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Since the COVID-19 virus prompted precipitous, large-scale changes to traditional classroom settings, headlines about the challenges facing higher education have become all too common. Indeed, the exogenous shock spurred by remote instruction, rising virus case counts, and reduced revenue streams has increased risks within the sector and accelerated the divergence in its underlying trends. At the same time, we believe this shift, in tandem with the surge in higher education taxable municipal issuance, particularly from institutions that are best positioned to survive this challenging environment, has also created opportunities for active credit investors.
Although recessions generally have a greater impact on households with only high-school educations, they also tend to prompt questions regarding the value of tuition investments. As a result, higher education institutions have experienced a general decrease in pricing power since the 2008-2009 financial crisis, leading to a reduced slope in the tuition inflation curve over the past decade (Figure 1).
This shift in pricing dynamics over the last decade has created a challenging fundamental backdrop, particularly for institutions that don’t have an appreciable value proposition. It’s also not unreasonable to expect this increased fundamental pressure to accelerate our expectations of consolidation within the higher education sector. Taken together, we believe this environment will likely create far less winners than losers over time.
We characterize the sector “winners” as institutions that continue to attract students while exercising pricing power (e.g. not continually attracting enrollment through tuition discounting) which drives improved credit quality. Specifically, we place “winners” in three categories:
In the taxable municipal market, institutions in the first two categories represent attractive credit trajectories and valuable diversification for taxable investors. In general, investment opportunities in Category 3 are limited in the taxable space, so we will focus on the first two categories in this post.
When comparing pre-COVID enrollment figures from the Fall of 2019 to the Fall of 2020 enrollment data (Figure 2), we see that the pandemic has added further stress on enrollment behavior, accelerating the pre-existing downward trend.
While COVID-19 has laid bare the sector’s divergent trajectories, the pandemic has also introduced some broader event risk into the equation. Seemingly endless amounts of litigation have been brought against universities with the goal of achieving reduced tuition now that institutions transitioned into remote learning environments for the Spring and/or Fall 2020 semesters. In general, the litigation argues that tuition expenses cover both course credits towards a degree and a comprehensive “college experience.” And with the latter no longer being provided, institutions are in breach of contract. Research into some filings suggests that this contractual basis is not addressed, and raises the question: can a pandemic be reasonably considered a force majeure in that context? To date, PGIM Fixed Income is not aware of a plaintiff alleging that a college pulled a “bait-and-switch” on its students.
Given the lack of clarity around this issue, it is reasonable to expect the traditional the legal process (filing of charges, seeking of dismissals, etc.) to play out, which will likely leave the issue unresolved in the near term and remain unsettling for investors.
And although a class-action lawsuit is the worst-case scenario for investors, it is an outcome to which we assign a low probability. Given the diversity of issues regarding college student composition at any given university, there is a strong argument that such diversity diminishes the probability of class certification by adding complexity and reducing commonality among potential plaintiffs. This lack of homogeneity makes the mechanics of class actions more difficult to consider, which should reduce the resulting probability of a worst-case scenario.
Despite the above threats to the higher education sector, we believe the complexities around the issue will prevent this from becoming a material credit event for the sector. Further, these institutions we’ve identified as having attractive enterprise characteristics are currently in a place to better manage the associated risks.
While the COVID-19 pandemic has accelerated a divergence in the sector’s trajectories, the current environment also offers opportunities for active credit investors that focus on institutions in the categories that are defying the larger trends in higher education and eschewing those that are not. And in general, PGIM Fixed Income believes that the higher-education taxable municipals sector presents a relatively risk-remote investment opportunity for investors seeking high-quality, long-duration investments with the added benefits of sector and credit diversification.
This material reflects the views of the authors as of November 19, 2020 and is provided for informational or educational purposes only. Source(s) of data (unless otherwise noted): PGIM Fixed Income.
All investments involve risk, including the possible loss of capital. Past performance is not a guarantee or reliable indicator of future results. Source: PGIM Fixed Income. The information represents the views and opinions of the author, is for information purposes only, and is subject to change. The information does not constitute investment advice and should not be used as the basis for an investment decision.
Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy. Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated, based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.
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Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information, nor do we make any express or implied warranties or representations as to the completeness or accuracy. Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated, based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.
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1042874-00001-00 Ed: 11/2020
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