Investing in DePauw University has become riskier, according to Moody's Investor Service, a prominent credit-rating agency.
Last week, DePauw received a bond rating of A3, down from their rating of A2 (see ratings explanation graphic on page 4).
As for why the rating was lowered, Moody's pointed to weak cash flow (the movement of money into and out of the university) and $120 million of outstanding, long-term debt. Moody's noted the net tuition per student in fiscal year 2010 was $14,289, significantly lower than the median total of $21,291 for other A-rated small private colleges. That contributed to the weak cash flow.
University expenses are paid from three sources of revenue: tuition and fees, the annual fund and money from the endowment. Like most universities, DePauw's endowment and gift revenue took a sizable hit after the financial crisis. Because of this loss, the university's expenditures were 12.8 percent higher than revenue coming from the university, according to the Moody's report.
In order to maintain the student experience on campus without going into further debt, the money would have had to come from tuition, said Brad Kelsheimer, vice president for finance and administration. However, he notes that increasing tuition during a time of financial hardship would have led students to choose lower-priced universities.
The Moody's report pointed to some strength of the university's finances. The university does have adequate financial resources to cushion their debt, with $164 million as of FY 2010. Investments grew 10 percent last year. Finally, DePauw has strong gift revenue, averaging $15 million over the last three fiscal years. Revenues are expected to grow significantly since the university plans to undergo a fundraising campaign for President Casey's "DePauw 2020" plan.
Furthermore, the amount of debt that DePauw currently holds is not necessarily a bad thing, a point mentioned by both Kelsheimer and Keith Morgan of Piper Jaffray & Co., the underwriter of the report. They note that the university has held debt for about 30 years, which has funded countless capital projects on campus. Kelsheimer pointed to the development of the Nature Park and the Julian Science and Mathematics Center as projects funded by the operating budget.
"The university has a reasonable amount of debt," Morgan said. "The university has a strong balance sheet…there is enough money that DePauw can pay off expenses on time."
Still, the higher the university debt, the higher the percentage of revenue going towards paying off interest. Economics professor Jeff Gropp said the lower credit rating could raise the cost of borrowing in the future. But he made sure to put the recent Moody's rating in perspective.
"DePauw bonds are still investment-quality bonds. These are not by any means junk bonds," Gropp said. "Junk bonds" is an industry term for high-risk bonds.
The university actually requested a Moody's update, said Brad Kelsheimer, vice president of Finance and Administration. The university needed the update so it could purchase letters of credit through Northern Trust and Harris Bank.
Here's how letters of credit work. Say an investor buys $1,000 worth of bonds issued by DePauw. Ten years later, the investor might want to cash out its bonds. If DePauw cannot pay the $1,000, DePauw would need a letter of credit from a second bank. Only with that letter could the second bank pay the original bank back.
Currently, DePauw pays out slightly under 5 percent interest annually to their bondholders, Kelsheimer said.
Gropp also said that while Moody's ratings continue to be an important source of financial information for investors, many investors also do more independent research. He said the reputation of Moody's, along with other credit ratings agencies such as Standard & Poor's, have taken a hit since the financial crisis, since companies such as Lehman Brothers and AIG were given strong credit ratings despite their poor financial situation.
Despite the debt, the university will move ahead with plans for structural changes to the university outlined in President Casey's 2020 Plan, Kelsheimer said. However, the projects will be funded through donor money and not through DePauw's operating budget.
"This will not add to the debt — no questions asked," Kelsheimer said.
But the costs of maintaining the "DePauw Experience" will still require a lot of money from students. To improve revenue into the university, Kelsheimer predicted that over time, financial aid will move towards need-based aid and away from merit-based aid in order to ensure that those who see the value in a DePauw education and can pay for it actually invest the money.
Gropp notes that the plan to improve cash flow has already begun, pointing to a recent 6 percent rise in tuition and fees. After all, he said, "someone is going to have to pay this back in the long run."