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Pitfall of Public-College Privatization

May 4, 2005

States are moving, in a variety of formal and informal ways, toward privatizing public higher education systems. Most of the discussion about the wisdom of the trend has centered on the relative merits of colleges' greater independence from state regulation and whether tuitions will rise excessively if state support drops off. But in a report issued Tuesday, Standard & Poor's suggests another possible outcome: much greater variation in the credit ratings of public colleges and universities.

Historically, public institutions -- even less prestigious and less wealthy ones -- have been far likelier to have strong credit ratings than are private institutions, because the public institutions are backed by the financial support of their states. "State support has historically had the general effect of improving public university credit quality -- essentially providing a rating 'floor' for credit ratings of public universities," Standard & Poor's notes. Ninety-two percent of public colleges and universities now have ratings of "A" or higher (with 33 percent "AA" and 59 percent "A"), and just 7 percent are in the lower "BBB" range, according to Standard & Poor's ratings as of April 20. 

Private institutions, judged as they are on their own individual financial situation, range much more widely: Seven percent earn the highest "AAA" rating, but 38 percent get a "BBB" rating, with the rest falling in between. 

As states like Virginia and Colorado adopt structures for governing their public college systems that cut state ties, and potentially funds, for the institutions, the Standard & Poor's report suggests, some colleges -- particularly "smaller second- and third-tier institutions, whose revenues are predominantly state support and student charges" -- are likely to see their credit ratings fall, S&P warns. 

"If an entire state becomes privatized, as it has for Colorado, then the rating spreads within a state may eventually broaden, and become similar to private universities." 

Standard & Poor's says that signs of such "spreads" have been evident already in the first few years of this decade, as state support for public higher education waned. "Standard & Poor's saw a greater differentiation in other institutional characteristics between institutions in the same states," its report says. "For some flagship institutions, student demand grew to unprecedented levels, while for others, the number of applications tapered off. Some engaged in multi-billion dollar capital campaigns, but others have yet to begin any major fundraising efforts. As these flagship institutions have become, 'practically,' more like private institutions, their credit becomes more differentiated."

This trend could accelerate in coming years if states either continue to cut back their appropriations or move actively to give public institutions the independence that some of them seek. Flagship and other wealthier public institutions that have vibrant fund raising operations should, Standard & Poor's says, be able to offset any reductions in state support and, especially, capital spending by legislatures on public college facilities. But "many second- and third-tier public institutions have modest or non-existent fund raising programs, and existing fund raising efforts are frequently targeted for scholarships. Thus, state support for capital facilities is the engine that drives facilities development."

At a time that many public institutions have a backlog of deferred maintenance on their facilities, S&P predicts, a decline in capital spending, either because of budget cuts or privatization efforts, could further hurt the credit ratings of regional state institutions.

 

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