As the economy reopens from COVID-19 restrictions, a question looms: What will colleges and universities look like come fall? Will students return to a more normal on-campus learning experience, some form of online experience, a combination of both … or will they simply not return? The question is important to municipal bond investors because the education sector accounts for roughly 7% of the investment-grade muni market.

We believe the core of a well-built muni portfolio should consist primarily of general obligation bonds and essential-service revenue bonds. However, for investors who wish to expand their municipal portfolios, another area to consider is higher-education revenue bonds, or bonds that are issued by public or private universities or colleges. But don’t consider just any university or college, especially in a COVID-19 world.

Public institutions, on average, tend to have higher credit ratings than private schools

Not-for-profit higher education bonds come in two major flavors: public and private institutions. Colleges and universities, both public and private, are generally not-for-profit enterprises. As such, interest paid on their bonds is generally exempt from federal income taxes, as well as state income taxes if the bonds are issued in the investor’s home state. From a credit ratings perspective, an issuer can be a standalone school or an entire system, such as the University of California or the University of Texas systems.

Overall the sector is very highly rated, but it’s somewhat bifurcated based on private or public institutions and size. On average, private institutions tend to have lower credit ratings compared to public institutions. But the range in credit quality for private institutions is wider, as illustrated in the chart below. Public institutions tend to have higher credit ratings, on average, because they benefit from state support and generally have economies of scale. The higher-rated private schools tend to be those that are highly selective and household names—like many of the Ivy League schools.

Public university ratings are more clustered compared to private universities

Source: Standard and Poor’s, as of 1/16/2020. For illustrative purposes only; some ratings may have changed since the publication date of the report.