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Historically Black colleges and universities (HBCUs) have faced their share of adversity and obstacles. Financial viability is among the most pressing. Critics and detractors of these schools often point to fiscal mismanagement and inadequate financial controls as the primary reason for their economic challenges. These concerns are compounded further by the COVID-19 pandemic.
A study published within the past year in the Journal of Financial Economics reveals a more complex portrait of the financial practices that disadvantage Black schools, including the ways in which they obtain funding for improvements and overall financial viability. The report looks specifically at the financial pitfalls that HBCUs endure when relying on bonds, credit ratings, insurance, and tax exemptions.
Bonds are fixed income security, a debt instrument used to raise capital. As a loan agreement between the bond issuer and investor, it requires the bond issuer to pay a specified amount of money (usually the face value) at a specified future date. For most institutions of higher learning, including HBCUs, bonds are one of the most common means of raising money for capital investments such as making improvements to college infrastructure in the form of new academic buildings, labs, and dormitories.
Larger bonds, including multi-million-dollar bonds, are usually broken up and distributed to multiple investors. Rather than tracking these bonds, underwriters are used. An underwriter purchases government, corporate, and municipal bonds or preferred stock and resells them for a profit. However, researchers found a stark difference in the overall amount paid to underwriters by non-HBCU and HBCUs.
Non-HBCU institutions routinely pay underwriters lower fees than HBCUs. According to the study, these institutions paid on average 81 cents on every $100 raised to underwriters. This means for a $10 million bond, $81,000 in fees would go to the underwriter. The fees for HBCUs, however, were significantly higher.
Researchers found they paid underwriters 92 cents per $100 raised. This means the HBCU would pay $92,000 on the same $10 million bond. This amount is 14% more than what a non-HBCU would pay. Underlying this disparity is the belief that finding a buyer for an HBCU bond is harder, so the cost is passed on to the institution, according to Professor Bill Mayew of Duke University, one of the study’s authors.
This situation is compounded further if an HBCU is located in the Deep South. Schools in Mississippi, Louisiana, and Alabama face even greater economic challenges. In these three states, according to the authors of the report, the cost of bonds is even higher. HBCUs pay 106 cents per $100 raised. This means that an HBCU will pay $106,000 to an underwriter on a $10 million bond.
Credit ratings and bond insurance also factor into this equation because the higher costs apply to HBCUs even when they have insurance and a AAA credit rating, the highest possible for an institution. Agencies such as Moody’s and Standard & Poor’sprovide these ratings which measure whether an institution will repay its debts in a timely manner. In addition, these universities have access to insurance, which ensures repayment in the event of default. In an ideal environment, these factors should level the playing field regarding bond fees.
This is not the case at all. Despite similar credit ratings and insurance, the researchers found that the same discrepancies in bond costs and underwriting fees are present for non-HBCU and HBCU institutions.
HBCU bonds were also found to take longer and cost more to sell in secondary markets. Bonds from an HBCU cost as much as 20 percent more than non-HBCU bonds to trade. Some of the larger bonds, more than $50,000, were packaged with a 60 percent premium. The study found insurance premiums tend to be higher in the Deep South as well.
The authors attribute this difference to racial animosity. They controlled for racial bias by measuring opposition to affirmative action, the percentage of voters who supported President Barack Obama in 2008, and state level data on racist searches culled from Google. Louisiana, Mississippi, and Alabama, states with the highest racial animosity index, issued more than 26% of all HBCU bonds. In those three states, HBCUs pay more than three times as much in underwriting fees than non-HBCU institutions, according to Journalist’s Resource.
The last issue the study considered is tax exemptions. Interest on bond payments is tax exempt but with a caveat: the exemption is limited to the state where the bond is issued. This severely limits the market HBCUs can access. Rather than being able to access capital anywhere in the country, if they want a tax exemption, HBCUs are limited to their home state. Researchers suggest a way to get around this limitation is a triple exemption — from federal, state, and local taxes. This would mean HBCUs could tap into a larger market less dependent on racial or regional limitations.
These disparities coupled with the sizable gap in fundraising outcomes for more well-known college brands many disadvantage HBCUs further. The one bright spot on the horizon is the promised support for these institutions from the incoming Biden-Harris administration. This support, however, must address and remedy the structural inequities in bond markets, insurance underwriting, credit rating as well as bolstering fund raising capability.