Back-to-School Deals on University Muni Bonds

The Nuveen Intermediate Duration Municipal Bond fund holds bonds issued by Harvard, the University of Texas, and the University of Chicago, above. (Christopher Dilts/Bloomberg)

It’s back-to-school season, and parents freshly back from dropping kids off at college (or contemplating where their high-schoolers might apply) should take a hard look at the finances of higher-education institutions.

Investors looking for tax-exempt income should join them. As it turns out, there are some excellent options to be had among higher-ed municipal bonds—as well as some major duds. “There is a lot of value, and there are also a lot of credits one needs to avoid,” says Dan Close, head of munis at Nuveen.

Close favors universities that are elite, get lots of state funding, are in high demand from students, and earn top marks from credit-rating firms. Current holdings in the Nuveen Intermediate Duration Municipal Bond fund include bonds issued by Harvard, the University of Texas, and the University of Chicago.

The yields are compelling. A triple-A rated tax-exempt Harvard bond maturing in 10 years has a current yield of 3.47%. That equals a 6.9% taxable yield for someone in the top bracket living in Massachusetts, or 5.9% for an out-of-stater. Education bonds make up about 9% of the broader muni market and are often favorites of state-specific muni funds.

Due to a flood of new issuance—in part to get ahead of potential funding cuts from the Trump administration, but also to fund infrastructure projects—these bonds have gotten cheaper. Higher-education bond issuance equaled $26 billion this year through the end of June, about the same issued all of last year, which was a record, says Close. Through August, an index of education munis is down 0.12%, while the overall muni index is up 0.32%.

In the past month, there were reports that some schools wrangling with the administration are near a deal to put the risk of the most dire funding cuts behind them. That has led to some improvement in bond prices. Still, a top education bond yields nearly a half percentage point more than the average triple-A rated muni, up from just over a quarter-point at the start of the year, Close estimates. “They are still on sale,” he says.

Headline risk could return if the White House imposes more funding cuts. “There has been some yo-yoing in terms of rhetoric and penalties,” says Vineeth Krishnakumar, higher-education credit analyst at MacKay Shields. “Now the administration seems to be stepping it back, but we’re not sure what the future looks like.”

More negative headlines concerning top-tier universities would likely be a buying opportunity, says Nathan Will, head of Vanguard’s municipal credit research. “Strong schools stay strong,” he says. “Elite institutions are most likely not even going to suffer any rating degradation.”

What about the rest? Political issues are largely “noise,” says Thomas Kozlik, head of municipal strategy at HilltopSecurities, but issues facing higher education more broadly are deep and long-lasting. In a report a year ago, he wrote that higher ed was in a crisis due to declining enrollment, expensive tuition, less government support, and “the increased chance that college doesn’t pay off for individual students.”

There will likely be more schools that close, merge, or are downgraded, says Kozlik. Small private colleges in the Northeast and Midwest are particularly vulnerable.

Muni credit experts look at a host of factors, but they urge investors (and, we’ll add, parents with other options) to avoid schools with high acceptance rates that discount tuition—that is, provide merit aid to attract higher-caliber students—and are under budget pressure. “Schools with more pressured enrollments may continue to wobble,” says Vanguard’s Will. “But we continue to feel good about the upper end of the education spectrum.”

Write to Amey Stone at amey.stone@barrons.com