by Sean Sweeney
Deferred maintenance remains a problem at most campuses. A July 2016 Atlantic magazine article reports that “after years of budget cuts and continuing austerity, universities and colleges collectively face a shortfall of a record $30 billion” for deferred maintenance.
I recently met with a prestigious university to discuss how they evaluate, prioritize, fund, and initiate capital renewal projects to drive down their ever-increasing deferred maintenance needs. While doing my research, I was surprised to learn that a bond rating agency improved the university’s cost of capital in part due to their partial elimination of deferred maintenance on campus.
Credit rating agencies view
Credit agencies view deferred maintenance as a future liability and are very concerned with the average age of the physical plant. As the average age increases, the need to invest becomes greater. Standard & Poor’s has suggested that “as age of plant rises, we believe it is critical that colleges and universities make the necessary investments to update and renovate facilities with internal funds or external funds, such as debt or gifts.” Some agencies have even suggested that operational funds and gifts be used to pay for capital renewal projects rather than debt so that one long-term issue does not create another long-term obligation.
College and university business officials had some advanced warning regarding rating agencies’ interest in understating a campus’ deferred maintenance needs. At the annual meeting of the National Association of College and University Business Officers (NACUBO) in Tampa in July 2011, college leaders were warned about credit rating agencies’ new focus on accumulated deferred maintenance. Dennis Gephardt, an analyst at Moody’s Investors Service, said analysts look to see if institutions have a financial plan for the deterioration of the campus infrastructure, which analysts can perceive through a site visit.
Standard & Poor’s and Moody’s use two ratios to evaluate capital investment to give them insight into an institution’s accumulated deferred maintenance: 1) Age of plant (accumulated depreciation/depreciation expense), which is an indication of the average age of the plant and equipment measured in years, and 2) capital spending ratio (purchases of PP&E/depreciation expense), which is a proxy for the pace of capital investment made by the institution.
Deferred maintenance affects bond ratings
Schools have seen where their deferred maintenance issues have led to higher borrowing rates. In March 2011, Moody’s downgraded the University of Dallas’ underlying rating and stated, “Management notes the need to move toward budgeting for full depreciation within operations which will allow investment in deferred maintenance and improve operating performance . . . inadequate investment in plant and growth of the deferred maintenance backlog could place additional pressure on the university’s ability to attract students.”
Tackling deferred maintenance can lead to better bond ratings and thereby lower an institution’s borrowing costs. In it’s review of the Massachusetts State College Building Authority’s (MSCBA) bond rating, Moody’s stated in November 2014: “Over the past decade, MSCBA has tackled deferred maintenance and reduced estimated deferred maintenance needs from $49 million to an estimated $9 million in FY 2014, a credit positive. This careful planning process and significant reduction in deferred maintenance have contributed to strong student demand for MSCBA facilities, as evidenced by high occupancy levels.” This investment by the MSCBA has driven down their cost of capital.
Charging for capital renewal
Many institutions have now begun to retain funds for capital renewal by taxing all capital projects. University of California, Berkeley charges a 4% assessment on all capital projects over $100,000. Oregon State University has started a 10% allocation to a facility stewardship fund on all major capital projects regardless of project type. Other universities have created renewal reserves based on building type. Vanderbilt University builds their budget by allocating renewal budget reserve for each group, reserving 2% for hospitals and clinics; 2% for academic, research, athletic, executive administration; and 1% for all other buildings.
Some institutions have taken the deferred maintenance problem to the students by charging them to help address capital renewal needs. For example, University of Colorado, Boulder now collects a renewal and replacement fee as part of the student activity fee.
What’s the solution?
Moody’s believes that campus renewal starts with strong governance and management. Positive indicators of capital investment practices include integrated financial and capital plans and sufficient capital investment to maintain attractiveness and competitiveness; operating budget includes annual depreciation or comparable amount for regular renewal and replacement of facilities, a multi-year capital plan that includes diverse funding sources, and the level of investment on pace commensurate with growth of balance sheet and revenue.*
In short, a school’s deferred maintenance problem can affect more than just the capital spend. Faculty and staff, current and prospective students, researchers and visitors, all are impacted by system failures, failing heating and cooling systems, and failing curb appeal. Unmitigated systems with deferred maintenance often fail, which puts undue stress on other building systems, which then prematurely fail. Lastly, credit rating agencies’ focus on deferred maintenance can significantly affect borrowing costs for future endeavors.
*”Renewing Campuses for Long-Term Strength,” Moody’s Investors Service, March 2013.
Seany Sweeney
Sean Sweeney is associate vice president at Arcadis.
