Believe it or not, schools are the second-largest public infrastructure investment in America behind transportation. For investors, getting familiar with education-sector municipal debt is crucial for understanding this massive segment of the market.
Colleges and universities rely on municipal debt for capital improvement programs, such as expanding campus facilities, at a time when post-secondary enrollment is beginning to decline. Demographic trends suggest this pattern will continue due to lower birth rates and the skyrocketing costs of post-secondary education.
Let’s take a look at the current status of the education sector of the municipal debt market and explore the opportunities and challenges the sector presents for investors.
Education Sector Municipal Debt
Public higher education debt outstanding surged more than 85% between 2007 and 2017, outpacing all other major municipal bond credit. Community colleges were a close second; debt outstanding for this segment rose nearly 81% over the same ten-year period.
Of course, higher education is only one segment of the education-sector municipal bond market. The other major segment is local school districts. Bonds for local district schools are used to finance buildings and projects that promote primary and secondary education.
This is part of what makes the United States such a unique case. Whereas other advanced industrialized countries rely on provincial or national governments to manage their education systems, in the United States schools are under the purview of local authorities. In other words, public schools are managed by locally elected or appointed representatives.
Combined, education accounts for roughly 10% of the U.S. revenue bond market, which itself accounts for roughly two-thirds of the total municipal bond market. Education revenue bond indexes yielded an average of 1.64% as of September 2019, which was lower than that of hospitals, special tax, leasing and transportation indexes.
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With interest rates anchored near zero for the foreseeable future, colleges and universities are beginning to capitalize on so-called century bonds. The financing option allows these institutions to pay back their investment over a much longer period than most traditional bonds.
With a century bond, schools pay off massive investments over the course of 100 years, usually at fixed, low interest rates. Investors in these bonds are usually made up of insurance companies and other institutional players looking for guaranteed returns over a lifetime, regardless of market conditions.
In 2019, four universities pursued century bonds: Penn, Rutgers, Georgetown and the University of Virginia. Combined, they have issued more than $1.23 billion in century bonds.
Be sure to check our Education section to learn more about municipal bonds.
Opportunities and Challenges for Investing in Education Sector Bonds
Like any investment class, education sector bonds present investors with opportunities and challenges.
The potential opportunities include:
- Benefits of century bonds: 100-year bonds offer higher interest rates than traditional municipal bond funds. They also provide guaranteed returns during a tough macro environment. For these reasons, they’re likely to provide greater access to foreign investors.
- Strength and stability of established institutions: Large, established education institutions have a long track record of strength and financial stability, which makes them attractive investment targets.
According to a recent update by Raymond James, Cornell, Boston College and the University of Chicago are recent examples of post-secondary institutions that have issued bonds. Upcoming higher education pricings include the Ohio Education Facility Commission, Harvey Mudd College and Northern Arizona University, among others.
The potential challenges include:
- Credit concerns: Smaller school districts run the risk of ending up with poorly structured bonds, which leads to uncertainty and a lack of transparency for investors.
- Higher education isn’t always safe: Colleges and universities have become increasingly reliant on rising tuition to fund their operations. But declining enrollment of international students and growing affordability concerns leave them exposed. For investors, this could be a cause for concern.
- Stress on non-market leaders: Non-market-leading universities – schools with lower rankings – will face the brunt of demographic shifts in post-secondary enrolment and programmatic changes, which could lead to permanent reductions in credit quality. To continue growing, these institutions will have to rely on mergers, aggressive budget maneuvers and increased enrollment of non-traditional students.
The Bottom Line
Post-secondary institutions are undergoing dramatic shifts in demographics and programming as more people begin to question the need for a traditional, four-year degree. But the education sector as a whole continues to provide municipal bond investors with plenty of opportunity in a macro environment characterized by lower yields and higher volatility.
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