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Making the grade


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Although the COVID-19 pandemic roiled municipal bond markets in March and April, the environment improved dramatically once the Federal Reserve signaled its unequivocal support. Bids returned to the market and prices largely rebounded, especially for higher quality issues. Yet despite this rebound, some investors worry that the new normal will have lasting ramifications for various segments of the muni market.


One area under the microscope has been higher education revenue bonds. Naturally, investors want to know if students will return in the upcoming school year, or will many opt for some form of less-expensive distance learning? Does this impact tuition and, ultimately, the financial well-being of our colleges and universities? And what does this mean for the education sector, which historically makes up an important segment of the investment-grade muni market?


Despite the magnitude of challenges facing colleges and universities, from an investment perspective, we expect that the best higher-learning institutions will implement appropriate actions to maintain credit quality over the long term. Generally speaking, colleges and universities tend to maintain comfortable credit quality, including solid balance sheets. According to a recent Moody’s report¹, approximately 40% of Moody’s rated higher education institutions fall into their Aaa or Aa categories, accounting for just under 90% of all Moody’s rated higher education debt outstanding in the United States. And according to a 2019 Moody’s US Public Finance default study, only one college rated by Moody’s has defaulted between 1970 and 2018.


That’s an excellent report card, but as long-time investors we all know that past performance doesn’t guarantee future results. So what’s the outlook for the higher education municipal sector in a pandemic or post-pandemic environment? And specifically, investors are keen to know if universities can manage cash flow in the face of challenges, such as unanticipated COVID-related expenditures, the potential for enrollment declines, and calls for possible refunds or tuition cuts in certain situations.


One key item to remember is that the schools most at risk are ones that were in a precarious position prior to the pandemic. For example, some smaller schools with declining enrollment and minimal endowments will find themselves even further challenged and sadly may face closures. But that’s not necessarily the norm. The vast majority of participants in this sector should be able survive, albeit some will emerge with weaker finances. The higher education sector overall has proven itself to be resilient thanks, in part, to its ability to evolve and adapt to virtual teaching environments. We will likely continue to see further changes and perhaps even innovations in curriculum development and delivery as circumstances change. In particular, we may see more widespread collaboration with businesses, particularly high tech companies as schools’ virtual needs increase. 


In this current environment municipal investors will need to analyze—even scrutinize—higher education bonds on an individual basis with careful consideration of both broader trends and specific circumstances. But the good news is that the higher education sector should continue to have a meaningful place in a diversified, high-quality municipal portfolio. From our perspective higher education muni bonds still get a passing grade.

Victory Capital, Inc. is a Registered Investment Advisor. The information in this article is based on data obtained from recognized services and sources and is believed to be reliable. Any opinions, projections or recommendations in this report are subject to change without notice and are not intended as individual investment advice. Not to be used as legal or tax advice.

©2020 Victory Capital Management Inc.