The outlook is getting darker for one part of the municipal bond market. The higher education sector was recently downgraded by Moody’s Ratings to negative from stable amid potential policy changes from President Donald Trump ‘s administration. Higher ed and K-12 education are the only two muni sectors Moody’s rates negative. The catalyst for the outlook change was a shift in public and private colleges’ operating environment, primarily related to growing uncertainty, explained Susan Fitzgerald, managing director of public finance at Moody’s Ratings. “The sector already had a fair number of stresses that it was addressing — particularly on the enrollment side, but also inflation and labor,” she added. “You add onto that a shifting federal policy environment, a lot of which is uncertain at this point, and that just makes it much more difficult for these institutions to operate.” Municipal bonds, in general, are favored by the wealthy because they are free of federal taxes. They may also be exempt from state tax if the holder resides in the state in which the bond was issued. Still, investors will need to distinguish between sectors of the muni bond market, as well as specific issuers. Within higher ed, that means taking an institution by institution look to determine how well positioned they are in this evolving environment. Policy impacts on higher ed There are several areas of impact from potential policies coming from the White House, according to Moody’s. For one, a 15% cap for National Institutes of Health funding of indirect costs for research will negatively affect operating results of many colleges and universities, Fitzgerald said. “They would either have to absorb that in their budget … or they would have to significantly scale back on their research if they weren’t able to fund it themselves, or they would have to find new donors for that research,” she said. The NIH announced the cap in early February, but a federal judge issued a preliminary injunction earlier this month. If enacted, the reduced funding could result in more than $100 million per year in cuts for some of the largest highest-tier research institutions that spend at least $50 million on research and development and award at least 70 doctorates annually, Moody’s calculates. In addition, there is the possibility that federal financial aid programs, which are run by the Department of Education, could be disrupted as the department is cut back and potentially shut down, Fitzgerald said. That raises a possible credit risk, she said. Trump signed an executive order Thursday aimed at dismantling the department , although only Congress can eliminate it. The move came after the Education Department laid off nearly half of its employees . The White House said it expects to continue running federal student loans out of the reduced agency. Lawsuits have been filed to stop the closure. Moody’s also noted that a possible increase in the excise tax on university endowments would hit more wealthy institutions’ budgets. Currently, only about 50 to 60 institutions pay the 1.4% tax on net investment income, which is for private colleges and universities with at least 500 students and wealth of over $500,000 per full-time student, the firm said. If increased to a tax rate above 10% or the base was broadened, it would “place a far greater strain on financial reserve growth for many more private universities,” Moody’s team said in a note last week. Higher ed institutions also face challenges to operations and enrollment due to possible immigration cuts and enforcement actions against diversity, equity and inclusion programs , Moody’s said. Winners and losers Any impact won’t necessarily be felt across the board. While wealthier institutions may be in the crosshairs of some of the policies, they are well positioned to come up with solutions, Fitzgerald said. The ones most at risk are smaller private colleges and regional public universities, who are reliant on students who use federal financial aid programs, she said. Those institutions “have potentially limited wealth and reserves so that they can’t really absorb any volatility in their operations,” she added. Bank of America agrees that top-rated institutions with significant financial resources and strong demand should weather the storm. “The bifurcation of credit quality continues as the ‘Haves’ maintain the liquidity and resources to handle the challenges ahead while the ‘Have nots’ may find the potential drying up of federal funding and additional actions more taxing on operating margins,” strategist Yingchen Li wrote in a note Friday. Dan Close, head of municipals at Nuveen, has also noted the “haves” and “have nots” in higher ed, which began before the latest policy announcements. Challenges with enrollment and expenses, as well the drying up of Covid funding has hit the sector, he said. “If you’re a smaller institution that just doesn’t have that endowment, doesn’t have the resources, this is just going to put that much more pressure on you,” he said. “The student aid — those loans and the Pell grants — have been able to drive tuition higher, and not having those, or at least having those maybe in a more limited capacity, is really what could affect top line. Close believes public schools will be OK because state coffers are fairly full, while elite schools will continue to get stronger. For instance, the Nuveen High Yield Municipal Bond Fund (NHMRX) has a 0.22% holding in American Musical and Dramatic Academy University, based in New York. Its Short Duration High Yield Municipal Bond Fund (NVHIX) has 0.69% of its assets in Ohio State University General Receipt Bonds. Paul Malloy, head of municipals at Vanguard, believes the current headlines are “just additional noise.” “This bifurcation has been happening for many years,” he said, noting that higher ed has been facing rising dilution rates, demographic issues and affordability concerns for some time. Malloy said big universities with strong pipelines to employers or that have a niche program will do just fine despite challenges, while smaller schools with declining enrollment could struggle. Get Your Ticket to Pro LIVE Join us at the New York Stock Exchange! Uncertain markets? Gain an edge with CNBC Pro LIVE , an exclusive, inaugural event at the historic New York Stock Exchange. In today’s dynamic financial landscape, access to expert insights is paramount. As a CNBC Pro subscriber, we invite you to join us for our first exclusive, in-person CNBC Pro LIVE event at the iconic NYSE on Thursday, June 12. Join interactive Pro clinics led by our Pros Carter Worth, Dan Niles, and Dan Ives, with a special edition of Pro Talks with Tom Lee. You’ll also get the opportunity to network with CNBC experts, talent and other Pro subscribers during an exciting cocktail hour on the legendary trading floor. Tickets are limited!