As the University moves ahead with bold large-scale projects, its reliance on borrowing from financial markets is growing — drawing concern from a credit ratings agency.
By SPARSH SHARMA
August 7, 2023
(Laurie Avocado / Flickr. Modified.)
A student at the beginning of their journey into academia, into adulthood or maybe even into a new country will be arriving at USC’s University Park Campus in the upcoming weeks. For them, it will probably be the first of many years they will spend adapting to a new life, understanding their field and exploring South Central.
They, and the majority of around 48,000 others, will almost exclusively be circulating the 22 schools at UPC that form the beating heart of what President Carol Folt called a “school of schools” in her State of the University speech in March. And yet, one of the biggest sources of the excitement she displayed in the speech was the developments taking place in one arm of USC’s operations, seven miles away at the Health Sciences Campus.
A closer look finds that these developments could affect all of the University’s students and faculty because of the increased prominence of the financial markets in its funding.
“If we build it, they will come”
In July, USC borrowed half a billion dollars from financial institutions to spend on large-scale projects — namely, the Discovery and Translational Hub at HSC. This seven-story facility, designed to employ 850 people and convert scientific findings into treatments starting July 2026, is expected to cost $315 million.
The price tag is well worth its weight, according to Moody’s, one of the world’s three largest credit ratings agencies. These are the suits who decide how risky institutions, or investments, are in their ability to pay back what they borrow. Then, they tell the world’s financiers about it. In its credit opinion, released a few days before the University’s foray into the markets, Moody’s said the Hub “could be a significant catalyst to research, commercialization and philanthropic opportunities.”
Why does Moody’s care? Back in 2018, an article in World Finance declared “higher education is the new frontier for the bond market.” It cited data that showed the value of bonds issued by higher education institutions worldwide had nearly tripled over the span of a decade up to 2017.
Following the pandemic, and with cash reserves dwindling, universities are expected to rely more on borrowing from the financial markets to fund their projects. Based on the 856 active bonds I was able to find that were issued by the United States’ top 25 universities — which stretch back to those issued by Stanford and Columbia in 1994 — nearly one-third were issued since the incidence of the pandemic in March 2020.
It’s a trend across higher education. Universities that borrow cash (i.e., buy ‘debt’) from the markets through bonds can range in size from less than 1,000 students, such as Iowa Wesleyan University, to several hundred thousand students for a state university system, like the UC system.
So, a company like Moody’s helps investors distinguish the thousands and thousands of bonds available from all universities through its credit ratings. These range from nonrated to AAA, and in its credit opinion, Moody’s held USC’s bonds on the second rung of its scale at Aa1 — a rating the University has maintained “for many years,” said Erik Brink, USC’s chief financial officer.
“The rating process is important from the perspective of how [the University] prices debt that’s going out to the market,” Brink told me. “So, to the extent that those ratings are maintained or increased positively, [the University’s] debt is cheaper.”
USC’s Aa1 ratings places it alongside the likes of the University of Pennsylvania, Northwestern University and Washington University, but below Ivies like Yale, Stanford and Harvard University.
It is with this rating, then, that USC has been able to ask for a total of $3.2 billion that it still owes to financial institutions. Among the top holders of USC’s debt are investment management companies like Prudential (which holds $182 million in USC debt), BlackRock ($93 million) and Goldman Sachs ($41 million). USC’s debt is even attractive enough for the State of Colorado to have purchased $22 million worth.
“Careful management”
It’s all about student demand. When the number of high school graduates increases — or the college participation rate and economic benefit of obtaining a degree rises — and the cost of attending is good enough, then a university generally stands to succeed.
USC stands uniquely as a large, selective, top 25 urban research university in Los Angeles — averaging close to $500 million in fundraising annually over the last three years. The University received $1 billion worth of grants & contracts in 2022 for the research it conducts.
Those grants & contracts and gifts represent 11% and 9% of USC’s revenue, respectively. Much of the rest comes from patient care (37%) and student charges (31%).
USC stands uniquely as a large, selective, top 25 urban research university in Los Angeles — averaging close to $500 million in fundraising annually over the last three years.
But nationwide, student demand is dropping. Undergraduate enrollment in the U.S. peaked at just over 18 million in 2010-11, and has lost one-sixth of that since then. The pandemic made things worse, with more than 1 million undergraduates disappearing from universities since 2020. Only last year, California lawmakers stepped in at the last minute with a bill to prevent UC Berkeley from having to slash fall enrollment by 3,050 students.
The SCOTUS ruling to strike down affirmative action may have increased the strength of the headwinds that floundering enrollment created.
So how is USC expected to pay back its borrowed billions with charges from what will probably be, within a decade, a reducing student base?
“National trends caught up”
The Discovery and Translational Hub is, in part, expected to help with this.
USC’s patient care operations are expanding, and the revenue from this is expected to grow significantly.
“USC Health’s expanding operations will continue to be critical to USC’s mission and strategic goals,” Moody’s wrote.
But the Discovery and Translational Hub becomes more expensive every day. Inflation lingers: It’s at 3%, which, while below its peak of 9% in June 2022, is still above the U.S. target of 2%. Construction, labor and supply chain costs make USC’s capital projects more expensive. The University has spent nearly $2 billion on its long-term investments over the last five years.
As a sector, healthcare operations are currently exposed to a challenging operating environment as well. A combination of these factors, as well as USC’s reliance on debt compared to its thinning operating margins, led Moody’s to shift the University’s outlook from “neutral” to “negative.”
“Everything, everywhere, all at once”
This outlook “lets the investor know that we would expect [operating margins] to continue to improve over time, or else there’s potential that we could downgrade in the future,” Brink said.
USC maintains its Aa1 rating, but the University has borrowed cash to fund its investments such that its profile may be “materially weaker than similarly rated peers,” according to Moody’s, hence the negative outlook.
“While stubbornly high inflation and labor force challenges present some headwinds, USC’s strong tuition pricing power, fundraising strength and growing healthcare enterprise will help mitigate the near-term impacts,” Moody’s wrote.
So, the University is expected to rely more on students to fund its projects. As the largest source of the University’s academic operating budget, USC raised student tuition by 5% for the 2023-24 academic year, reaching a record high of $66,640 for two semesters of study.
But students have their own cap. While Brink would not speculate on whether the University would continue hiking tuition, he said that the University “understands that the financial load to our students is important.”
“The University’s constraint [is that it] doesn’t want to be the most expensive because, as great as we are, students and their families do consider how affordable it is and if we’re too expensive, people may choose not to attend for that reason,” said Larry Harris, the Fred V. Keenan Chair in Finance at the Marshall School of Business. “We, of course, want to get the best students, and so forth. There’s not a one-for-one linkage.”
The University’s affordability initiatives, such as USC Competes, aim to solidify the two-thirds of students who currently receive some form of financial aid.
“Increases in tuition actually increases our financial aid pool pretty significantly, so there’s a lot of factors that go into [the tuition-setting process] … it’s one of those things we will continue to evaluate and figure out what is the best at that time,” Brink told me.
However, federal financial aid is at risk, with the newest House Republican proposals to withdraw federal work study and federal supplemental education opportunity grants. And what about the one-third of students who don’t receive financial aid?
International students, who account for nearly 30% of total enrollment, are far less likely to receive any form of financial aid. China and India are expected to surpass the United States as the frontrunners in educated populations within the next decade or so, and more than 50% of USC’s students are in graduate and professional programs.
USC stands where many other universities have fallen. Financialization may increase the gap between large and small institutions. The World Finance article from 2018 described how “bond markets tend to favor universities that issue large chunks of bonds and penalize universities with more modest borrowing needs.” Iowa Wesleyan University is one of a number of universities that have had to close down over the last year, while in debt.
So, depending on whether the student that arrives in the fall is low-income or well-off, domestic or international, they might find their financial outlook tied closely to the University’s capital projects and subsequent activities in the bond market.
“To be a relevant research university, you need to continue to grow and develop facilities to bring in the most talented faculty, staff and students to really do cutting edge research,” Brink said. “If you go back and look at Dr. Folt’s moonshots in healthcare, in frontiers of computing, it’s really all about bringing in the highest quality faculty and students; and in order to do that, you have to have facilities that individuals would feel meet those needs.”❋
Sparsh Sharma is the finance beat writer for the Daily Trojan. He graduated USC in 2023.