BRADENTON, Fla. - Moody's Investors Service downgraded Atlanta's Morehouse College two notches to Baa3 from Baa1, citing deficits and potentially insufficient cash flow for debt service, among other issues.
The lower rating affects $40 million of bonds issued on behalf of Morehouse by the Development Authority of Fulton County. The outlook is negative, Moody's said in a May 13 report.
The downgrade exacerbates a split rating scenario that may create a dilemma for investors.
"The downgrade to Baa3 with a negative outlook is based on Morehouse's structural deficits with insufficient cash flow from operations to cover debt service, ongoing enrollment declines, and weak liquidity with financial performance that will remain compressed through at least fiscal year 2015," said analyst Erin Ortiz.
Fiscal 2015 also will be the first full year that the college's new senior leadership team will be in place to see the results of strategies to stabilize enrollment, operations, and the balance sheet profile, Ortiz said.
"The negative outlook reflects the probability of a further downgrade should the college be unable to improve cash flow and debt service coverage in fiscal year 2015 and beyond or if there is a further decline in liquidity or enrollment," said Ortiz.
In response to Moody's downgrade, Morehouse said that its new senior administrative team has introduced strategies to address enrollment and operations.
"Morehouse College finds itself in the company of many small liberal arts colleges that are facing enrollment volatility," President John Silvanus Wilson Jr. said in a statement. "I am confident that with the strategies that we are deploying, we will experience stability soon."
Standard & Poor's said strategies to address expense and enrollment pressures are "still in process, and their outcome will take time to be fully realized," when affirming its A-minus rating and stable outlook in March.
"The A-minus rating is supported by the college's maintenance of good financial resource ratios and a very manageable debt service burden," said S&P analyst Debra Boyd.
The three-notch difference between Moody's and S&P's ratings on Morehouse's bonds highlight how the agencies use different methodologies, said Matt Fabian, managing director of Municipal Market Advisors.
Fabian said, as an example, that S&P's rating methodology looks at default risk, while Moody's looks at default plus loss severity.
Split ratings have become "incredibly common," and force people to understand that rating agency systems are not strictly comparable, he said.
"That's an added level of difficulty in what is a tough market to navigate," said Fabian. "This hurts both the value of a particular bond and, looking at the entire scheme of ratings as a whole, overall market liquidity."
In today's market, where available product and credit spreads are so tight, a split rating is less of a pricing detriment.
"But it adds to a particular bond's potential re-pricing risk if the market corrects," he said. "Meaning that all else being equal, split rated bonds are more likely to be sold than uniform rated bonds if the market begins to cheapen or if investors begin to sell."
In reviewing Morehouse's credit, Moody's said the college has "very thin" liquidity given its operating performance with 110 monthly days cash to cover operating expenses. Liquidity has remained low due to extraordinary endowment draws to fund operations and debt service.
Thin cash flow of 2.2% provided 0.41 times debt service coverage in fiscal 2013.
The college has high dependence on federal funding, including financial aid, which increases its vulnerability to changes in funding requirements and other policy shifts that have adversely impacted enrollment in recent years, said Moody's. The institution has seen a 19% drop in total enrollment since fall 2009, to 2,099 full-time equivalent students in fall 2013.
S&P said the college has adequate resources to manage through its outlook period.
"While there was improvement in operations in fiscal 2013 for the first time in three years, in our opinion, it is too soon to tell if this is the start of a stabilizing credit profile," said S&P.
Some of Morehouse's bonds are actively trading near par and the same 5% yield when they were sold in 2007. On Thursday, a customer bought $15,000 of bonds maturing in 2037 for $99.6 cents on the dollar to yield 4.52%.
Founded in 1867, the historically black liberal arts college for men is located on a 66-acre campus in Atlanta.
Morehouse is among 105 institutions participating in the White House's initiative on historically black colleges and universities.
