Rural Colleges’ Lenders of Last Resort

January 2, 2019

Rick Seltzer
Inside Higher Ed

A U.S. Department of Agriculture program has provided $1.7 billion in grants and low-cost loans to struggling rural colleges and universities in the last three years. That raises questions about who closes and who gets to stay open.


Iowa Wesleyan University found itself facing closure in November as a cash crunch left it needing additional money in order to operate for the spring semester.

But soon after the 700-student university in southeast Iowa went public with its peril, it rallied. Leaders determined they had received enough in gifts and newly favorable financing from the U.S. Department of Agriculture to remain open, at least for the short term.

Both the gifts and the loan modifications were necessary for the university’s survival, said its president, Steven E. Titus. Could Iowa Wesleyan have announced in November that it was staying open if it hadn’t secured changes to its outstanding loans? Titus’s answer was simple.


The university was able to extend the time frame on an existing USDA loan from 35 to 40 years. It deferred some interest and principal payments, and it changed its collateral requirements.

Collectively, those moves save Iowa Wesleyan hundreds of thousands of dollars annually and free up a sum of about $3 million that can now be used in a pinch, Titus said. Those are substantial amounts for a university the size of Iowa Wesleyan.

“We’re a $23 million-a-year enterprise,” Titus said. “We’re a very small institution from that standpoint, so yeah, when you start talking about $80,000, $100,000 at places like ours, that is really significant.”

What, exactly, was Iowa Wesleyan doing with a USDA loan in the first place? Colleges and universities receive funding from a variety of sources, including the federal government, for any number of research initiatives and other projects. When it comes to sources from which they can borrow, though, the Department of Agriculture isn’t necessarily the first place that comes to mind.

Nonetheless, one USDA program seems to surface again and again when small colleges are under intense stress. It has become an important source of cheap capital on favorable terms to colleges and universities in rural areas that have struggled to increase enrollment and revenue in the face of demographic changes and other pressures bearing down on higher education.

The program, the USDA Rural Development Community Facilities Direct Loan program, was authorized in the Rural Development Act of 1972. The law allows the federal agency to directly lend money to several types of “community facilities” deemed essential, such as those for health care, public safety and higher education.

Lending under the program has grown in recent years. Colleges frequently use it to build dormitories or renovate buildings, often with an eye toward using their new facilities to bring in more students or additional revenue. Institutions have also found ways to use the program to refinance existing debts — sometimes when they are finding it difficult to pay those debts or to meet requirements put in place by bondholders.

Consequently, some in the financial industry are taking notice of the federal lending to colleges and universities. Skeptics privately wonder whether the USDA is functioning as a lender of last resort. The agency has, after all, stepped in to lend to small institutions that can’t secure financing elsewhere and that otherwise would be unlikely to survive.

Such an argument is politically fraught. Yes, a hard-line free-marketer’s view would be hostile to the idea of the government bailing out failing colleges and universities with cheap capital. And some small colleges that are closing and leaving holes in their communities are not rural. On the other hand, champions of small colleges and rural America can point out that the campuses receiving funding are often among the largest employers in their regions, making them critical pillars of small communities that deserve support.

Paradoxically, a small campus representing a major chunk of a region’s economy may not have access to enough capital. Local banks don’t always have the cash on hand to meet their lending needs. National lenders sometimes hesitate to provide financing on favorable terms to far-flung areas.

Yet such small colleges still feel they must make major investments in order to remain viable into the future. Their aged buildings will fall apart without work. They need at least some gleaming new facilities to be able to compete for students.

Many of the leaders who have used the USDA financing admit it may not conform to the mandates of a free market. But they say it gives rural colleges a chance.

Under that line of thinking, public financing looks less like a handout and more like a tool to help rural communities that have few other anchor institutions.

“We’re talking about how we preserve a local economy and regional sustainability,” Titus said. “Even though we’re a small institution, we’re in our 176th year. So historically, culturally, this institution is a convener and provides a lot of cultural and educational opportunities in the region. It also contributes to the human and social capital.”

Underpinning all of those discussions are questions that have long roiled higher education and economic development in the United States. Who gets to decide when a struggling institution deserves to close because it made the wrong bets or serves a market that has evaporated? And at what point does lending to those institutions flip from giving them a puncher’s chance to throwing good money after bad?

Buying Buildings, Freeing Cash

In November 2017, U.S. Senator Jerry Moran, a Kansas Republican, announced that a small college in his state, Bethany College, had received a $21.2 million loan under the USDA Community Facilities Direct Loan Program.

In addition to quoting leaders at Bethany, the announcement included a statement from a congressman, Roger Marshall. In that way, it was like many other announcements local leaders and politicians make to promote their successes bringing home federal funding.

USDA direct loans to colleges are regularly highlighted in such announcements. Bethany College in Kansas isn’t even the only Bethany College to receive a USDA loan recently. Bethany College in West Virginia announced its own USDA loans this year.

None of that changes the fact that the 2017 announcement was critically important to Bethany College in Kansas. The $21.2 million loan allowed Bethany to purchase a residence hall that it had been leasing from a for-profit company. It also refinanced long-term, high-interest debt with conditions that were much more favorable to the college.

Bethany had been paying what amounted to a 12 percent interest rate on the dormitory and between 6 percent and 8 percent interest rates on different sets of bonds, said the college’s president, Will Jones. Now, it is paying a 3.25 percent interest rate over 30 years, and it did not have to pay any principal early in the loan.

All told, the deal saved Bethany about $600,000 per year. It was a critical boost for a college that had recently been on probation with its accreditor because of concerns about its finances and operational processes.

Although Bethany had its probation lifted a few months before, the college’s balance sheet wasn’t particularly strong when the loan was announced.

“Being able to do this really was a godsend for Bethany,” Jones said.

Those changes gave the college the resources it needed to invest in a crafts program that teaches students about the arts and Swedish culture in the college’s home of Lindsborg, Kans. It helped Bethany further build upon its Swedish roots by planning a “Swedes to Sweden” service-learning trip in which the college will cover students’ costs.

The new loan also enabled the college to repay $2.7 million it had borrowed from its endowment, said its chief financial officer, Vincent Weber. And it came without some of the strictest requirements that are often written into other forms of borrowing, like requirements that the college meet certain equity ratios.

Securing the loan wasn’t easy. It took 18 months, according to Weber. Local community members had to write letters of support, the college had to provide financial projections for the next five years with and without the USDA loan, political representatives had to sponsor the application, and the college had to explain why the loan would be good for the surrounding area.

“It really does take a lot of cooperation with the local community,” Weber said.

Local banks probably would have had the capacity to refinance Bethany’s loans, Jones said. Only they might not have wanted to, given the college’s recent stint on probation.

“The issue for Bethany was, I’m not sure anyone would have wanted to take on the risk,” Jones said.

In other cases, local banks have clearly been willing to lend money to rural colleges, but they would have been hard-pressed to come up with the money quickly. Emory & Henry College in southwest Virginia secured $51 million in financing through USDA Rural Development in 2016 — $46 million in a direct loan and $5 million in a loan through a local bank that the USDA guaranteed.

The college turned to USDA financing after two national banks, Bank of America and BB&T, called its loans. Emory & Henry had been paying on time, but the national banks weren’t interested in working with it further, said the college’s president, Jake B. Schrum.

“One day, they just got in touch with our chief financial officer and basically said, ‘We’re calling your loans,’” Schrum said. “They thought our ratios were not as healthy as they wanted them to be.”

That left Emory & Henry seeking to refinance between $35 million and $39 million in long-term debt. The college tried local banks first, but no single bank was large enough to meet its lending needs. Bankers looked into putting together a consortium that would allow Emory & Henry to refinance, but then the college discovered it could refinance with the USDA.

Doing so required the college to be developing a new project, Schrum said. It had been considering building an eight-residence-hall, 206-bed project that included six apartment-style townhomes and a community center. The architectural plans had even been drawn up.

Emory & Henry did the deal with the USDA, securing a total of $51 million in direct and guaranteed USDA lending. The college’s interest rate is 2.375 percent, and it is fixed over 40 years.

“After the loan, we actually had a lower payment than we had before,” Schrum said. “We had a number of older housing units on campus, so it really upgraded the facilities for housing.”

While many of the colleges and universities receiving direct loans under the Community Facilities program have used the money to construct new buildings, invest in existing facilities or buy buildings that they didn’t own, such action doesn’t always take place. A review of numerous colleges receiving loans in recent years shows other arrangements.

Alderson Broaddus University in West Virginia used a $27.7 million loan to shore up its financial indicators in a complex transaction that involved the university’s endowment corporation. The endowment corporation used the loan to acquire parts of the university’s campus, which are being leased back to the university.

“The USDA loan will allow for the reallocation of additional resources to cover operating expenses at AB,” according to the university’s official announcement of the deal. “The immediate effect on the financial position will also result in improved numbers in the university’s Composite Financial Index (CFI), a key indicator used by the Higher Learning Commission in determining financial viability.”

Alderson Broaddus is far from the only institution to use a USDA loan to facilitate such a sale-leaseback agreement with an affiliated entity. It’s the strategy Iowa Wesleyan used when it first secured its USDA financing — $21.4 million in direct lending and a $5 million guaranteed loan — in 2016. A review of Community Facilities loans made in 2018 shows it to be a relatively common part of loan transactions. Often, the transactions also include plans to purchase new facilities, build them or buy land a college didn’t previously own — but not always.

Large Sums Lent

The Community Facilities program has infused more than $1.7 billion into colleges and universities in the last three fiscal years through direct loans, guaranteed loans and grants. USDA figures do not break down the totals, but a review of grants and loans made in the 2018 fiscal year indicates loans are likely a large component of the total. Loans tended to be counted in the millions or tens of millions of dollars, while grants were often in the hundreds of thousands of dollars.

Loan and grant funding totaled $396.7 million in the 2016 federal fiscal year, $984.9 million in 2017 and $326.9 million in 2018.

Federal lending to higher education has caught the attention of bond ratings agencies. In March, Moody’s Investors Service issued a paper looking at the Community Facilities program and the Historically Black College and University Capital Financing Program. The programs support institutions’ near-term financial viability, according to Moody’s.

“For the colleges that are able to obtain that financing — and not all qualify — it is a bit of a release valve,” said Susan Fitzgerald, associate managing director at the ratings agency. “They are able to obtain lower-cost capital financing than they could in the public market. Some may not even have cost-effective financing alternatives.”

The Community Facilities program is estimated to have $3.5 billion in direct loans in 2018, according to Fitzgerald. That number isn’t just loans to colleges and universities. It includes other types of institutions that qualify for the financing. Still, it shows how large the program has become. In 2014, the program totaled about $1 billion.

Even so, the loans represent a relatively small slice of the total borrowing by colleges and universities. Public and community college debt more than doubled from $73 billion to $151 billion over a decade, according to “The financialization of U.S. higher education,” a paper published in the journal Socio-Economic Review in 2016. Debt for private colleges totaled $95 billion in 2012, it found.

Wealthy institutions were more likely to borrow for many different purposes, including instruction and research, the paper found. They tended to borrow in order to maximize their financial revenues — they paid less interest on their debts than they earned on their endowment assets, making it cheaper to borrow for projects than it would be to pay for them out of pocket. Private institutions that were not as wealthy increasingly borrowed in order to invest in in auxiliary and student services, including student amenities like dormitories, cafeterias and athletics and recreation centers. That likely indicated the less wealthy institutions used debt in order to maximize their commercial revenues in a bid to attract students who are willing to pay higher tuition and fees.

The USDA Community Facilities program doesn’t just provide financing to private institutions. It has financed public institutions as well.

Concerns and Criticisms

The USDA loans are not without their drawbacks — or their critics.

After Bethany College in Kansas announced its loan, a self-described conservative wrote a letter to the editor in a local newspaper arguing that the government was giving away tax money that could be better spent elsewhere.

“Due to extremely low commodity prices, many farmers could much better utilize U.S.D.A. loan money than a private, for-profit college,” the letter said.

Bethany leaders pointed out that the letter writer incorrectly identified the college as for-profit and seemed to equate the loan with a grant. Bethany is in fact a nonprofit affiliated with the Evangelical Lutheran Church in America, and its leaders say they intend to fully pay back the money they borrowed.

Bethany’s president, Jones, acknowledges people may have objections to the government providing loans.

“I definitely could see that there are likely to be folks out there who have a problem with the USDA making this type of loan,” Jones said. “I personally think it’s a great investment on the part of the federal government to invest in local, rural communities that often do struggle to find financing.”

Any comparisons between the USDA lending to colleges and federal lending to HBCUs could also prompt other worries: about the likelihood that the loans will be paid back and about whether the lending is being done in the most effective way possible.

Some HBCUs have had difficulty accessing the HBCU Capital Financing Program, and others have struggled to pay their loans under it. Two HBCUs recently defaulted on loans under the program, and 29 percent of loan payments were delinquent in 2017, according to a June 2018 report from the Government Accountability Office. Eight private institutions received deferments under the program earlier this year.

Further, the Department of Education in 2018 forgave hurricane-relief loans made to four HBCUs that were made after Hurricanes Katrina and Rita. The forgiveness came under a budget bill that cleared more than $300 million in loans made to the institutions.

Comparisons between HBCUs and other types of institutions are fraught and imperfect. HBCUs have long faced challenges borrowing, raising money and enrolling students who can afford to pay to attend college. Their needs are clear. HBCUs responding to a GAO survey said 46 percent of their building space needs repair or replacement, on average.

Many predominantly white institutions arguably have advantages that would make them more likely to be able to repay loans. Still, those same advantages could make predominantly white institutions more likely to be able to access nongovernmental sources of capital.

Setting that discussion aside, USDA statistics indicate its Community Facilities loan portfolio is performing well. Payment delinquencies are less than 2 percent across the direct and guaranteed programs, according to the agency.

That figure is for the entire portfolio, not just higher ed. It only addresses payments, not nonmonetary defaults that would take place when debt covenants are breached.

Some still wonder whether the government is set up to operate as a lender.

“From the government’s point of view, what is the appropriate risk-adjusted interest rate to charge?” asks Marc Joffe, senior policy analyst at the Reason Foundation, a libertarian think tank. “If you actually want to be a loan program and not a subsidy program, you have to charge enough interest to make sure you’re covering your defaults.”

The USDA program could play an important role by sustaining colleges and universities in areas where they are needed, said Charlie Eaton, an assistant professor of sociology at the University of California, Merced, who was the lead author on “The financialization of U.S. higher education,” the paper published in the journal Socio-Economic Review.

“At some level, it can be a good thing we provide capital to colleges and universities via the federal government rather than bond markets, because the federal government can make decisions about borrowing based on social need and where investments will serve a social good,” Eaton said. “Bond markets are going to be making lending decisions based on what’s likely to generate the highest rate of return.”

In other words, some colleges and universities might want to make the decision to build a dormitory based on factors other than whether it will make enough money to satisfy lenders. They might want to build dormitory — or other facility — because it is needed.

All of this comes at a time when various levels of government have pulled back on investing in higher education. College borrowing increased in recent years because federal and state governments have provided less capital for the construction of facilities, Eaton said.

When historically available sources of cheap capital dry up, institutions will turn to other sources, like the public bond markets, or a USDA program.

“The question is, does the USDA really have structures in place to make sure that it’s making its loans where there’s a social need, and where it’s not going to lead to risk or wasteful investments by the colleges doing the borrowing?” Eaton asked.

The answer to that question isn’t entirely clear. If, theoretically, a college with dated dormitories builds a new facility, then raises room and board rates in order to improve its budget outlook, is it taking action that the community needs? Or is it taking action that it needs? When are those two needs at odds, and whose job is it to evaluate them?

Those well versed in the way the USDA program works describe some decision making for smaller projects centered in local offices and a majority of final decisions being made in Washington. The agency, experts say, looks at many factors to gauge creditworthiness and eligibility. Factors include the regional impact a loan can have.

“In a lot of these smaller towns, the colleges are either the top one or two or three employer in the area,” said Rick Gaumer, who was chief financial officer at Emory & Henry when it borrowed from the USDA and is now a consultant at Academic Innovators, where his work includes helping colleges secure USDA financing.

In Gaumer’s experience, institutions pursuing funding are seeking to improve, become more relevant to students and grow. The Community Facilities program also adopts a “defensive strategy” at times, attempting to prevent entities from failing and hurting a region.

The agency doesn’t always step in to prevent an institution from closing. St. Gregory’s University, which was Oklahoma’s only Roman Catholic University, decided to close in 2017 after the USDA turned down an application for a loan that college leaders said it needed to survive.

Colleges have also turned to the USDA when other sources of financing have soured on them. Bard College in upstate New York had its debt rating downgraded in 2016 amid concerns about cash and borrowing from its endowment. A year later, it was publicly discussing USDA financing.

“Bard did make an application for a loan, but it did not make it out of the New York State office because it was thought that the level of debt was too great for the college,” said the college’s chief financial officer, Jim Brudvig, in an email. “We have not withdrawn that application yet pending the submission of a new application.”

The new application calls for a smaller loan and a larger equity contribution from the college, Brudvig added. Bard is aiming to finish the application by April.

Clearly, some cases will be easier than others. Emory & Henry didn’t need USDA financing to survive, said its president, Schrum. It could have applied about half of its $80 million endowment in a pinch. Such an emergency plan would have raised numerous other issues, but it meant the college wasn’t facing closure.

It is important to note that Emory & Henry did its deal with the USDA at a time when rural Virginia colleges were suffering, Schrum said. Virginia Intermont College had just closed its doors in 2014. Sweet Briar College had attempted to shut down in 2015 before its alumnae put a stop to that plan.

“Those things were happening in the local area, and I think some of these national banks are very risk averse and are not used to taking chances — certainly on institutions that are far away from their headquarters,” Schrum said. “We can tell them that we have a $70 million to $75 million economic impact on this area, but that doesn’t make as much sense to them, or they don’t care as much, as it does to First Bank & Trust, which is just down the street from us.”

For a more complicated case, think back also to Iowa Wesleyan’s situation. The university this year managed to refinance a USDA loan it initially received in 2016. It only received those 2016 loans after going into forbearance on two sets of bonds. It went into forbearance because it was out of compliance with bond covenants, according to a 2016 consultant’s report.

Iowa Wesleyan never skipped a scheduled principal or interest payment, said its president, Titus. When it first received the USDA funding in 2016, it had an improvement plan in place that included rapid growth in online programs. It hired an online program management company to assist.

Eight months after signing its USDA loans, the OPM went out of business.

“That was a major blow to our turnaround strategy,” Titus said. “That was about a $2 million revenue hit for us at a very fragile time.”

Who is to say whether Iowa Wesleyan was a victim of circumstance or a university that should have had enough time outrun its problems?

Gaumer described a worldview in which struggling institutions should be left to close — although he wasn’t speaking specifically about Iowa Wesleyan’s case. The wolf, he said, is chasing you. Maybe the slower institutions should be caught and eliminated.

That comes with costs, too.

“But you work for higher education,” he said. “The small school has to survive. Not everyone can go to the big state university. There is a place for smaller schools in our society, and I think that society has been well served.”