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What's Behind Our Sector View

Enrollment downturns and operating pressures persist.   Many colleges and universities continue to report falling enrollment amid heightened competition for students and a greater focus on affordability. Although international student enrollment is rising, changes to federal work program and visa policies might once again dampen it, and schools with a significant international population could face additional budget pressures. At the same time, inflationary expense growth has eased, but salary and benefit increases and rising financial aid and scholarships remain a strain for higher education providers, and translate to material operating pressures facing some schools in 2025, especially those with shrinking enrollment or constrained financial flexibility. Revenue recovery, even with recent tuition hikes, remains limited, especially for private colleges and universities, and hasn't been enough for most to fully offset expense growth. In particular, schools with sustained diminishing net tuition revenues have been especially pressured.

In fiscal 2023, 50% of rated private universities generated operating deficits, and fiscal 2024 operating margins generally will be weaker, given the limited revenue recovery, net tuition revenue pressure, and increasing costs experienced. Based on our conversations with management teams, we expect fiscal 2025 operating margins might struggle to exceed those of fiscal 2024, especially at the lower end of the ratings scale.

Balance sheets remain sound, despite recent investment market volatility.   With solid investment market returns in fiscal 2024 and a slower ramp-up of capital spending for many institutions, balance sheets have improved slightly. Although new money debt issuance increased in 2024, most schools were able to absorb the additional debt and debt service within the rating. S&P Global Ratings continues to monitor operations and cash flows, particularly for lower-rated schools, to see how the additional spending, and potentially debt, could influence liquidity and credit quality.

The higher education industry remains pressured, which causes uncertainty and reduces rating flexibility for some colleges and universities.   We rate a broad mix of colleges and universities that span the rating scale. A significant portion of those schools continue to fare well and sustain credit strength, with solid management teams and accumulating financial resources. However, for some schools at the lower end of the ratings scale or those still trying to improve and steady their cash flow and fill gaps caused by nonrecurring revenue recognized in recent years, we believe there's less rating flexibility. We also acknowledge that uncertainties and industry headwinds, including a changing administration and its emerging priorities, could affect colleges and universities in different ways.

Outlooks and rating actions point to more pronounced credit divergence in 2025.  As of Nov. 30, 2024, 53 schools we rate (about 12% of all ratings and primarily private colleges) have a negative outlook, most at the lower end of the ratings scale. As of the same date, 19 schools have a positive outlook. Downgrades are primarily on low investment-grade and speculative-grade institutions; and negative outlooks are more concentrated in these categories. S&P Global Ratings expects continued credit quality divergence, with weaker-positioned institutions--often smaller, more regional private colleges and universities--being disproportionately hampered by operating pressures including increased financial covenant violations. We expect that there will be more downgrades than upgrades in 2025, but that the majority will be at the lower end of the ratings scale.

At the same time, more positive outlook revisions and upgrades (six and 11, respectively, in 2024 year to date) have occurred at the higher end of the ratings scale. We expect this bifurcated trend will persist in 2025.

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Sector Top Trends

Enrollment likely will remain a pressure point for many years to come.   Enrollment continues to vary widely across the sector and across rated institutions, depending on the type of school, location, and overall credit quality, with many smaller and lesser-known schools finding it tough to compete for students in the current market. Fall 2024 enrollment was particularly difficult, especially for schools with higher populations of lower-income and Pell Grant-eligible students, due to regional demographic trends and delays with the Free Application for Federal Student Aid (FAFSA). For many schools that faced enrollment drops pre-pandemic, persistent and material enrollment decreases are causing deepening deficits.

We anticipate that enrollment across the sector will remain strained, as value proposition, ongoing FAFSA issues, the impending "demographic cliff," and possible international enrollment declines, shrink the applicant pool. Schools with a highly regional draw will likely face continuing diminishing enrollment, unless they can attract students through expanded programmatic diversity. More institutions have introduced master's and doctorate programs in industries such as health care and technology, and they're offering certificate programs in hopes of recruiting more corporate employees. For some struggling institutions, these changes might allow for a reprieve from lower undergraduate enrollment and revenue but the success of these strategies typically takes several years to materialize.

Falling net tuition revenue and rising costs are still creating operating pressure.   Institutional financial aid continues to increase while enrollment figures are dropping for many, causing sustained weakening in net tuition revenues, which make up the majority of many schools' budgets. Despite inflation moderating, rising expenses--in particular for faculty salaries--will still stress school budgets in 2025, creating ongoing operating difficulties for those schools with less financial flexibility. For the past couple of years, schools have been trying to cut expenses, but inflation hasn't made it easy. Contributing to margin compression are increasing expenses for insurance, including property and environmental risk insurance; cyber security; and health care. In addition, a buildup of deferred maintenance at some schools has created ongoing operating pressure, as they must address aging campuses and ongoing facilities needs to keep offering students a good campus experience. This work often requires costs that typically cannot be covered fully by fundraising.

As budgetary pressures have persisted, more and more schools are taking extraordinary endowment draws or loans to bridge operating gaps. This trend, when sustained for several years, can greatly reduce a school's available liquidity. We will likely see a continuation of this in the year ahead. Significant operating pressures at smaller schools with less management oversight can lead to technical covenant violations, such as a breach of a debt service coverage covenant, constituting events of default. About a dozen schools that we rate experienced a covenant default in 2024, and we believe this could occur more frequently in the year ahead.

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Universities and colleges with academic medical centers and health care exposure may benefit from revenue diversification; however, industry-related risk is greater, as many health care entities continue to face volume variability, margin compression, and the need for significant capital investment. Although these institutions are overall highly rated and provide high-acuity, essential care to broad regions, many face labor shortages, increased wage and benefit costs, and inflation. These pressures, while not accelerating, nevertheless likely will impede cash flow and margin recovery in 2025. Temporary labor costs are dropping, but providers have raised pay and enhanced benefits that lift the cost of care.

Athletics, revenues, and impacts of conference re-alignment.   College and university athletics is shifting toward more professionalism and less amateurism. This prompts much discussion about the future of athletics at each institution. Schools are having more frequent discussions about conference re-alignments, the transfer portal, and the multibillion-dollar National Collegiate Athletic Assn.'s proposed settlement for past and future payments for name, image, and likeness compensation and their implications for revenues, costs, and facility needs. Similarly, revenue share from broadcast contracts due for renewal or renegotiation will affect some schools' athletic programs. We believe enhanced revenue growth the schools receive from these contracts, much of which may be distributed to student athletes in the next five to 10 years, might offset some of the costs associated with conference transitions.

Institutions will stay focused on maintaining liquidity.  Given annual market fluctuations, one good or one bad year of investment returns, in isolation, does not typically affect investment strategies, capital spending plans, and debt capacity. Fiscal 2024's preliminary investment reports indicate, on average, positive gains, which yields growth to financial resources and means most institutions' absolute levels of cash and investments are consistent with, or above, pre-pandemic levels. Many highly endowed institutions' portfolios realized moderate returns, reflecting an overweighting of private equity in their portfolios, but it remains to be seen if this strategy will produce solid returns in the longer term and liquidity will not be compromised.

Fundraising, especially at higher levels of giving, held steady or climbed in 2024 and we expect schools will sustain this. We anticipate management will remain focused on preserving or augmenting reserves to improve balance-sheet flexibility due to concerns about likely weaker cash flow and capital spending needs. Over the next year, the strength of the balance sheet will continue to play a key role in credit stability, given the pressured operating performance that we expect, especially at the lower end of the ratings scale. Despite solid cash and investment positions overall, some struggling institutions are increasingly depleting their unrestricted resources, which could create problems. Available liquidity and unrestricted funds will remain paramount to address debt service and other operating needs.

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Leadership turnover at an increasingly higher rate creates additional hurdles for the sector.   The average tenure of college and university presidents is shrinking, leading to difficult successions and impeded long-range planning. This has implications for enrollment and operations while contributing to event risk. Increasing risks in the sector (cyber, physical, and headline) can cause cash flow and liquidity disruption at a time when many schools have less operating flexibility and could take management's attention and slow or disrupt certain strategic investments. Effective and stable management will be important to maintaining ratings stability, especially given higher rates of leadership turnover, in particular at the presidential level, across the sector.

Mergers and partnerships are becoming more familiar in higher education.   While not all consolidations and partnerships generate stronger credit quality, many have been successful and led to maintenance of, or improvement in, credit quality. Colleges and universities with valuable real estate, brand, or institutional core competencies have had an easier time securing an affiliation or merger, but these are still very difficult agreements to close and take considerable time. School closures average about a dozen a year, but were more pronounced during 2024. In the next year, we expect to see further consolidations, and also closures, as operational struggles escalate for small, regional private institutions. We also anticipate seeing more partnerships, particularly in areas that might not be core to a school's mission (for example, utilities, student parking, faculty housing, etc.). Across the sector, institutions are using such partnerships with increasing frequency and they tend to be credit neutral to positive for sponsor institutions.

AI is increasingly being integrated into the higher education landscape, creating both opportunities and risks.  Some colleges and universities are much savvier with their data and are able to use AI to their operational and strategic advantage, especially in this tough higher education environment where operating margins are stressed. Schools are beginning to adopt AI tools for admissions, marketing, teaching, and streamlining back-office operations. Although these tools present opportunities to enhance efficiency and improve student outcomes, institutions also face greater scrutiny regarding AI ethics and data privacy. Furthermore, schools must reconsider how they prepare students for a rapidly changing labor market where AI will play a large role. Those schools with clear institutional guidelines may more effectively harness the power of AI to benefit both students and staff.

The incoming administration's policy changes could affect the sector over the longer term.   The incoming administration is in the early stage of crafting its education policies and much remains uncertain at the moment. Nevertheless, President-elect Trump's first term, campaign priorities, and early cabinet appointments suggest that significant changes may be forthcoming with potential credit impact. International students play an important role in the sector and the economy, and during the first three years of President-elect Trump's previous administration, the number of foreign students enrolled in U.S. colleges dropped. We'll be watching to see if there are any changes made to federal grants and research funding, the endowment tax, and many social issues in education that were discussed throughout the campaign, including reduction or elimination of diversity, equity, and inclusion initiatives, student debt forgiveness, and elimination of affirmative action, which could dampen enrollment and student demand.

Ratings Performance

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Related Research

• Not-For-Profit Higher Education Outside Of The U.S. Outlook 2025: Credit Stability Amid Market Turbulence, Dec. 5, 2024
• U.S. Not-For-Profit Acute Health Care 2025 Outlook: Stable But Shaky For Many Amid Uneven Recovery And Regulatory Challenges, Dec. 4, 2024
• Economic Outlook U.S. Q1 2025: Steady Growth, Significant Policy Uncertainty, Nov. 26, 2024
• U.S. Higher Education Rating Actions, Third-Quarter 2024, Oct. 11, 2024
• U.S. Higher Education Rating Actions, Second-Quarter 2024, July 19, 2024
• Rising Covenant Violations Are A Symptom Of The Pressure Facing Lower-Rated U.S. Higher Education Entities, June 20, 2024
• U.S. Higher Education Rating Actions, First-Quarter 2024, April 18, 2024