As we approach fall in a national cloud of uncertainty around school openings, both at the K-12 and university levels, there are fundamental implications across the U.S. municipal bond market. Investors must be careful in their choices when investing in — or exiting — the education sector.
In this pandemic, we favor education bond issuers that can maintain market position, revenue diversity and budgetary flexibility to overcome the potential austerity the municipal market faces.
Overall, however, our outlook is at best guarded on U.S. education sector bonds.
Public school districts are in crisis, operationally and financially. In March, the Trump administration and the U.S. Congress dedicated $13.2 billion for K-12 districts, far less than the $100 billion provided for state education budgets by the Obama administration in 2009, during the Great Recession.
Many analysts expect school districts over the next two years to lose $200 billion in revenue, driving roughly 300,000 teacher layoffs.
Fortunately for school districts, the primary funding source is property tax revenues, and the national housing market remains strong. But school districts also receive about 21% of their revenues from state and local funding. These sources could be vulnerable if states and localities do not receive additional (and equally meaningful) federal assistance.
But on aid to the states and enhanced education funding, Congress is deadlocked.
The White House, looking mostly through a political lens, wants to tie additional federal funds to require schools to hold in-person classes. Yet many public school districts, facing real pressure from parents and teachers’ unions to be ruled by public health determinations, are grappling with how and when — or even whether — to bring teachers and students back into classrooms.
The impact on private secondary schools should be negative but bifurcated between those with and without strong balance sheets. Charter schools may receive some more emergency funds from Congress, but they received less than $1 billion in the first round.
While most U.S. municipalities maintain enough budgetary flexibility to manage the current economic challenges, absent a robust federal aid package we expect austerity measures at the state level.
Education is one of the states’ largest budget items, and often first cut during times of stress. Other big-ticket items, such as Medicaid, generate federal matching funds, making them more expensive to cut.
The degree of austerity and budgetary pain on downstream entities is unknown and will be determined on a case-by-case basis. Ultimately, it will be informed by the aid, if any, Congress provides.
When it comes to higher education, federal funding is critical: about 10% of university revenues are driven by state and local funding. Colleges and universities, already reeling from pre-COVID 19 online programs and tuition discounting, have lost large swaths of funds from cancelled room-and-board charges, study abroad programs and spring athletic events.
Cancellation of major college football, the industry’s biggest money maker, alone could cost more than $4 billion for the 75 universities (50 public) that make up the Power 5 conferences. Two of those conferences have already cancelled all fall sports. The other three have announced they will play football this fall, but whether they can do so safely remains to be seen.
In the near-term, public colleges are budgeting for significantly less in-state appropriations. Private colleges, which tend to be more expensive, could face enrollment declines.
Universities across the country also will suffer if international students stay away, because they typically provide higher-margin revenues. All told, the short-term outlook for higher education is bleak.
Student enrollment could take a major hit. The industry has been forced to move almost all classes online. This may seem a saving grace, but it could become a serious long-term threat.
Online degrees are likely to become more accepted by employers. These degrees cost much less to attain than those from prestigious brick-and-mortar colleges. To be dramatic, most streaming services cost about $150 per year, yet classic higher education can easily exceed $50,000 in a single year.
Those costs are staggering, particularly to educate more than one child close in age. If a protracted recession follows this pandemic, higher education could become a very hard, if not untenable proposition for American families that have decent resources but are not wealthy.
Thus, post-COVID our outlook on higher education sector bonds will remain guarded.
