CHICAGO – Seven Illinois public universities with more than $2 billion in rated debt are on notice that their already battered ratings face another blow.
Moody’s Investors Service on late Monday downgraded Northeastern Illinois University in Chicago as it struggles to retain the liquidity needed to stay open. Its rating – B1 after a two-notch downgrade from the already junk level Ba2 -- remains under review for a downgrade along with six other state universities, Moody’s said late Monday.
“The review is prompted by failure of the state of Illinois to enact a budget providing full operating funding to the universities for the current fiscal year,” Moody’s wrote. State aid makes up on average about 40% of the universities' operating revenue.
The state has been without an enacted budget since July 2015.
Without one, the seven schools – which have $2.2 billion of rated debt outstanding – have been starved for cash, receiving piecemeal appropriations well short of expected aid levels in fiscal 2016 and 2017, and have suffered a series of downgrades, sending several to speculative grade with more on the brink.
While funding for 90% of state government activities goes on during the budget impasse under continuing appropriations and legal orders, higher education aid requires an appropriation.
The state’s nine public universities have warned of the dire, long-term impact of the funding drought on their balance sheets, reputations, and ability to attract students as the impasse progresses and they are forced to cut programs and staff, drop school days, and raise tuition.
“It’s a vicious cycle,” said Howard Cure, director of municipal research at Evercore Wealth Management LLC. As schools struggle to keep their doors open without their operating aid, enrollment suffers.
“The regional schools are more dependent on Illinois residents and people who can are questioning the resources that the state is willing to dedicate to its public universities and are questioning the value of an education” there, Cure said.
Moody’s makes clear just how severe the strain has become on some of the schools due to the prolonged stress and that’s beginning to translate into worries over their ability to meet their debt obligations.
“We will also assess each university's near-term debt service commitments against pledged revenues and related reserves,” analysts wrote. “The result of the review could result in differing actions, including some potential multi-notch rating actions depending on liquidity and ongoing ability to adjust to the prolonged lack of state operating funding.”
The market would rarely worry about a public university defaulting but given the uncertainty of when Illinois might resolve its budget stalemate, it’s within the realm of possibility, Cure said. “The pressure is mounting.”
The Moody’s analysis will consider projected liquidity and operating performance for the current fiscal year that ends June 30, contingency plans and other actions being undertaken to cope with the shortfall in state appropriations as well as budgeted fiscal 2018 assumptions.
The schools put on review for a downgrade include the flagship University of Illinois. It has seen credit deterioration but overall has fared better during the stalemate thanks to its diverse revenue streams. The school’s auxiliary facilities system revenue bonds and certificates of participation are rated Aa3, its south campus development bonds are rated A1, and its health services facilities system revenue bonds are rated A3.
Others on review include Illinois State University’s auxiliary facilities bond rating of Baa1 and its Baa2 COP rating; Southern Illinois University’s Baa2 housing & auxiliary facilities bond and Baa3 COP rating; and Northern Illinois University’s Baa3 auxiliary facilities and Ba1 COP ratings.
Also under review are Governors State University’s Ba1 facilities system revenue bonds and Ba2 COP rating, and Eastern Illinois University’s B1 auxiliary facilities rating and its Caa1 COP rating.
The Northeastern Illinois downgrade affected $32 million of debt. The school’s “continued rapid liquidity deterioration due to weakened cash flow caused in part by a protracted state budget impasse” drove the downgrade, Moody’s said.
The university, which carries a U.S. Department of Education Hispanic-Serving Institution designation and serves 9,500 students, has canceled class days and furloughed or cut employees to stay open.
COPs are payable from both state-appropriated funds and from budgeted legally available funds of the universities such as tuition and fees, and Moody’s sees them as particularly pressured. The COPs represent unsecured obligations and a university’s board can terminate the obligation should it fail to receive sufficient state appropriations and it determines that the school lacks other legally available funds.
“While the COPs typically benefit from the breadth of revenue available to pay debt service, the lack of state appropriations and tightened operating budget weakens this structure,” Moody’s said. The COP structure is similar among the universities.
The auxiliary revenue bonds of the various schools are secured by a pledge of net revenues of the auxiliary system as well as pledged fees and tuition and sometimes parking, dining, residential, athletic, and research facilities.
S&P Global Ratings considers the auxiliary revenue pledge broad enough to equate to a full faith and credit or general obligation rating but the strength of the facilities systems are heavily based on the underlying enrollment, demand profile, and financial operations of the institution.
“The tenuous state fiscal and political environment could have an indirect negative impact on these systems over time,” S&P said in a report last year.
Moody’s does not rate Chicago State University which has been among the hardest hit by the loss of state aid due to its heavy reliance on those funds, and it previously withdrew its rating on Western Illinois University.
S&P rates seven of the nine schools. All have been stung by downgrades. The University of Illinois and Illinois State University retain respective ratings of A-plus and A that are higher than the state’s BBB rating. S&P rates Eastern Illinois BB, Governors State BB-plus, Southern Illinois BBB, and Western Illinois BBB. All carry a negative outlook.
The latest warnings come as the dispute between Republican Gov. Bruce Rauner and the Democratic-controlled General Assembly has ratcheted up. Rauner launched an advertising campaign touting the need for his policy and governance reforms, making campaign-like appearances across the state to drum up support.
Democrats are opposed to the policy proposals which Rauner has demanded be included in any budget plan that includes tax hikes. House Democrats countered by launching a social media campaign Monday to promote candidates they say support an agenda “lifting up the middle class” and who oppose Rauner’s proposals they claim are too favorable to corporations.
The latest alarms for higher education come after the House’s Democratic majority pushed through an $800 million funding package it described as a “lifeline” for higher education and social service agencies.
The legislation provides $559 million for the public universities and 39 community colleges and provides some Monetary Award Program grant funding for lower income students. It’s unclear whether the Senate will vote on the legislation.
If approved, higher education would still have received less than 50% of its expected funding over fiscal 2016 and 2017. Moody’s said in a March report the state has so far appropriated $2.2 billion less for higher education during fiscal 2016 and 2017 than it would have under the prior two years’ spending levels.
Rauner opposes the appropriation as a short-term fix, saying a long-term budget plan is what’s needed.
The Senate’s Democratic president and Republican minority leader are trying to resolve differences with the Rauner administration on their stalled bipartisan “Grand Bargain” package of tax, spending, and reform bills.
The state is at risk of losing its investment grade status if the stalemate drags into the next fiscal year July 1 or beyond.
Moody’s has also warned of the long-term damage.
"Material programming reductions and staffing cuts, while necessary to keep the state's public universities operational in the short-term, will further impair the universities' abilities to sustain their strategic competitiveness and attract students for the upcoming fall 2017 class," Moody's wrote in a March report.
The comments from rating agencies and market participants echo school officials. The state is “on the verge of dismantling the higher education system” Illinois Board of Higher Education Director James Applegate told lawmakers at a March legislative hearing. The Higher Learning Commission has also warned the state that schools which suspend operations could be at risk of losing their accreditation.
The reputational hit adds to enrollment challenges that existed before the budget impasse. Long-term projections show a decreasing numbers of high school students nationally and regionally in the Midwest over the next 15 years.
Illinois is expected to fare worse than its regional and national peers with high school graduates expected to be 14% lower in 2031-32 than 2016-17, compared to 3% lower nationally and 7% lower regionally.