School Bonds Buttressed by Tuition Resist Budget Ax: Muni Credit

Higher-education debt is outperforming tax-exempt municipals because colleges and universities are able to raise tuition and draw on endowments even as states prepare to slash funding by $5 billion in 2012.

“This will easily stand as the biggest downturn in funding for universities since the Great Depression,” said Michael Tanner, chief academic officer of the Association of Public and Land-Grant Universities in Washington. “There has been a sustained loss of money.”

Higher-education debt has produced a total return of 9.17 percent this year, 67 basis points above that for tax-exempt municipal securities and 110 basis points above Treasuries, according to Bank of America’s Merrill Lynch Municipal Master Index, which includes price changes and interest income. A basis point is 0.01 percentage point.

The outperformance benefited California State University, which funds the biggest U.S. public higher education system, as it sold $430 million of revenue bonds yesterday at rates below debt sold by the average school system. That compares with a premium it paid above the benchmark on its last tax-exempt sale in 2010. The university raised tuition 32 percent and cut costs by $273 million last year, according to the offering document.

States recovering from an 18-month recession that ended June 2009 may cut $5 billion from higher education for fiscal 2012, according to the Washington-based National Association of State Budget Officers. They face a combined $103 billion of budget shortfalls in fiscal 2012, according to the Center on Budget and Policy Priorities.

Other Resources

To make up for those cuts, colleges and universities can increase tuition and fees, said Matt Dalton at Belle Haven Investments Inc. who manages more than $800 million of municipal bonds. Many private schools, including Stanford University, also benefit from income from endowments.

“They have other resources,” Dalton said. “The private ones have the endowments and higher education can reach out to fundraising efforts. You’re not going to get a fundraising effort in Harrisburg,” he said, referring to Pennsylvania’s capital and its payroll and debt-service cost challenges.

Harrisburg’s City Council Sept. 13 moved to avoid a default by accepting a real-estate deal that provides cash for costs including debt service.

Stanford University in Palo Alto, California, used $855 million from its endowment to cover operating costs last year, representing 26 percent of its operating budget, according to the institution’s most recent annual report.

Revenue Credit

“There are a lot of things they can do that can’t be done at the city and county level,” Dalton said in a telephone interview from White Plains, New York.

Investors view higher-education bonds as a revenue credit secured by tuition fees, with U.S. students and oversees applicants continuing to pursue a college career, he said.

“The demand side is there whether it’s domestic or foreign, and I don’t see that going away anytime soon,” Dalton said.

Education debt trailed the overall municipal market the past two years, after beating it from 2005 through 2008, according to Bank of America Merrill Lynch index data.

The California State University deal priced with $22 million of debt maturing in 2021 yielding 2.82 percent, or 16 basis points below a 10-year index of AA education bonds, which is two grades higher than the issuer’s A+ rating from Standard & Poor’s. That compares with an 11 basis point premium above the index it paid on the 10-year portion of $147 million of revenue bonds sold March 2010, according to data compiled by Bloomberg.

S&P changed the university system’s outlook Sept. 9 to positive from stable.

Following is a description of a pending sale of municipal debt:

THE DORMITORY AUTHORITY OF THE STATE OF NEW YORK, which issues debt on behalf of higher education facilities, hospitals, and not-for-profit institutions, will sell $402 million of revenue bonds as soon as today. Proceeds will help finance capital projects at North Shore-Long Island Jewish Health Care System facilities and refund prior debt. The bonds are rated A3, Moody’s Investors Service’s fourth-lowest grade. Citigroup will lead a syndicate of banks. (Updated Sept. 15)

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