With higher education issuance set to jump, analysts are pondering whether the higher yields on the credits are worth the risk.
Anticipated higher education volume has surged 10% according to Barclays' 30-day visible calendar, the largest increase of any sector, Barclays wrote in a report released Friday. Among the deals, the University of Alabama is expected to auction $243.9 million of general revenue bonds in a two-part deal Tuesday, followed by the Build New York City Corporation, which is scheduled to issue $68.7 million revenue refunding bonds for Queens College later in the week.
Analysts cited declining student population, massive amounts of student debt and tuition inflation as factors that may put stress on higher education issuers.
The bonds are outperforming the general municipal market though, with Standard & Poor's Municipal Bond Higher Education Index returning 7.52% year-to-date while the S&P Municipal Bond Index has returned 6.58%, J.R. Rieger, global head of fixed income indices at S&P Dow Jones Indices wrote in an email.
Issuance has remained low all year, and the high yield sectors have been hit particularly hard. Higher education volume has totaled $6.03 billion through July 31, 28.4% lower than it was for the same period in 2013, according to data compiled by The Bond Buyer and Ipreo.
One reason higher education issuance may be picking, according to Jim Colby, chief municipal strategist at Van Eck Global, is that issuers "woke up to the reality interest rates are going to rise."
Colby predicted that rates will increase within the next nine to 10 months, saying in an interview that the specter of less attractive rates later is prompting the institutions to issue debt now.
"I think it's a couple things," Dan Heckman, senior fixed income strategist at U.S. Bank, said in an interview. "One is that on the state tax selection side [cash from the taxes] will be for state institutions like education. Also you have the development of very good capital markets. As people's net worth has increased, you're going to see a pickup in contributions to private institutions as well."
With high yield issuance so low, an increase in higher education deals, which are known to carry some yield, offers an opportunity for buyers. Higher education offers investors "the reward of incremental yield which can make a difference in a portfolio's performance for the year," Adam Buchanan, sales and trading vice president at Ziegler Institutional Sales, said in an interview.
Colby said private for-profit universities have begun to access the muni market to fund infrastructure projects. By "private for-profit universities" Colby said he means entities that are not the 501c3 non-profit entities, "private colleges like Harvard, Yale, Stanford, those that are in effect funded through tuition and fees and endowment in opposed to getting any public assistance."
"The fact that there has been reduced issuance in municipal high yield makes those issuances more appealing to high yield funds," he said. "The higher education part of marketplace has a significant foothold because there is a lack of [higher education] issuance."
Higher education deals offer diversification opportunities that are all the more attractive in a low issuance environment.
"There are diversification because of the type and rating of university and because of the state [the university is in]," he said. "Most portfolios are structured to look or opportunities to diversify, and certainly higher education not unknown and not inconsequential [compared to its] overall presence."
Buchanan listed second-tier California universities as a way investors can buy higher education to diversify their portfolio.
"The rally in Cali paper makes it very difficult to find any [California] yield, there some second-tier California higher education credits that are demonstrating value," he said.
Higher education bonds do carry some problems, analysts said, especially with the lower rated credits that tend to carry the most yield.
"In the short-term, higher education officials face the demographic challenge of fewer high school graduates," Roy Eappen, an associate at Wells Fargo Securities, wrote in a July 29 report. "In the long term, institutions will have to meet the needs of a growing non-white student population."
He also noted that 40% of higher education chief business officers are expected to retire within five years.
"We've seen a move towards more enrollment in junior colleges, technical colleges, and less expensive state colleges," Heckman said, listing that as a challenge higher education faces going forward.
One of the issues with higher education is that the market's opinion of the credit is colored by the finances of the state or municipality the university is in, according to analysts.
In "states that have some fiscal stress right now, Michigan for example, [investors] might want to do some more careful analysis in terms of what support has been promised and guaranteed, what the timing is in terms of cash and obligations, and compare it to finances of the state itself, and whether it has to bail out some contingents in trouble such as the city of Detroit," Colby said.
Buchanan said that if higher education institutions receive state financial support, the health of the municipality has to be part of the credit analysis.
While Colby said that "certainly" investors, in particularly smaller firms that do not have a large analyst staff, can be deterred from higher education credits in distressed states or municipalities because of the negative connotations associated with the state name, Buchanan pointed out that is not always the case. He listed the $573.6 million University of Chicago revenue bond deal sold on Aug. 5 as an example.
"It's a globally recognized institution that has a favorable education track record," he said. "Despite [Illinois] being on negative outlook by S&P the transaction did very well."
The lack of transparency in lower rated higher education credits also concerns analysts.
"I have seen instances where some of the private for profit colleges and universities have been less than transparent in terms of their overall finances, in delivering that sort of information that you might otherwise find available for some of the more prosperous and well-endowed schools," Colby said.
Heckman said that while he agrees with the comments about transparency, investors do have to look at the credits on a case by case basis.
"The lack of transparency in high yield higher education credits is part of the sector that needs to improve," Buchanan said.
Heckman recommends looking at states with very positive growth trends that have a population age that is younger than other states, and strong economic growth especially on the employment side.
"We are preferably looking at low single A, high BB, where you best have that value proposition of some additional spread and less worries," he said.
