The credit crisis tying global financing systems into knots has left hundreds of colleges scrambling for cash to pay their bills and to cover the spiking interest on their debts.
While it is still unclear to what extent the federal government’s new $700-billion bailout package will help unwind the credit tangle, the crisis has exposed weaknesses in policies and management that left some institutions more vulnerable than they should have been. A few have already halted construction projects in midstream because of the higher cost of borrowing. Others are considering faculty or pay cuts.
“What happened in the last six months so fundamentally changed the rules of the game,” says Stephen T. Golding, executive vice president for finance and administration at Cornell University. “If the credit markets and the banks are not going to stand by you, your risk tolerance may be less than what you thought it was.”
At the same time, bankers who do business with colleges and academic medical centers note that as a sector over all, higher education is faring better than other industries, even if colleges are finding they’re paying more for credit.
“They’re not happy about it, but they can manage through it pretty effectively,” says John Augustine, a managing director of Barclays Capital, the British bank that bought the North American arm of Lehman Brothers when it went bankrupt in September. He said one reason colleges have not been frozen out of the credit markets altogether is that investors understand that most colleges’ debt obligations relative to their overall budgets remain well below 10 percent.
Risk Tolerance
Across the board, the credit crisis has been Topic A for college administrators and their trustees in recent weeks.
Already, college leaders who rarely if ever thought about their relationships with their bankers, the need for diversification in how they borrow money, or the risks they might be taking on with their floating-rate debt, are quickly recognizing the dangers of such inattention.
“There’s going to be a call for colleges to get back to a risk-management approach” with their debt, predicts Richard Staisloff, vice president for financial affairs for the College of Notre Dame of Maryland.
Some colleges were in investment funds and didn’t understand that the money could be tied up. Now, says Mr. Staisloff, governing boards will be saying, “We need to know more.”
He is referring to the shock that hit nearly 1,000 colleges last month when Wachovia bank froze accounts they had invested in through Commonfund, leaving institutions unable to access billions of dollars in short-term funds they depend on for salaries, campus construction, and debt payments (The Chronicle, October 10).
While the accounts have since become more liquid—colleges can now get to more than 40 percent of their money—the surprise move by Wachovia has led many colleges to reconsider their investment strategies.
“We have to look at the underlying security of where we’re putting our money,” says Lynne B. O’Toole, vice president for finance at Endicott College, in Massachusetts. “We all thought this Commonfund short-term fund was safe, and lo and behold, it wasn’t.”
Restricted Borrowing
Wachovia’s abrupt move wasn’t the only source of surprise.
The tightening of credit markets is making it harder and more expensive for some colleges to obtain lines of credit from banks, a problem for many smaller institutions, which often depend on such credit to help manage their cash flow.
Still, for hundreds of colleges, the biggest problem remains the sharp rise in interest rates on the variable-rate debt, which shot up to historic highs in late September. For some institutions, that has meant millions of dollars in unexpected costs.
Figures on overall use of such debt, which colleges use to finance new residence halls, academic buildings, and athletics complexes, are not available. But, according to Moody’s Investors Service, the 290 private institutions it rates held about $25-billion in such debt as of June 2007, or about 39 percent of their overall debt load.
Heidelberg College, in Ohio, has $17-million in variable-rate bonds and is struggling to resell a portion of them that investors have “tendered,” or returned, to the institution.
The bonds were part of a pool of $145-million issued by more than a dozen small private colleges in Ohio and all backed by a letter of credit from the Fifth Third Bank. As investors across the country became more and more squeamish about the safety of regional banks like Fifth Third, bonds backed by its credit became harder to sell.
In response to the difficulties that Heidelberg and others encountered, the bank offered to suspend for 90 days a hike in interest rates that would have gone into effect if the bonds were not resold in five days.
“The intent was to really give these institutions some extra time” to find suitable buyers for their bonds at reasonable prices, says John Rolander, fixed-income trading manager for Fifth Third Securities, the investment arm of the Cincinnati institution. He does not know how many other colleges are finding resistance to their bonds.
Insulated ... for Now
Colleges that converted their variable-rate bonds into fixed-rate debt through a hedging technique known as “swap agreements” with banks have been more insulated from the market fluctuations. While colleges with such agreements may have paid more for that protection when interest rates were low, they are paying considerably less now that rates are high.
And in the turmoil of recent weeks, some colleges found that even the hedging techniques they used to shield themselves from fluctuating interest rates wouldn’t protect them in the most volatile of markets.
The University of San Francisco, which has swap agreements on most of its roughly $160-million in debt, nonetheless saw interest rates climb from 1.4 percent to as high as 8 percent in September. To put that growth in perspective, consider that each 1-percent increase in the interest rate on $160-million is equal to $1.6-million in interest a year.
Wealthier institutions, which can sell bonds based on their own creditworthiness, are suffering less, says Cornell’s Mr. Golding. “People want to hold Cornell paper, want to hold Harvard paper, want to hold Princeton paper,” he said, although even for his institution, he noted, interest rates have ticked up by about one percentage point.
John D. Walda, president of the National Association of College and University Business Officers, says colleges that relied on variable-rate bonds weren’t taking undue risks. “Most of this wasn’t foreseeable,” he says. It’s the result of “a breakdown in the banking system and the regulatory system.” Even so, he says new realities require new thinking.
Before the crisis hit, maximizing return took precedence over liquidity for colleges, he says. “Now the priorities have switched.”
Linda Fan, managing partner with Prager Sealy & Company, a financial advisory firm that works with dozens of colleges, says the crisis points up the need for more colleges to develop overall policies for their debt, just as they do for their investments.
In some cases, colleges just view the financing for each construction project in isolation, she says, and “they end up with a bunch of different transactions rather than a debt portfolio” guided by policies that might govern the mix of debt or the debt load relative to overall resources.
Mr. Staisloff, of the College of Notre Dame of Maryland, says there are other lessons as well. “It reinforces how important it is to have a great relationship with your bank,” he says. “You don’t want to be out looking for new friends and new money when times are bad.”
Brad Wolverton contributed to this article.
