Michigan State University plans to join the small club of century bond issuers in the not-for-profit higher education sphere early next year, a plan officials say will strengthen the university’s financial stability.
The board of trustees approved a
MSU would become the first Michigan-based university to use the 100-year repayment structure. Century bonds saw an uptick in 2019, but that tapered off with the onset of the COVID-19 pandemic as schools focused on managing the costs and the shift to remote learning.
“This is a unique opportunity to take advantage of the historically low interest rates to advance MSU’s strategic plan goals,” said Lisa Frace, MSU’s chief financial officer and treasurer.
The deal planning is in the early stages although Frace expects to be ready to offer the bonds within 90 to 120 days of the board’s Dec. 17 approval, which is typical for the school. The timing, however, also remains “subject to market rates at the time,” Frace said. No other borrowing is planned until late 2022 or early 2023.
The university is working with its financial advisor Blue Rose Capital Advisors and will select a banking team from its group of approved bankers, a pool established through a competitive selection process, Frace said in an email.
The school began considering the issue in late summer as a means to fund capital and diversify its debt-amortization schedule.
“This is a unique opportunity to take advantage of the historically low interest rates to advance MSU’s strategic plan goals,” Frace said. “This opportunity allows the university to seek issuance to further its research and capital expenditures. It will also help to improve the university’s financial stability.”
Melanie Foster, MSU trustee and chair of the Board Committee on Budget and Finance, said the university is “now in a position to attract faculty and projects with this financial commitment.”
The university’s investment banking providers have told the school it believes there’s sufficient investor interest to place the bonds, Frace said.
Such long-dated structures are typically limited to either highly rated universities or ones with a long history and expectation they will remain intact for a long time to come. The low interest rate environment and a healthy taxable market drew universities to the structure before the pandemic.
“We saw a lot of century bonds in 2019. We have not seen much in 2020 and 2021,” said S&P Global Ratings analyst Jessica Wood, who serves as lead credit analyst on MSU.
With interest rates so low and favorable market indicators, five universities issued century bonds in 2019, including the University of Pennsylvania, the University of Virginia, Rutgers University, Georgetown University, and the most recent entrant to the club, the University of Pittsburgh, according to a 2019 year-end report from S&P.
The University of Pennsylvania is rated AA-plus and stable, the University of Virginia is AAA and stable, Rutgers is A-plus and negative, Georgetown University is A-minus and negative, the University of Pittsburgh is at AA-plus and stable. The five issued more than $1.63 billion in 100-year financings, according to S&P.
“Over the years, just over a dozen institutions in the higher education sector have issued century bonds — a small group, which has made the flurry of activity this year unique,” the 2019 report read. “These universities benefited not only from longer amortization of debt, but also, more flexibility in use of proceeds.”
Since the bonds are taxable, the universities are freed of tax restrictions that limit uses on tax-exempt borrowing.
“At the same time, interest rates for taxable bonds were not significantly higher than the rates on tax-exempt municipal bonds, and as a result, we saw significant growth in taxable higher education bond issuance in 2019,” S&P said.
Others that previously issued century bonds include Ohio State University, Ohio University, California Institute of Technology, the University of California System, Tufts University, Massachusetts of Technology, University of Southern California, and Wesleyan University.
Three of the overall 13 are rated in the single-A category with the others rated between AA and AAA and the sizes have ranged from $250 million to $1.8 billion and date back to 2011, according to data from S&P.
"MSU is not alone in considering century bonds, although the practice is indeed still limited to universities with strong credit quality, with significant endowments and typically strong treasury management practices," said Susan Fitzgerald, associate managing director in the global higher education and nonprofit group at Moody's Investors Service.
In a 2019 report "Century bonds provide credit-positive financing tool for select U.S. universities," Moody's noted the University of Virginia and State University of New Jersey both had "received an attractive long-term cost of capital with flexible use of proceeds" and the move was a credit positive because the funds helped with capital planning and investment over long-term horizons.
"Still, century bonds carry risks, including locking the universities into very long-dated contractual arrangements with costly restructuring and refunding provisions due to expensive make-whole call provisions" that are typically more expensive than traditional municipal call provisions, Moody's warned.
Expected federal fund interest rate hikes next year could prompt more to jump into the market before interest is dampened.
Michigan State University carries ratings in the double-A category after
Nassar, a team doctor for the university, sexually abused student-athlete gymnasts. Officials at the university and USA Gymnastics, which also employed Nassar, have come under fire for letting it happen over many years. The university’s former president resigned over the scandal initially faced criminal charges, although a judge later tossed them.
The school in 2019 borrowed to help cover a $500 million legal settlement that resolved many cases. The U.S. Education Department also ordered changes at the school and imposed a $4.5 million penalty.
The university sold
S&P affirmed the university’s AA rating and negative outlook last March.
“The negative outlook continues to reflect our opinion that MSU's management and governance remain in transition and that additional other impacts are possible from the fallout of the Nassar scandal and associated lawsuits, which could affect the university's risk profile during the outlook period," S&P said. "The COVID-19 pandemic adds further uncertainty related to enrollment and financial operations.”
Moody’s also in March affirmed the East Lansing-based school’s Aa2 rating and stable outlook saying it was supported by “a sizable scope of operations and wealth, providing the university with significant operating flexibility.”
MSU is the land-grant university and member of the Big Ten Conference with $2.6 billion of annual operating revenue and $4 billion of cash and investments and $1.6 billion of monthly liquidity. The university has $1.7 billion of debt.
The school enjoys strong demand and enrollment, and is a large employer and economic driver in the state. Enrollment is stable, but the university “does face potential headwinds because of projected low population growth in Michigan and short-term volatility because of the COVID-19 pandemic,” Moody's said.
Additional credit factors considered include low total adjusted debt, a large research portfolio, and potential for future unknown residual risk of civil claims against the university stemming from its handling of sexual abuse claims related to Nassar, Moody’s said.
“The stable outlook reflects our expectations of a manageable operating deficit in fiscal 2021, with a return to a near double-digit operating cash flow margin in fiscal 2022.”
The university exhausted a $75 million settlement reserve fund in fiscal 2020 that was dedicated to additional Nassar-related claims beyond those included in a $425 million settlement. The university paid an additional $15 million of payments beyond remaining balances in the settlement reserve fund.
The university doesn’t expect a material amount of additional payments for known claims but does face continued risk of further claims beyond those known and an unexpected large wave of additional claims against the university could lead to credit pressure, Moody’s warned.
The school also benefits from strong philanthropy that has enhanced endowment growth, financial aid, and strategic initiatives. The university concluded a $1.5 billion fundraising campaign in 2018 and topped its goals by raising $1.8 billion “with little to no donor fallout because of negative headlines,” Moody’s said.
The university’s debt is secured by a general revenue pledge, which includes tuition, net auxiliary revenues, unrestricted income, and unrestricted gifts. State operating appropriations are specifically not included in the pledge.
The university benefits from “historically positive operating performance on an adjusted, full-accrual basis (except for fiscal 2018 due to extraordinary items) with surplus operations in fiscal 2020, although deficit operations are expected for fiscal year 2021 as a result of COVID-19,” S&P said.
