Liquidity Pressures and Opportunities in a COVID Market

In addition to its significant public health impacts, the coronavirus pandemic has had sweeping impacts on the global economy and financial markets.  Since the start of the virus’s spread, and during the widespread shutdowns that followed, businesses of all shapes and sizes have experienced rapidly diminished demand for their products and services, significant disruptions to current and future income expectations, and costly disruptions to their day-to-day business operations.  Certain market sectors have been impacted to a greater degree than others, and the higher education sector stands as a prime example of one that will suffer the effects of this pandemic acutely, and for the foreseeable future.

Prior to the pandemic, many market analysts held the view that the higher education sector was facing strong headwinds due to factors such as declining demographics, shrinking enrollment, increasing deferred maintenance, and negative changes to federal funding and assistance programs.  Now, squarely in the midst of the pandemic, higher education institutions are facing additional headwinds as they respond to and prepare for the challenges that the pandemic poses, as well as uncertainty as to how long these challenges will endure.

Among the most significant of these challenges created by the pandemic is an unfortunate combination of an increasing need for capital with a reduction in available capital liquidity.  Capital needs are increasing as universities and colleges across the country are in the process of implementing new health and safety procedures, investing significant funds in IT infrastructure to support remote/virtual learning, redesigning/renovating facilities to support de-densification and social distancing, and increasing investments in marketing and student recruitment to maintain student enrollment.  Many university systems also face the cost-intensive challenge of supporting university health systems, which are similarly facing significant monetary pressures due to both reductions in demand for elective surgeries, and the need to organize and operate COVID-related units. All of these efforts require the significant investment of time, labor and maybe most importantly, capital.

Concurrently, universities and colleges are facing liquidity pressures arising out of a number of COVID-related factors. One of the more visible of these factors was the campus-wide shutdowns that occurred in the spring 2020 semester, which eliminated essential revenue streams like on-campus housing and dining income, and created significant revenue losses that were in most cases only mitigated, but not eliminated, by federal assistance programs like the CARES act.  These cash flow disruptions are expected to continue into the fall 2020 semester, due to continued restrictions on in-person classes, on-campus occupancy, facility operations, and student life activities, implemented to varying degrees on a campus-by-campus basis.  Further, less obvious factors are also exacerbating to these liquidity concerns, such as students pausing their higher education, diminished state/public funding availability, declining international student populations due to travel restrictions, and/or reductions in positive sentiment towards education-abroad programs.

Higher education institutions will need to be strategic in identifying opportunities to relieve these liquidity pressures, and to address the increased capital requirements created by the COVID pandemic.  In the short term, it will be important that these institutions leverage existing relationships to procure short term solutions like bank lines of credit. Implementing effective advocacy to procure federal and state assistance will also help buoy ongoing campus operations until the campus environment returns to a more normal state of affairs.

Rating Agencies

Rating agencies have taken a negative outlook on the higher education sector as a whole, and it’s possible in this environment that some institutions may see a downgrade to their credit rating.  Although an undesirable outcome on its face, with potential political implications based upon the value and emphasis placed on such rating, one positive to be taken from a downgrade is that it generally results in increased credit capacity insofar as an institution’s ability to increase debt ratios without risking further downgrades.  This increased credit capacity may prove worth the reduced credit rating in an environment where liquidity is both reduced in its availability and increased in its necessity.

Monetizing Housing Assets

Another important liquidity opportunity for universities and colleges to consider is the monetization of its housing, or other auxiliary assets, both existing and future, through the use of a public private partnership or “P3”.  P3’s allow an institution to enter into a long-term partnership agreement with a private sector partner, usually a real estate fund, a 501c3 owner, and/or a developer.  Under these agreements, future revenues generated by the housing/auxiliary asset are assigned to the private partner in exchange for compensation provided back to the institution, most often in the form of an up-front capitalized payment, on-going annual ground rent payments, or some combination thereof.  Moreover, in addition to the direct compensation package offered to the institution, these agreements provide additional benefits and risk mitigations by transferring occupancy demand risk, operating expense risk, and long-term capital maintenance risk.  Through these P3 agreements, Universities may also take advantage of cost efficiencies that the private sector partner can achieve in the development and operations of these facilities, in comparison to costs the higher education institution would incur to build and operate the facilities itself.

The monetization produced by these P3 agreements can be assigned to any number of valuable institutional uses, including paying down outstanding asset-level debt, investment into the university endowment, scholarship offerings and housing cost reductions for students, capital projects in other areas of the campus, or for any of the COVID-related capital requirements mentioned above.  That said, P3 student housing agreements generally carry a term of 40-65 years depending on the financing structure utilized, and require that the institution divest significant control over the operations and maintenance of the housing facility in which the institutions most critical asset, its students, reside.  Accordingly, in addition to the near-term financial benefits, institutions should carefully consider the long-term implications of such agreements before divesting ownership and control over this critical component of the student experience. Selecting a P3 partner who understands the importance of on-campus student housing and campus life, and whose interests can be properly aligned with the institution’s long term goals and objectives, is essential to a successful P3 partnership.

 

Author: Jordan Gaston, Director of Finance