These days, when states catch cold, their public universities Tare bound to start sneezing. State budget deficits, aggravated by a drawn-out recession and an anemic economic recovery, have led to cost-cutting that in many cases has lessened funding for higher education. And the link between a state's financial condition and the creditworthiness of higher education institutions has some municipal bond analysts pondering whether public universities should be disclosing more about the states that help fund them.

"It's very important to know about a state's fiscal condition," said Katherine R. Bateman, an assistant vice president and sector manager of higher education at John Nuveen & Co. "If [a university] is getting over 50% of its revenue from a state, it would be ideal for both the state's and the school's financials to be included in the official statement."

Bateman, who is also chairperson of the National Federation of Municipal Analysts, said that when a state faces fiscal stress its annual appropriations to higher education institutions can drop.

In some cases, a downgrade of a state's general obligation rating could trigger a downgrade for its university debt as well.

University disclosure of a state's finances became an issue in January 1992, when First Chicago Capital Markets withdrew at the last minute from bidding on an issue of $31.9 million certificates of participation from the University of Illinois.

Officials at First Chicago contended that the COPs were supported by the state of Illinois and that investors needed more current information about the state's financial condition. At the time, Illinois was shouldering a $520 million deficit in its $13.6 billion general funds budget for fiscal 1992.

As a result of the state's shaky finances, Illinois' GO rating was downgraded by both Moody's Investors Service and Standard & Poor's Corp. And at Standard & Poor's, the ratings for seven of the state's public universities, including the University of Illinois, were cut as well.

Disclosure Survey

First Chicago's concern over the lack of adequate state disclosure found its way into a 1992 membership survey by the National Federation of Municipal Analysts. While the survey found that 47.2% of the respondents were completely or generally satisfied with the way public universities disclose their state's credit quality, 39.6% of respondents expressed varying levels of dissatisfaction with the disclosure.

Richard Ciccarone, a senior vice president at Kemper Securities Inc. and co-chairman of the federation's industry practices and procedures committee, said the survey results "suggest that more is needed to be done in the area of providing information about a state's credit quality."

Ciccarone pointed out that if state problems lead to appropriation cuts for higher education, then universities can likewise be forced to make cuts or raise fees and tuition to compensate for the loss.

Indeed, a report released in April by the American Association of State Colleges and Universities concludes that the "big loser in the state budget battles over the last two years has been higher education." The report says that since 1990 institutions of higher education institutions have lost $7.7 billion because of state appropriation cuts and inflation.

Comparing state funding levels between fiscal 1992 and 1993, the report finds overall state funding increased 1.23%, or slightly more than one-third of 1992's inflation rate of 3.2%.

According to the report, public universities took the biggest chop in Ohio, where funding dropped 11% in fiscal 1993. Higher education funding was at the center of a heated debate on dealing with Ohio's $520 million budget deficit for fiscal 1993, which began last July 1.

When legislators rejected Ohio Gov. George Voinovich's plan to raise $123 million from increases in tobacco and alcohol taxes, the governor threatened to cut the higher education budget by $224 million. In the end, Voinovich cut the higher education budget by only $171 million, citing unexpected surge in tax revenues in June and lower-than-estimated fiscal 1992 spending.

Paolo De Maria, assistant director of the Ohio Office of Budget and Management, said the state's "hands were tied" because Ohio had to continue funding for mandated spending programs in areas like Medicaid.

"We have to have a balanced budget," De Maria said. "One of the places the state can cut money is [in appropriations] to the higher education system."

Ohio is not the only state that has cut back on funding for higher education.

For public universities nationwide, fiscal 1993 marked the second year in a row that the aggregate amount of money allocated by states dropped, according to Robert Sweeney, a policy analyst for the Association of State Colleges and Universities. The group represents 375 state colleges and universities and over 30 higher education systems.

Rating Factors

State financial support is high on the rating agencies' list of credit quality factors that determine a public university's debt rating.

Mary Peloquin-Dodd, a director at Standard & Poor's, said state support of a higher education institution is "Paramount." With universities on average getting half of their operating funds from their states, she said, a state's GO rating becomes the ceiling for the universities' own ratings.

Worse, a state's financial ills can become contagious to its higher education credits.

For example, when Standard & Poor's downgraded California's GO rating to A-plus from AA last July, as a result of the state's chronic budgetary problems, the ratings on debt issues for the University of California and California State University systems were also downgraded.

In 1992, Fitch Investors Service's downgrade of California's GO rating, to AA-plus from AAA, resulted in a ratings downgrade to A-plus from AA for the University of California, according to Jerry Solomon, a Fitch analyst. A subsequent state downgrade to AA in September did not affect the university's A-plus rating because of the security structure on the debt, Solomon said.

New York State's downgrade from Standard & Poor's in January of 1992, to A-minus from A. also resulted in downgrades for New York State Dormitory Authority debt issued for the State University of New York, the City University of New York, and Upstate Community Colleges because of their dependence on state support. Last month, when the the state's rating outlook was upgraded to stable from negative, so was the outlook for the higher education credits, Peloquin-Dodd said.

On the other hand, a Standard & Poor's downgrade of New Jersey's GO rating in 1991 did not lead to downgrades for higher education debt because the schools' ratings were in a lower category than the state's rating, according to Peloquin-Dodd.

Howard Cure, a vice president and supervisor of the higher education finance group at Moody's. pointed out that while state funding is a "critically important" factor in rating public university debt, Moody's has made no ratings downgrades as a direct result of a state downgrade.

Sweeney of the state colleges and universities association said that when states need to cut spending. higher education "looks like an inviting target" because it serves a smaller percentage of the overall population. Plus, he said, spending for higher education is not protected by court order or federal mandate, unlike outlays for many social services. Colleges and universities also have the power to increase the fees for their services to offset reductions in state appropriations.

What's next? Many believe higher education's turn beneath the budget ax is not over yet. In its report, the Association of State Colleges and Universities found "mild pessimism" from institutions toward the state funding outlook for fiscal 1994.

"We don't see any sense of upcoming generosity in state capitals," Sweeney said.

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