarily a panacea for what ails higher education, but they are an extremely worthwhile tool within the governing board arsenal. They should be viewed in conjunction with the institution’s budget, financial statements, and the audit to provide a complete picture of the financial situation facing the university. Board members should use the information as a starting point for questions and in-depth discussion about the financial status and the financial management of the institution.
A board member commenting to AGB ’s National Commission on College and University Board Governance last spring in Nashville noted the importance of boards knowing the bond rating of their institutions and lamented, “I’m not sure how many know there is a bond rating.” So, board members should not overlook this important tool—one of many for engaging in financial oversight of their institutions.
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