From the issue dated February 7, 2003



|From the issue dated February 7, 2003 |

|[|Junk-Bond Colleges |

|p|Declining fiscal ratings reflect the struggles many small colleges face |

|i| |

|c|By MARTIN VAN DER WERF |

|]| |

| |The long-predicted decline in the fortunes of small private colleges is |

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| |ALSO SEE: |

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| |Fall in Value |

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| |Growing Pessimism |

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| |beginning to show up in the bond market. Since the beginning of 2002, six colleges have |

| |been downgraded to "below investment grade," or "junk bond" status. The number now rated |

| |in the junk category, 17, has nearly doubled in the last two years. |

| | |

| |The reasons are familiar. Investments are performing poorly, which has hurt endowments; |

| |the sinking economy is causing parents to question the worth of the higher tuition at |

| |private institutions; and debt that was taken on during the flush years of the late '90s |

| |is now proving to be a drag on already thin balance sheets. |

| | |

| |To lure students, smaller colleges have been doling out more financial aid and building |

| |new facilities to match those at the college down the road. The result is that many |

| |colleges are operating year after year with deficits, further depleting their resources. |

| | |

| |Once colleges have their bonds downgraded to junk status, it creates uncertainty about |

| |their financial strength, and, in most cases, it forces colleges to pay higher interest |

| |rates to the holders of their bonds. |

| | |

| |Nonetheless, investors, particularly those who make purchases for mutual funds, remain |

| |interested in bond issues from low-rated small colleges. The bonds are a staple of |

| |tax-free high-yield municipal funds. Only one college, Bradford, has defaulted on its |

| |bonds in recent years. The Massachusetts liberal-arts college closed in 2000 because of |

| |financial problems. The possibility that more small liberal-arts colleges might follow |

| |that same path, however, and fears that Life University, a Georgia institution primarily |

| |known for its chiropractic program, will default on its bonds, too, have sent the first |

| |shivers through the higher-education bond market. |

| | |

| |Barnet Sherman, who buys small-college bonds for Van Kampen Funds, says he is focusing |

| |less on liberal-arts colleges, and more on specialized colleges that he thinks will |

| |remain popular. |

| | |

| |"We look for schools that have a very important market niche," says Mr. Sherman, a vice |

| |president and fund manager for the New York-based mutual-fund company. "Liberal-arts |

| |schools? I would say more generally that they have a harder sell. People are looking at |

| |them more carefully, and wondering what their long-term chances of success are." Van |

| |Kampen is still buying bonds of some liberal-arts institutions, like Bennington College, |

| |in Vermont. But it is spreading more of its money to places like Daniel Webster College, |

| |in New Hampshire, which specializes in aviation careers, and the Boston Architectural |

| |Center and Montserrat College of Art, in Massachusetts. |

| | |

| |Terry J. Goode, a senior municipal credit analyst for San Francisco-based Wells Capital |

| |Management, says, "We are keeping an eye on [college bonds] we do own to make sure they |

| |will be able to continue to perform. If this anemic economy continues, they do risk |

| |further declines in credit quality. I think 2004 will be a critical time for them if the |

| |equity markets do not come around." |

| | |

| |Financial Pinch |

| | |

| |The bond markets offer an incomplete picture of the financial health of all of American |

| |higher education. Only about 500 of the 4,000 or so colleges and universities in the |

| |United States carry a public bond rating. But on an individual basis, the struggles of |

| |colleges with ratings offer a glimpse into the serious financial pinch being felt |

| | |

| |around the country, particularly in the Northeast and Midwest, where most small private |

| |colleges are located. Many are in spirals of accumulating debt and diminishing resources.|

| | |

| |Eastern Nazarene College, in Massachusetts, for example, has financial resources of about|

| |$4-million, but debt that exceeds $22-million. At the University of Findlay, in Ohio, the|

| |debt is $28.5-million, far more than the institutions' total financial resources of less |

| |than $17-million. At Clarke College, in Iowa, total financial resources have slipped |

| |below the college's overall debt of $12.3-million within the last two years. All are now |

| |rated one notch below investment grade. |

| | |

| |Colleges that have been downgraded to "junk bond" status wince at the implications of the|

| |rating, but say it is not unusual in a bad economy, and reflects what is happening with |

| |corporate bonds and some government bonds. |

| | |

| |The report with the downgrade decision "is a good tool for usit's interesting and |

| |important to look at it," says Eugene T. Kirschbaum, vice president for business and |

| |finance at Clarke. "But it shouldn't be taken as a sign that the college is falling apart|

| |because it isn't falling apart." |

| | |

| |Clarke used an $8-million bond issue in 1998 to build a new student union and a student |

| |apartment complex. Both have been open for three years now. They were added to a campus |

| |that is made up of comparatively new buildings, since about half of Clarke's campus was |

| |destroyed by fire in 1984. The Roman Catholic college, which has about 960 students, has |

| |been cutting costs by, among other things, reducing cafeteria hours and negotiating new |

| |purchasing contracts. |

| | |

| |"Unless something unforeseen happens, we will have a balanced budget this year," says Mr.|

| |Kirschbaum. |

| | |

| |That would be a marked change from recent years. According to a review of the college's |

| |credit by Moody's Investors Service, published last month, Clarke has averaged an |

| |operating deficit of 6.4 percent for the last three years. The college's saving grace has|

| |been fund raising. It has raised an average of $3-million a year for the past three |

| |years, but the college endowment is only about $10-million. That is because some of the |

| |money given to the college is diverted straight to the general operating budget, or to |

| |pay for building projects, says Mr. Kirschbaum. |

| | |

| |At Findlay, the drop in ratings is meaningful, but no reason to panic, says Martin Terry,|

| |vice president for business affairs. |

| | |

| |The financial problems "have really brought this university together as a team to see |

| |what we could do, rather than just cut positions and cut programs," says Mr. Terry. |

| |"We'll just get in there, and do the things we need to do to straighten this out, and in |

| |two years, we'll reapply" for a rating review. |

| | |

| |Findlay, however, appears to be in worse financial shape than it was three years ago, and|

| |Moody's "believes that the recent erosion of balance-sheet resources is unlikely to be |

| |reversed over the near term," according to a credit report released in November. The |

| |college has been running deficits for five consecutive years, and total financial |

| |resources have plummeted by more than 40 percent since 1999. |

| | |

| |How the Ratings Work |

| | |

| |Colleges are rated on the same scale as other bonds. The highest rating, AAA, goes only |

| |to the wealthiest colleges and state-university systems. The AAA institutions include |

| |five of the eight Ivy League members (Dartmouth College and Columbia, Harvard, Princeton |

| |and Yale Universities), other large national universities, such as the University of |

| |Notre Dame and Stanford University, and smaller institutions with extraordinary financial|

| |resources, such as Amherst and Grinnell Colleges. |

| | |

| |In descending order from AAA, there are three categories of AA ratings, three of A, and |

| |three of BBB. Below BBBñ, in the case of Fitch Ratings and Standard & Poor'sor Baa3, as |

| |Moody's expresses ita college is considered "below investment grade" or "speculative." |

| |That category, made popular by such traders as Michael Milkin and Ivan Boesky, became |

| |known as "junk bonds" in the 1980s. |

| | |

| |The ratings continue: Three BB ratings, then three B ratings, and there are also ratings |

| |at CCC, CC, and C. If a bond drops below C, it is marked D, for "default." In addition to|

| |a rating, a bond issuer is also assigned an "outlook"positive, stable, or negative. |

| | |

| |All of the colleges now listed as below investment grade are at the upper end of the |

| |junk-bond scale. Of the 17 institutions now rated in the "junk" category, all but one are|

| |BB. Only Life University is below that, at B. |

| | |

| |Analysts of college bonds say that while a drop into "junk bond" status is not a death |

| |knell, it marks the existence of financial problems so fundamental that recovery would be|

| |arduous. |

| | |

| |"It is more typical than not that they don't come back to investment grade," says Joshua |

| |Stern, a higher-education credit analyst at Standard & Poor's. |

| | |

| |"The erosion of resources is difficult to restore." |

| | |

| |Mr. Stern wrote a report in November predicting that colleges and universities might |

| |"consolidate in large numbers or close as they struggle against stagnant levels of |

| |financial resources and substantially higher levels of debt." |

| | |

| |In 2002, Standard & Poor's upgraded the bond ratings of seven colleges and downgraded the|

| |ratings of nine, the first time downgrades have outnumbered upgrades since the mid-1990s.|

| |From 1990-95, Standard & Poor's upgraded the ratings of 80 colleges, and downgraded 178. |

| |But the trend reversed from 1996-99, when the ratings agency upgraded 120 institutions |

| |and downgraded only 14. Now the pendulum is swinging back again. |

| | |

| |It was predominantly lower-rated colleges that were downgraded in the last year. "That is|

| |pretty much in line with what we expected," says Mary Peloquin-Dodd, who heads the |

| |higher-education-rating division at Standard & Poor's. "What we are asking ourselves now |

| |is how long the downturn will be in the sector, and how long it will be before it begins |

| |to affect colleges that appear to be more insulated from financial concerns." |

| | |

| |Moody's had more upgrades of colleges, 29, than downgrades, 18, in 2002. But for private |

| |colleges, the number of upgrades and downgrades were the same, 18. Analysts at Moody's |

| |say the colleges most likely to be downgraded are those losing students they used to be |

| |able to attract. |

| | |

| |"When things are going bad, there is sort of a chain reaction, and it often begins with |

| |declining enrollment," says Naomi Richman, the head of the higher-education analyst group|

| |at Moody's. "Declining enrollment leads to declining tuition revenue, which leads to |

| |operating deficits and poor liquidity. Colleges can cut, but they can't cut everything, |

| |because their quality will suffer, and then even more students won't come." |

| | |

| |Turning Things Around |

| | |

| |Before all of the low-rated colleges are written off as goners, however, consider the |

| |case of Dowling College, on New York's Long Island. |

| | |

| |As of June, Moody's had tagged it with the lowest bond rating of any college in the |

| |country, four steps below investment grade. In September, just as many colleges opened |

| |their doors to another year of red ink, Moody's upgraded Dowling by one category, and |

| |announced that it has a positive outlook on the college's finances. This, even though |

| |Dowling sold $10.9-million worth of bonds late last year, adding to the $37-million in |

| |debt it was already carrying. |

| | |

| |Moody's analysts were impressed that the college has a growing enrollment, and, after |

| |years of deficits, it has balanced its budget for three consecutive years. That came |

| |after a disastrous investment of more than $26-million in the late 1990s in what was to |

| |be an international center for the study of aviation and transportation. The project |

| |failed, and the center has been turned into a branch campus of Dowling. |

| | |

| |How is the college turning itself around? |

| | |

| |In late 1999, the college's new president, Albert E. Donor, and the new chief financial |

| |officer and treasurer, Susan E. Williams, began meeting every Monday at 7 a.m. with six |

| |of the college's trustees to set an agenda for what had to be accomplished that week. |

| |Every step was designed to nurse the college back to financial health. |

| | |

| |"We called all of our vendors, and we said we really need your help," says Ms. Williams. |

| |"'How can we work with you to maintain ourselves and have it cost less, but still make |

| |sure you get paid.' We talked with them often. So if they didn't get a check from us, |

| |they got a phone call from us, explaining the situation. Those phone calls have meant a |

| |lot." |

| | |

| |The college slashed advertising costs for recruiting students, focusing instead of |

| |rebuilding relationships with local high schools. |

| | |

| |It reduced executive salaries across the board, froze hiring, and beefed up collections |

| |on student accounts. Tuition makes up 86 percent of the college's revenue. No costs were |

| |considered too minor to escape attention, says Ms. Williams. And, slowly, the situation |

| |has improved. |

| | |

| |A Flood of Bond Issues |

| | |

| |Like Dowling, a number of other colleges in relatively weak financial condition are going|

| |further into debt, reasoning that they need new science centers, residence halls, |

| |recreation centers, and other facilities sought by students. It's either that, or close |

| |for sure. |

| | |

| |D. Scott Gibson, a managing director for Advest Inc., a Hartford-based investment bank, |

| |says the market is being flooded with bonds from small colleges. Temporarily, at least, |

| |the economy is working in the colleges' favor. Interest rates are at historic lows. |

| | |

| |Even colleges with lower-level bond ratings, such as BBB, are getting interest rates of |

| |around 5.5 percent. Rates at that level are, in some cases, even lower than the interest |

| |rates on AAA-rated college bonds sold at a time when the economy was much stronger. |

| | |

| |"That's an incredibly low borrowing rate for BBB schools," says Mr. Gibson. "Yes, it |

| |means more debt, but who's to say that isn't the best deal going right now?" |

| | |

| |But there is a downside, too. Rates for bond insurancewhich allows a college, or any bond|

| |issuer, the chance to buy a higher credit ratingare up by more than 25 percent in the |

| |last two years, says Mr. Gibson. And underwriters of college bond issues and the |

| |bond-insurance companies are asking for much more in bond covenantscollateral, |

| |stipulations, or other requirementsthan they used to. |

| | |

| |In 1999, the College of New Rochelle, for example, did not have to offer any covenants, |

| |other than a pledge that its debt would not exceed 15 percent of its annual expenditures.|

| | |

| | |

| |Now, the discussions begin with colleges offering a mortgage on the buildings being |

| |built. |

| | |

| |At Salve Regina University, the bond insurer took a mortgage on the core of the Rhode |

| |Island campus when the college's $40-million bond issue went to market late last year. At|

| |Western New England College, in Massachusetts, there will be a mortgage on the residence |

| |hall being built with a new bond issue, meaning bondholders would have preference over |

| |other creditors if the college or the dormitory itself goes bust. |

| | |

| |It is just another indicator that investors are looking to protect themselves, even when |

| |buying into colleges, which up to now have been considered one the safest investments |

| |going. |

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| |FALL IN VALUE |

| | |

| |A growing number of colleges have low bond ratings. |

| | |

| |The following institutions have been downgraded since December 2001 to "below investment |

| |grade" ("junk bond") status, which means that bond-rating agencies believe they have |

| |significant financial problems: |

| |Clarke College (Iowa) |

| |Eastern Nazarene College (Mass.) |

| |Lasell College (Mass.) |

| |Ohio Dominican U. |

| |Texas Wesleyan U. |

| |U. of Findlay (Ohio) |

| |The following institutions were "below investment grade" before 2002: |

| |Bennington College (Vt.) |

| |Daniel Webster College (N.H.) |

| |Dowling College (N.Y.)* |

| |Eckerd College (Fla.) |

| |Franklin Pierce College (N.H.) |

| |Life U. (Ga.) |

| |New England College (N.H.) |

| |Nichols College (Mass.) |

| |Southern California U. of Health Sciences |

| |Touro College (N.Y.) |

| |Tougaloo College (Miss.) |

| |These colleges are currently being reviewed for a downgrade to "below investment grade": |

| |Polytechnic U. (N.Y.) |

| |Saint Peter's College (N.J.) |

| |Bond-rating agencies also state whether colleges' financial outlooks are stable, |

| |positive, or negative. The following colleges are still considered to be above junk-bond |

| |status, but they have the lowest investment-grade rating, and negative outlooks: |

| |Bloomfield College (N.J.) |

| |Christian Brothers U. (Tenn.) |

| |College of Santa Fe |

| |Delaware Valley College (Pa.) |

| |Dowling College* |

| |Lewis U. (Ill.) |

| |Regis College (Mass.) |

| |U. of Louisiana at Monroe |

| |* Dowling College is rated "below-investment grade" by Moody's, and carries an |

| |investment-grade rating with a negative outlook by Standard & Poor's. |

| |SOURCES: Fitch Ratings, Moody's Investors Service, Standard & Poor's |

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| |Section: Money & Management |

| |Volume 49, Issue 22, Page A0 |

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| |Easy-to-print version |

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