'We had a bad year:' How a covenant violation led Bradley University to make $13 million in cuts
Bradley University will pay a higher interest rate and need to have more money on hand to cover debt after violating the bond covenants on some $17.1 million worth of borrowing last year.
That's the underlying story behind last year's academic cuts on the Hilltop. WCBU obtained information on the covenant violation from the Illinois Finance Authority via Freedom of Information Act (FOIA) requests.
Documents filed with the Illinois Finance Authority on Jan. 17 said the university violated the Series 2021B continuing covenant agreement with PNC Bank for the year ending May 31, 2023. The specific provision breached required the university to maintain a debt service coverage ratio of not less than 1.25 to 1.0, with one being the minimum net operating income required to service the debt annually.
Matt Fabian, a partner at Municipal Market Analytics in Concord, Mass., says debt service coverage ratios are a measure of cash flow adequacy.
"Lenders or bond investors or whomever typically want the university to finish their fiscal year with just a little more money than they would otherwise need to pay debt service," Fabian said. That financial cushion gives the lender some added assurance there's funds to cover unexpected costs, he added.
Jim Cofer, the interim chief financial officer of Bradley University, said they're not going broke, but he didn't sugarcoat his assessment of what happened.
"We had a bad year. And that bad year threw off the debt service coverage ratio," Cofer said. "It's just, you know, what can you say? It was a bad year. Students were down and we spent too much money, basically."
Cofer said the university's debt-service coverage ratio went negative last year for the first time.
PNC Bank could have called in the $17 million immediately, but instead agreed to waive the university's bond covenant violation in exchange for new conditions to the bond terms.
That includes an interest rate hike, and a gradually increasing debt-service coverage ratio. The required ratio decreases to 1.0 for the year ending in May 2024, but it then goes up 1.35 in 2025 and 1.5 in 2026.
While a covenant violation isn't considered to be as serious as missing a payment, Fabian said it's still a red flag.
"It's not a payment default, but it's a technical default. And universities in strong financial health don't have technical defaults," he said. "So there's clearly challenges that the school is trying to work through."
What are the 2021 bonds?
In 2021, Bradley University essentially refinanced existing debt by asking the Illinois Finance Authority to issue new bonds refunding older ones.
The $77.6 million Series 2021A and $22.5 million 2021B bonds refunded the bonds issued in 2017 to cover some of the construction costs of Bradley University's Business and Engineering Convergence Center.
The 2021 bonds also refunded 2008 bonds that were in turn issued to refund previous debt issued in 2002 and 2007. The 2007 revenue bonds were issued to fund construction of Renaissance Coliseum and a parking deck, among other costs. The 2002 bonds were issued for the renovation of Bradley Hall and to refund debt issued in 1999.
PNC Bank purchased the 2021B bonds from the Illinois Finance Authority. The bank then entered a convenant agreement with Bradley University spelling out the legal terms and conditions of the debt repayment.
As of January, about $17.1 million in principal was still outstanding on the Series 2021B bonds. Those bonds were issued at a variable interest rate, though those rates are subject to negotiations between Bradley and the bank. Final repayment is due in May 2033.
The modified terms dated Jan. 17 increased the applicable spread of the variable interest rate from 56 basis points, or just over half a percent, to 250 basis points, or 2.5%. Assuming Bradley University hits the debt-service coverage ratio goals going forward, that will decrease to 2.25% after May 2024, 2% after May 2025, and 1.5% after May 2026.
Fabian said those terms are a reflection of the increased risk the lender takes on by waiving the borrower's covenant violation.
PNC Bank declined to comment, citing client confidentiality.
What does this mean for Bradley going forward?
Standard & Poor's doesn't issue ratings on privately-held debt like the 2021B bonds, but the ratings agency pegs Bradley's 2021A and 2017C bonds at a stable BBB+. That's on the lower end of what S&P considers investment-grade. But Fabian said the bonds still trade in the high 90 cents on the dollar range.
Ruchika Radhakrishnan is a credit analyst with S&P Global. She said a covenant violation isn't necessarily cause for a ratings change by itself. Rather, that's determined on a case-by-case basis.
She said Bradley's covenant violation was triggered by a larger-than-expected operating deficit, but PNC's default waiver and the university's consistent regular debt payments are two factors in the institution's favor. She also noted management actions to control costs like the December cuts.
President Stephen Standifird announced in July 2023 that the university was running a $13 million operational deficit and would need to slash 10% of its spending to right-size its long-term spending. Those cuts mostly fell upon academic programming to the chagrin of faculty, who took an unusually public stance denouncing the moves. The University Senate also passed votes of no confidence in the president and provost Walter Zakahi.
The Bradley chapter of the American Association of University Professors argue the cuts hurt the university's academic standing. They've also retained legal counsel regarding the cost-cutting process, which they say violated their Faculty Handbook.
Ultimately, Standifird announced the termination of 38 faculty jobs. Another 23 were cut through attrition, for a total of 61 positions. Fifteen programs will be phased out, and another five will be demoted from majors or concentrations to classes in the core curriculum.
Cofer, whose stint as interim CFO ends this month, defends that move. He said making cuts is difficult, but Bradley is positioning itself to move into the future.
"It may not be popular, it may not be what you want to do, it may be a change. But you got to stick with the plan and make those necessary changes," he said.
The cuts can't take effect immediately for a couple reasons, Cofer said. Bradley's accreditors require the university to "teach out" the eliminated courses over the next few years to allow currently enrolled students the opportunity to graduate. Faculty contracts also need to be honored, he said.
Radhakrishnan said Bradley's overall balance sheet remained solid even through fiscal year 2023. The university has a $350 million endowment and more than $700 million in assets. But she said operating performance has been an offsetting factor for the past several years.
"They have spoken to us about some financial improvement plans they have in place and the expectation that by 2026, they're expecting significant improvement," Radhakrishnan said.
A recurrence of the violations and additional waivers would put more pressure on the rating, she said.
Enrollment is one key factor S&P Global is watching at Bradley and other institutions as the agency gauges operational health. The higher education sector at large is facing a steep enrollment cliff as students born during the Great Recession begin graduating high school. Birth rates in those lean years dropped off along with the economy, leading to a smaller pool of potential students now.
Cofer said most institutions that built up their operations to serve the Baby Boomers are now overbuilt for the needs of this new, smaller generation. He said the impact is particularly acute for midsized institutions.
"You got a little bit of COVID backlash, a little bit of the demographic cliff, and then you got a little bit of, we added things that were popular, and now they're not," Cofer said. "So you got a whole lot of things. It's basically too few students chasing too many seats and classes."
Tuition discounting has become one strategy for smaller private universities competing for a diminishing pool of students, and Bradley is no exception. Industry-wide, S&P notes tuition increases have a limited impact on recovering revenues due in part to ballooning tuition discounts or rebates.
Cofer said enrollment is a moving target that requires a frequent "very hard look" at any institution he's ever worked. Bradley University's first-year undergraduate enrollment in fall 2023 was around 870 students. That was lower than anticipated. A little more than a thousand enrolled the previous autumn.
"I do think it's a tough environment," Radhakrishnan said. "So especially on the demand and enrollment side, that is definitely going to be a pressure for most institutions of this category, in a way."
Expense pressures and a tight labor market are also taking their toll on higher education around the country, she said.
How does the future look for higher ed at large?
S&P Global's 2024 outlook for higher education is bifurcated, or mixed. Selective, higher-rated universities have a positive outlook, while smaller regional schools are expected to continue facing financial and enrollment challenges.
"Bradley in particular falls at sort of that lower end of the rating curve where we are seeing more operating pressures," said Jessica Wood, managing director for education at S&P Global Ratings.
The outlook says liquidity and bond covenant pressures could increase if expenses at an institution outpace revenue growth. That in turn could affect ratings if breached covenants lead to putting up collateral or accelerating debt.
Both Fabian and Radhakrishnan noted 2023 saw an unusually high number of covenant violations at institutions of higher learning. Fabian said last year saw the most since his company first began tracking them in 2009.
"There's been talk in the country about how the higher education providers are coming under stress, and that there will be problems. And that's been discussed for decades," Fabian said. "But last year may have been the year when it actually starts."