Higher Costs For Students Could Spell Trouble For Private U.S.

Colleges And Universities' Credit Quality

Primary Credit Analyst: Carolyn McLean, New York (1) 212-438-2383; carolyn.mclean@standardandpoors.com Secondary Contact: Jessica A Matsumori, San Francisco (1) 415-371-5083; jessica.matsumori@standardandpoors.com Research Contributors: Phillip A Pena, San Francisco; phillip.pena@standardandpoors.com Stephanie Wang, New York (1) 212-438-3841; stephanie.wang@standardandpoors.com

Table Of Contents
The Double-Edged Sword Of Tuition Discounting Regional Variations Underlie The Broader Trends Managing A New Normal

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Higher Costs For Students Could Spell Trouble For Private U.S. Colleges And Universities' Credit Quality
Since the Great Recession, tuition growth and ever-higher student loan burdens across the U.S. have caused many to question whether higher education is worth its cost -- especially for private colleges and universities. As another academic year is about to commence, students, parents, and others who may be footing the bill are paying close attention to both the affordability of higher education and the financial sustainability of the universities themselves. U.S. colleges and universities are approaching a point where many of their customers can't afford the tuition without significant financial aid. And typically, tuition is the largest revenue source for universities, so increased financial aid expenses are whittling into their financial stability. Standard & Poor's Ratings Services believes that rising college costs -- both from tuition and other expenses -- could begin to significantly stress the ratings on some schools and universities, particularly those in highly competitive markets. While affordability and financial health are concerns for both public and private universities nationally, the pressure is more acute at those that do not receive governmental financial support. We believe tuition discount rates (financial aid expense divided by gross tuition revenue), the net tuition revenue change (net tuition growth or declines from year to year), matriculation rates, and full-time equivalent (FTE) enrollment could all take a hit at private universities, which could ultimately affect our ratings on them. And although the problems extend across the ratings spectrum, we expect rating pressure will most likely occur at the lower end of the rating scale ('A' category and lower). Overview The increasing costs of higher education in the U.S. have many potential students reevaluating where they will go to college or university. Private colleges and universities are offering much more in the way of financial aid to students, which is cutting into their profitability. We believe our ratings on private universities, which don't receive government support, are particularly vulnerable. Lower-rated private colleges and universities could experience negative rating actions in the next few years if they are unable to build a sustainable business model with a declining revenue source.

The Double-Edged Sword Of Tuition Discounting

Students and their families have become increasingly sensitive to cost when choosing a college, and financial aid has become a crucial deciding factor. Generous financial aid packages, particularly in competitive markets, are key to attracting a high-quality and diverse student body. But offering additional financial aid squeezes net tuition revenue, which is often a university's largest revenue stream. University chief financial officers must meet the demand for more financial aid to maintain quality and enrollment with a flat or declining key revenue source. Although net tuition

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Higher Costs For Students Could Spell Trouble For Private U.S. Colleges And Universities' Credit Quality

revenue at most universities increased significantly in the late 1990s and early 2000s, when tuition increases were relatively limitless and discounting did not drive enrollment, these increases have moderated in the past five years. The majority of colleges and universities we rate have carefully balanced increased discount rates and flat enrollment with modest tuition increases over the past four years to continue producing modest growth in net tuition revenue. However, we believe, if demand for financial aid continues to rise and universities cannot offset this with increased tuition revenue, we expect to see more net revenue declines. This could mean increased fundraising, endowment growth, or higher enrollment in graduate or nontraditional programs, which often have limited discounting. Expense management plays an important role as well when managing a declining or slowly increasing revenue base. The high fixed costs across the industry could necessitate substantial expense restructuring, including decreasing personnel costs through layoffs or early retirement incentives and reining in administrative expenses.

Regional Variations Underlie The Broader Trends

We've found that, for the most part, the pressure to increase financial aid to attract students and the subsequent stress on net tuition revenue are happening across the country. Not surprisingly, tuition discounting has increased and net tuition revenue growth has slowed. In addition, matriculation rates have weakened across the sector, which we believe demonstrates increased competition for students. We attribute both of these factors to an increase in the average number of applications that each student submits as well as increased proclivity for "financial aid shopping" when making a decision of where to attend. In certain cases, universities have increased freshman tuition discount rates as high as 60%. While we believe institutions with large endowments can offset this increased expense with endowment-draw revenue, smaller or more regional institutions are struggling to make ends meet. Tuition discounting in the Northeastern U.S. is the highest compared with that in other regions, with a median tuition discount rate of nearly 34%, up from 31% in fiscal 2008 (see chart 1).

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Higher Costs For Students Could Spell Trouble For Private U.S. Colleges And Universities' Credit Quality

Chart 1

The lowest discount rates nationally were in the Western U.S., with a median discount rate of just 31% -- up only two percentage points. We believe this is attributable to lower tuition levels overall in the region. In fact, when applying the median discount rate to the median tuition in the West, the discounted tuition is the lowest nominally of any region. This is likely due to strong competition with public universities there, which offer significantly lower tuition levels for in-state students. Most dramatically affecting net tuition revenue growth are the shifts in the economic condition of students and their families (see chart 2).

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Higher Costs For Students Could Spell Trouble For Private U.S. Colleges And Universities' Credit Quality

Chart 2

Although the Western U.S. has the lowest discount rate, its nominal tuition levels are also the lowest across the country, and its decline in net tuition was the most dramatic, at nearly five percentage points between 2008 and 2012. We believe that regions with strong competition between private and public universities put even more pressure on discount rates, because if students can attend a state university with similar or better-quality education than private university choices for a much lower cost, many families are encouraging this option. Supporting this point, we saw the weakest matriculation rates in the Western U.S, although declines are industry-wide (see chart 3).

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Higher Costs For Students Could Spell Trouble For Private U.S. Colleges And Universities' Credit Quality

Chart 3

Managing A New Normal

Some universities have successfully weathered the Great Recession and managed the pressure on net tuition revenue, while others are facing looming expenses and a declining revenue source. Although the most dramatic declines in net tuition revenue were in the recession's first year, continued declines are a real threat to the sector's financial sustainability. We believe the fiscally strong universities will absorb increasing expenses through new or alternative revenue streams, and the fiscally weak will have more trouble getting by -- and might have to resize enrollment, accept lower-quality applicants, or significantly reduce expenses. We believe that protracted pressure on net tuition revenue could lead to operating deficits, significant deterioration in financial resources, and (potentially) mergers or closures over time, particularly in the lower rating categories. The ability to successfully manage affordability concerns remains a key credit concern for private colleges and universities. Overall, we believe that the highly rated universities will retain strong credit profiles, given their good demand and financial flexibility, and the lower-rated universities will be faced with significant challenges.

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