Higher Education in a High-Rate Era: Challenges and Opportunities

As interest rates climb, the U.S. higher education sector faces financial headwinds that could reshape its operations and funding strategies. With institutions relying heavily on long-term borrowing for campus expansions and operational funding, rising rates bring both challenges and opportunities for colleges and universities.

Treasury management is a crucial function within Universities and Colleges. Many have outdated treasury and investment policies which makes it difficult to balance the return on funds with risk and liquidity requirements. Current practices for short term cash include use of bank deposits, money market funds and the direct purchase of treasury bills.

Outdated banking and payments arrangements are a challenge with lazy banking providers and the sector moving generally at a slow pace.

The Cost of Borrowing in Higher Education

Higher interest rates increase the cost of capital, significantly impacting the sector:

Debt-Funded Projects: Universities with ambitious expansion plans face higher borrowing costs, potentially delaying critical infrastructure projects.
Variable-Rate Debt Risks: Institutions with significant exposure to variable-rate debt may see their debt service costs rise sharply.
Tuition Dependence: Many colleges rely on tuition for revenue, and higher rates may increase student borrowing costs, affecting enrollment numbers.

Endowments and Investment Portfolios

Rising rates can affect endowment performance, as fixed-income instruments provide higher returns but often lead to rebalancing challenges:

Short-Term Gains: Institutions benefit from better yields on cash reserves and short-duration instruments.
Market Volatility: Stock market fluctuations due to rate changes may affect equity-heavy endowment portfolios, reducing their ability to fund scholarships or capital projects.

Student Borrowing and Affordability

Higher interest rates also impact students and families, increasing the cost of federal and private loans:

Student Loan Burden: Rising rates may deter some students from pursuing higher education, especially in lower-income demographics.
Institutional Responsibility: Universities may need to enhance financial aid packages or explore alternative funding models to address affordability.

Statistics and Industry Data

In 2024, average municipal bond yields rose by over 1.5%, increasing borrowing costs for colleges issuing tax-exempt bonds.
Federal student loan interest rates for undergraduates climbed to 5.5% for the 2024-2025 academic year, up from 4.99% in the previous year.
Endowment returns fell by an average of 6.4% in 2024 due to market volatility and rebalancing.

Strategies for Higher Education Leaders

To navigate these challenges, institutions should consider:

Optimize Debt Portfolios: Transition variable-rate debt to fixed-rate instruments to minimize exposure.
Boost Liquidity: Strengthen cash management strategies to take advantage of rising short-term yields.
Enhance Fundraising Efforts: Increase development campaigns to reduce reliance on debt financing.
Support Students: Expand institutional financial aid to address rising borrowing costs and maintain accessibility.

Conclusion

Rising interest rates bring significant challenges to the U.S. higher education sector, from increased borrowing costs to student affordability concerns. However, proactive strategies around debt management, endowment optimization, and student support can help colleges and universities thrive in this high-rate environment.

Robust treasury policies are essential to protect the financial interests of the institutions and they need to be reviewed and updated regularly in a rapidly changing environment.

Legacy banking and payments arrangements should be reviewed and institutions should benchmark them against best practice in the sector using KPI’s for price, risk and liquidity.

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Sources :

Bloomberg Ed.gov NACUBO

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Higher Education in a High-Rate Era: Challenges and Opportunities