The revenue and expense pressures facing smaller colleges will lead to increased closures and mergers in the next few years. While the sheer number of closures and mergers will remain low overall, the pace will accelerate largely due to enrollment declines and lost market share. Many students are opting for larger colleges with greater resources to invest in academic programs and facilities. For this analysis, we consider small not-for-profit private colleges

to have fiscal 2014 operating revenue below $100 million, and public colleges below $200 million.

» Closures and merger activity will increase as the sustained impact of revenue declines intensifies. Closures of four-year public and private not-for-profit colleges averaged five per year from 2004-14, while mergers averaged two to three. The closure rate is likely to triple in the next few years and the merger rate will more than double. Still, the number for both will remain below 1% of the 2,300 four-year not-for-profit private and public colleges.

» A majority of small colleges have failed to achieve sustained revenue growth above 2% per year and the trend will continue. From fiscal year 2006 through 2014, the percentage of Moody’s-rated small colleges with average revenue growth below 2%, approximately the level of inflation, soared.

» The smallest colleges will continue to lose market share as the largest achieve growth. Revenue softness at small colleges leads to a reduced ability to invest in academic programs, student life and facilities. These investments influence demand and prospective students are increasingly choosing larger colleges.

» The smallest colleges have inefficient cost structures with net tuition revenue funding only three-quarters of educational expenses. Smaller colleges have fewer students to support their fixed costs and tend to garner lower net tuition per student. Net tuition revenue generally covers only three-quarters of the colleges’ educational costs, creating persistent disadvantages.

» While many small colleges are under stress, some will continue to thrive. Some have clear niches that help attract students and generate revenue growth. Other small colleges benefit from private gifts or public support. Some colleges have balance sheet strength that will continue to bolster their long-term prospects.

College closures and merger activity will increase as the sustained impact of revenue declines intensifies

The number of closures among four-year public and private not-for-profit colleges averaged five per year during the 2004 to 2014

decade. With intense revenue pressure, the number is likely to triple by 2017. Separately, merger and acquisition activity averaged two to three per year in the recent decade, and the pace will double in the next few years.

College closures and mergers will be more concentrated among the smallest four-year colleges. Appendix 1 lists representative college closures in calendar years 2010 through 2015.

The base projection in Exhibit 1 of the tripling closure rates extrapolates revenue trends of Moody’s-rated small public and not-for- profit private colleges across the sector. Small private colleges are defined as those with fiscal 2014 operating revenue below $100 million, and public colleges with a $200 million threshold. Moody’s rates approximately 150 small not-for-profit private and public colleges. Those that are rated tend to be among the strongest within the small college market segment.

Exhibit 1

Revenue Stress Will Drive Higher Closure Rates Among Small Colleges Through 2017

Number of college closures by calendar year

Sources: US Department of Education National Center for Education Statistics, Moody’s Investors Service for expected 2014 total and projections

While the closure rate will triple, it will likely remain below 1% per year across the broader higher education sector. The National Center for Education Statistics reports approximately 2,300 four-year public and not-for-profit private colleges in the US, so closures would need to exceed 23 colleges per year to exceed 1%. While the closures may be disruptive to students, the sector impact will

be muted because many of these colleges are remarkably small. In 2013, of the combined 12 million headcount students, colleges enrolling under 1,000 students had a relatively small 2.5% market share. Of the 2,300 four-year colleges, the smallest 1,000 have median headcount enrollment of under 500 students.

Even in the face of material financial challenges, small colleges have proven to be tenacious. In some cases, deep stress can serve to mobilize alumni and other donors to provide extraordinary gift support. The presence of tenured faculty, donor restricted endowments and the intervention of state attorneys general also complicates the decision to close. The 2015 case of Sweet Briar College (unrated)

in Virginia underscores these themes as the decision to close was reversed, at least temporarily, amid increased donor support and legal challenges and other advocacy for the college’s continuance. Small public universities are unlikely to be closed due to political support and their community roles, but may be merged with other institutions or into systems where they can benefit from greater economies of scale.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

Majority of small colleges will be unable to achieve sustained revenue growth above 2% per year

In keeping with recent trends, a majority of small colleges rated by Moody’s will struggle to produce revenue growth above 2% per year. Some of these colleges have experienced successive years of reduced entering class sizes, and in many cases the declines take many years to overcome. As Exhibit 2 shows, the percentage of small public and private colleges with a sustained three-year growth rate of less than 2% rose to approximately 50% in 2014, up from below 10% in 2006.

Exhibit 2

Increasing Portion of Small Colleges Have Sustained Revenue Growth Less than 2%

Percentage of Small Colleges with Three-Year Compound Annual Growth Rate (CAGR) Below 2%

Small colleges defined as those with operating revenue below $200M for publics and $100M for privates and rated by Moody’s. Sustained revenue trends based on three-year compound annual growth rate.

Source: Moody’s Investors Service

The sustained nature of revenue softness can create material challenges for small colleges, leaving them less able to strategically position themselves in a highly competitive environment.

Small colleges will continue to lose market share to larger ones

Since fall 2010, the smallest colleges have lost market share to larger colleges. This trend will continue, amplifying challenges. Based on recent shifts in enrollment, the smallest colleges will continue to lose market share through 2016, as shown in Exhibit 3. Public and private colleges with enrollment over 10,000 students will gain market share.

Exhibit 3

Small Colleges Will Continue to Lose Market Share as Larger Colleges Grow

Headcount Enrollment Market Share Changes Indexed to Fall 2010

Based on all four-year public and private not-for-profit colleges. 2014-2016 values are Moody’s estimates.

Sources: US Department of Education National Center for Education Statistics, Moody’s Investors Service for projections

The shift in market share away from the smallest colleges is primarily driven by factors related to student preferences. Colleges with more substantial scale have greater ability to reinvest in degree programs, student life and capital facilities. The larger colleges are often able to offer a deeper set of academic programs and a larger social network of both current students and alumni. While some smaller colleges historically thrived by serving place-bound students, increased online education and student mobility are eroding that advantage. The ability of larger colleges to refine and develop an array of program offerings and student support services will remain a key competitive advantage over smaller colleges.

Smaller colleges have inefficient cost structures with net tuition covering only three-quarters of educational expenses

The ability of many smaller colleges to invest in programs and facilities will remain limited because of inefficient cost structures, with

fewer students to support fixed costs. The smaller colleges that are heavily reliant on tuition revenue to cover educational expenses often have less pricing power and lower net tuition revenue per student. Exhibit 4 shows that tuition may cover only about three- quarter of expenses for the smallest colleges.

The operating challenges of the smallest colleges will continue to be compounded by increasing fixed costs. The escalating costs include those related to the evolving regulatory framework in higher education, as well as increasing personnel costs. Growing pension and post-retirement expenses will be a pressure for some public universities. Without significant endowment income or sustained donations to help fund current operations, the smallest colleges will continue to have limited means to strategically invest in the programs and facilities key to attracting and retaining students.

Exhibit 4

Small Tuition-Dependent Private Colleges Cover Fewer Expenses through Tuition Revenue

Tuition-Dependent Private Colleges Ranked by Operating Revenue Quartiles Show Direct Relationship between Size and Ability to Cover Expenses through Net Tuition

Tuition-dependent defined as reliance on net tuition and auxiliary revenue above 70% of total revenue.

Source: Moody’s Investors Service fiscal 2014 data

Some small colleges will continue to thrive in diverse higher education landscape

While many small colleges will face ongoing headwinds, some are well positioned to thrive and attract students well matched to their offerings. Some of these have clear niches, helping generate revenue growth. Other small colleges have sizeable endowments and ongoing donor support that offset challenges in generating net tuition revenue growth. Some smaller colleges build demand through more individualized attention, enhanced faculty interaction and smaller class sizes. Among Moody’s-rated colleges, the top 10 small private and public colleges by revenue growth from 2010-2014 are detailed in Appendices II and III.

Appendix I: Representative Closures from 2010-15

Sources: Department of Education, Moody’s Investors Service

Appendix II: Top 10 Small Private Colleges by Five-Year Revenue Growth

Five-Year Revenue Growth represents percent change from FY2010 to FY2014

Source: Moody’s Investors Service

Appendix III: Top 10 Small Public Colleges by Five-Year Revenue Growth

Five-Year Revenue Growth represents percent change from FY2010 to FY2014

Source: Moody’s Investors Service

Moody’s Related Research

Medians Report:

» Signs of Moderating Stress in Private University FY 2014 Medians, July 2014

Issuer Comment:

» Berklee College of Music (MA) Explores Merger with Boston Conservatory, June 2015

» Clarkson University (NY) Approves Merger with Union Graduate College, May 2015

Sector-in-Depth:

» Sweet Briar’s Announced Closure Highlights Challenges of Small, Rural, Niche Brand Colleges, April 2015

» College Consolidations and Closures Are Credit Positive in an Increasingly Competitive Sector, March 2015

» Mission Changes and Mergers Underscore Pressures on Small, Tuition-Dependent Colleges, August 2013

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients.

© 2015 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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AUTHOR

Dennis Gephardt

ASSOCIATE ANALYST

Chris McMahon