CHICAGO — Illinois' public universities are burdened, as are the state's local governments, by the weight of state inaction on pension reform, but face additional fiscal strains from declining aid and tight in-state tuition regulations.

That's the conclusion in a report Moody's Investors Service published last week following its Aug. 9 downgrade of seven of the state's eight public universities. The action impacted $2.5 billion of rated debt. All eight carry a negative outlook.

"Illinois public universities face multiple financial challenges which will continue to pressure credit quality," said the report, authored by analysts Erin Ortiz, Diane Viacava, Emily Schwarz, and Edith Behr.

The August downgrades came after Moody's put the credits on review in June over their exposure to the state's fiscal woes. Moody's previously had downgraded four and confirmed the ratings of the other four in a review concluded in March.

The latest review cut even the flagship University of Illinois' rating. The school, which enjoys more financial flexibility and balance sheet strengths than the others, had been spared credit deterioration over the state's pension and liquidity troubles in recent years.

Analysts put the universities' exposure to the state's pension mess at the top of the list of pressures squeezing them. Proposed reforms have not been able to break through political gridlock in the state capital. A legislative conference committee is expected to unveil a new reform package this month.

Illinois' $95 billion of unfunded liabilities strain both the state's budget and its liquidity, impacting the size of operating aid and the timing of those payments to the universities. The state is chronically behind on aid and closed out fiscal 2013 on June 30 owing $6 billion to aid recipients and vendors.

Even if the state acts soon on pension reforms that ease its escalating annual payments, the state's liquidity problem shows may not abate any time soon due to the partial expiration of an income tax increase looming in fiscal 2015.

The state's fiscal 2014 budget held aid levels steady, but Moody's noted that overall the universities have seen "continued declines in operating funding from the state on a real inflation adjusted basis." Illinois is rated A3, the lowest held by a state rated by Moody's, and carries a negative outlook.

Gov. Pat Quinn and local governments are all clamoring for the General Assembly to overhaul state pensions and then apply them, or some version of the reforms, to local plans, easing their collective pension funding and budget woes. University leaders have floated their own plan they believe could serve as a model with benefit changes and a shift in how cost of living adjustments are calculated.

Various proposals have called for a phased-in shift in the state's coverage of a portion of teacher pensions over to local schools, public colleges, and universities, which could add to their fiscal burdens.

Unresolved state pension issues could result in shifting pension costs to the universities, or further reductions in operating support as a greater share of overall state appropriations that are made for "on-behalf" payments of pension and post-retirement liabilities, Moody's noted.

The universities also face limited growth of net tuition revenue due to changing Illinois demographics and tight state limits on tuition increases for in-state undergraduate students. Student charges are the second largest revenue stream for most of the schools.

State law requires that tuition for incoming in-state students be held steady for four consecutive years. Another strain on the horizon is the shrinking number of Illinois high school graduates, which is expected to weaken net tuition revenue growth. Illinois residents made up 90% or more of undergraduate enrollment across the seven regional universities in fall 2012 while the University of Illinois flagship draws 25% of its undergraduate students from outside Illinois' borders.

In assessing the credits of each of the eight and their ability to manage through the various strains, Moody's said. Student demand, size and scope of operations, amount of leverage, available liquidity, and strength of financial management are the primary factors it considers.

"These factors are key because they drive each university's ability to respond to the challenges," Moody's said.

Illinois' public universities tend to be more reliant on state aid than their peers when figures are adjusted for inflation. The state flagship's 31% reliance on state support compares to a median for other flagships of just 22%. The other seven rely even more on the state - between 38% and 46% -- compared to a median of 28% for their national counterparts.

While public higher education institutions have seen their share of state help dwindle, the impact in Illinois schools is more pronounced due to state payment delays. Since fiscal 2010, the universities have not received their total aid by fiscal year end on June 30. Instead, they received it by the calendar year's end.

"Fiscal year 2014 operating appropriations are expected to be comparable to fiscal year 2013, although we believe there is a risk that funding could be cut during the year or payments again delayed," Moody's warned.

To date, all of the universities have successfully navigated the slowdown of state aid payments and none have needed to borrow to meet cash flow needs, Moody's said.

While the state dictates that the four-year rate be capped, universities have flexibility in the size of the initial tuition rate and in raising fees.

Richard Ciccarone, chief municipal research officer at McDonnell Investment Management, said too steep an increase poses other challenges. Illinois' universities are increasingly growing reliant on tuition revenue beyond the national medians.

"You can eventually hit a resistance point. Colleges are under pressure to keep the cost of an education for in-state students affordable," Ciccarone said, or risk losing their appeal.

Moody's in August downgraded the University of Illinois' $1.56 billion of debt one notch to between A2 to Aa3, depending on its backing. Its auxiliary facility system bonds and certificates of participation now are rated Aa3, its south campus development bonds are rated A1, and its health facilities bonds are rated A2. Moody's noted that "the university's broad revenue base from student charges, research and other sources mitigate the reliance on state funding… and enhances UI's ability to absorb reductions or significant delays in state funding."

Southern Illinois University and its $318 million of rated debt fell one notch to A3 from A2 due to a reliance on chronically late state aid for 40.8% of operating revenues.

Western Illinois University's $27 million of debt fell two notches to Baa1 from A2 due to state exposure, enrollment declines, and narrowed operating performance. It relies on state support for 41% of operating revenues.

Moody's downgraded Governors State University's $23 million of debt one notch to Baa1 from A3 over its high reliance on state aid and its limited resources to manage through the delays. It relies on the state for 46% of operating revenues.

Moody's downgraded Illinois State University's $132 million of debt one notch to A3 from A2 due to state exposure, enrollment challenges that could limit tuition growth, and expected debt issuance. The school relies on state support for 38% of its operating revenues.

Moody's lowered Northeastern Illinois University's $63 million of debt one notch to Baa1 from A3 citing reliance on the state for aid for 46% of its operating revenues.

Eastern Illinois University saw its rating on $121 million of debt fall one level to Baa1 from A3 due to state exposure, enrollment declines, and narrowing operating margins. It relies on the state for 41% of its revenues.

Moody's confirmed Northern Illinois University's A3 rating but assigned a negative outlook to its $217 million of debt. It relies on state aid for 37.5% of operating revenues. It was previously downgraded to the A3 level.

Municipal Market Advisors' Matt Posner said he did not see any institutional trades on the universities' paper but traders said the schools have been penalized by a cheapening of bids and fewer accounts in general interested in the securities. Posner said Eastern, Northeastern, and Governor's State were hit hard as were Illinois State's certificates of participation. Bids remain strongest on the flagship but they too have weakened.

The downgrades last month further underscore the need for reform, Quinn's budget spokesman Abdon Pallasch said at the time. "Lack of action on the pension crisis is costing state taxpayers $5 million a day, hurting our economy and our credit rating, and now hurting our universities."

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