Do Bond Markets Punish Nonprofits for Aligning With Donor Preferences?
Evidently, yes.
Donors favor lean organizations — those that keep overhead low, spend down surpluses, and avoid debt — because they see leanness as evidence resources are flowing to today’s mission.
But what happens when organizations, praised by donors for their financial prudence, enter the bond market?
According to research by Qingqing Sun, they may face higher interest rates.
Sun’s analysis, published in a recent Public Budgeting & Finance article, examined ~750 nonprofit bond issuances between 2009 and 2016, uncovering something unfortunate.
“Nonprofits that operate with thin financial margins, meaning little surplus, limited cash reserves, and relatively low operating revenue tend to receive weaker ratings in the municipal market.”
But why do bond rating agencies penalize leanness? And how can nonprofits navigate the tension between donor and lender preferences?
Low Bond Ratings Are Unsurprising
“Since nonprofits are encouraged by funders, watchdogs, and public narratives to minimize surpluses and reserves,” Sun begins, “my expectation was rating agencies might interpret their finances differently. Instead, findings suggest they apply a credit-risk lens similar to that used for other borrowers.”
Which makes sense.
A lender’s first and last questions are: ‘Will they be able to pay us back?’
And if you’ve bought a house recently, you may remember how important your debt-to-income ratio was. Similar logic applies to bond issuances; strong revenue, surpluses, and profits are key factors.
“It may seem logical that a credit agency would penalize organizations with low profits and thin cash reserves,” begins NYU Director of Finance, Thad Calabrese, who was not involved in the study. “However, what makes this study noteworthy is that, for the first time, it provides empirical evidence of a ‘trustworthiness tax’ for the nonprofit sector.”
Rating agency behavior may not be surprising. If they treat nonprofits the same as businesses, lean organizations will appear weaker by default.
But what’s the cost of higher nonprofit borrowing rates?
The Cost of Interest
One might imagine debt as something for corporations, not nonprofits. Why would a small neighborhood museum or food bank, operating entirely on donations and community generosity, need a loan?
But “nonprofit” is a tax status, not a business model, and many of the organizations we rely on need access to affordable long-term capital to accomplish their missions.
Calbrese explains: “From hospital beds to charter school classrooms and universities, nonprofit bond ratings directly impact the quality and availability of services. And while for-profits can raise money by selling stock, there’s no efficient equity market for nonprofits.”
Nonprofits are stuck between a rock and a hard place. They need capital to succeed, but simultaneously attracting donors, grants, and bond market lenders is a challenging balance to strike.
All the while, higher interest rates limit the sector’s ability to expand, strain current-day finances, and restrict their ability to positively impact communities.
What, Exactly, Impacts Bond Ratings?
Moody’s publishes six key rating criteria, from which her analysis expanded into 23 explanatory variables.
Positive Impact: High operating revenue, days cash on hand, profitability, and revenue diversification contribute most positively to good bond ratings. Keeping your board member count relatively small was also moderately impactful.
Negative Impact: Funding mixes relying too heavily on donations or program revenue, as well as asset mixes weighted heavily toward fixed assets.
(Surprisingly) Neutral Impact: Debt burden, measured by the ratio of annual debt service to total revenue, had no statistically significant impact, nor did operating margin or percentage of total assets coming from endowments.
How Might Nonprofits Respond?
It’s easier said than done, but Sun shared a handful of approaches that can better position nonprofits in bond markets:
“Rating agencies place greater weight on revenue that’s predictable, renewable, and within managerial control. For example: mission-aligned revenue, such as tuition and university housing services, government contracts for charter schools, and museum memberships.”
Calabrese concurs, adding:
“To secure the best bond ratings, strong profitability, consistent surpluses, cash reserves, and multiple income streams that aren’t overly dependent on volatile donations are regarded as characteristics of financial strength.”
However, most organizations can’t do so without risking other funding sources.
“The ‘nonprofit dilemma’ is that large reserves tell donors ‘we don’t need your check right now,’ while high profit margins might suggest you’re overcharging or under-serving beneficiaries.”
But how can organizations position themselves for bond market and donor-based fundraising?
The right approach, according to Calabrese, is educating stakeholders away from the “lean is better” myth, and toward a mindset that values surpluses rather than punishes them.
Sun concludes similarly, advising:
“The implication isn’t that nonprofits should pursue revenue growth at all costs, but that they should think strategically about revenue mixes and financial buffers. Modest surpluses, diversified income streams, and liquidity reserves can coexist with mission integrity.”
Sun’s article, Is Financial Leanness Punished by Bond Credit Rating Agencies?, appeared in the March 2025 issue of Public Budgeting & Finance.
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