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Funding In IOUs

January 27, 2012

Some students and employees at Illinois public colleges and universities might count themselves lucky. Compared to public universities in other states that have seen their state appropriations cut more than 10 percent for each of the past three years, Illinois institutions have had small reductions.

While per-student funding at the University of California at Berkeley, for example, dropped more than $3,000 -- 20 percent -- between the 2008 and 2009 fiscal years, the University of Illinois at Urbana-Champaign only saw its per-student appropriations slashed by $32, a 0.4 percent decrease, over the same time period.

Yet on Jan. 8, Moody’s Investor Service put all of Illinois’s public universities on notice for a potential downgrade, which, if the review goes unfavorably, could end up costing the universities millions of dollars in increased interest costs on debt.

Unlike states where lawmakers cut college and university budgets to reflect lower tax revenues, Illinois took an unconventional approach to its budget woes by delaying -- sometimes for months -- payments to state agencies, such as universities, starting in 2009, as revenues failed to materialize. For many institutions, this resulted in a lower regular payment than they were expecting. By the time the end of the fiscal year rolled around on June 30, the state still owed many universities more than 40 percent of their appropriated revenues. “It is the only state I know of that has handled it as a cash flow problem rather than an appropriation issue,” said Dennis Jones, president of the National Center for Higher Education Management Systems.

With almost six months’ worth of funding delayed, the universities had to spend reserves, postpone paying their own bills, force employees to take furloughs, and place temporary freezes on hiring, travel, and other expenses.

While the delayed-payment strategy is unique to Illinois, institutions in other states have been subject to different types of unexpected funding changes, such as midyear budget cuts. The hard lesson that public universities have learned in the past few years is that when states’ own budget pictures are put in jeopardy, not only do universities lose out on valuable state appropriations, but states also become less reliable partners in the funding of higher education.

As a result of the uncertain funding, Illinois higher education leaders, like many public university presidents and chancellors, have been asking the state to establish a more constant and predictable funding stream, even if its lower than it used to be.

“Having the promise of money, but not being certain it will be fulfilled, that’s been a difficult situation,” said William Weber, vice president for business affairs at Eastern Illinois University. “We would be able to use funds more effectively if we knew upfront that, 'Here’s your budget, and you’re going to get it on a timely basis.' ”

Throughout the 2009, 2010, and 2011 fiscal years, state payments to the universities were less than expected. The 2011 fiscal year, which started on June 30, 2010 and ended on July 1, 2011, was the worst for Illinois universities. That year, Eastern Illinois was appropriated $47.8 million. By June 30, 2011, the state still owed the university about $20 million. It would take until Dec. 6 for the state to pay out the full appropriation for the previous fiscal year. 

The situation was similar at Southern Illinois, which had only received 56 percent of its state appropriation by July 1.

Managing delayed funding is different from managing budget cuts, administrators at these universities say. While administrators have the benefit of a whole year to spread out cuts when budgets are slashed, and can strategically cut departments or positions to right-size the budget before the year starts, they don’t have that luxury when money simply fails to show up, as happened in Illinois.

It also wouldn’t be advisable to raise tuition to cope with the shortfalls, administrators say. “You shouldn’t raise tuition unless it is to meet long-term multiyear revenue and spending targets,” said Dan Hurley, director of state relations and policy analysis for the American Association of State Colleges and Universities. Increased tuition, which tends to kick in at the start of a new school year or semester, doesn’t help with a shortfall that comes up suddenly in November or February. Moreover, if institutions do increase tuition to cope with late payments, and then the payments materialize, the university has a public relations disaster on its hands.

Duane Stucky, senior vice president for financial and administrative affairs at Southern Illinois University, said his institution has addressed the shortfalls by delaying construction and renovation projects and implementing a hiring freeze. “That has freed up cash and increased the cash balance to a point that allows us to manage until the state money comes in,” he said.

Eastern Illinois adopted similar measures. Administrators cut back on travel and equipment purchases, and required all such expenditures to be approved at the vice president level. New hires had to be approved by the president, and the university reduced its employee headcount by about 100. That saved about half the necessary funds. Administrators covered the rest by shifting around money from other unrestricted funds. “They just have to hope that the state’s payments kicks in late in the fiscal year soon enough to keep the institutions afloat,” Jones said.

Administrators at Illinois State said they’ve had an easier time coping with the funding shortfalls than their peers because the university has seen enrollment increase over the three-year period, so budget administrators there have been able to use increased tuition revenue to cover shortfalls. The university did put off some big-ticket construction projects, said Jay Groves, director of media relations, and repaired buildings instead of replacing them.

The state also delayed payments to Illinois' 48 community colleges at roughly the same rates as the universities. Several institutions increased tuition, laid instructors off, and froze travel expenses.

Unreliable Partners?

Illinois isn’t the only state that has faced unexpected budget challenges. In 2009, as state revenues crumbled, several states made midyear cuts to university budgets.

The budget situation in California, which has seen some of the deepest cuts of any state, also has elements of unpredictability. In December, the University of California, California State University, and California Community College systems were all subjected to $100 million cuts when revenues anticipated in the budget, written in June, did not materialize. The community college system raised tuition in response.

Analysts from Moody’s Investor Service have said that the shift away from relying so heavily on state funding has actually been credit-positive for many institutions. If the majority of an institution’s revenue comes from the state, a single shock like a delayed payment or a midyear cut can have a huge impact on the bottom line and the university's ability to make payments. A revenue model that is diversified, whether through tuition, corporate contracts, research grants, or another funding source, can better absorb shocks.

In a report from September 2011, analysts for the rating agency said large dependence on funding from a state with an uncertain outlook could lead to ratings downgrades at public universities. “Specifically for public universities, a major state policy change to reduce state funding or to cap annual allowable tuition increases could negatively impact ratings, especially if the impacted college has thin liquidity or the change is abrupt and leaves the university with little time to respond.”

Increasing dependence on tuition, which likely comes from a diversified student population and is less likely to be upset by a single shock, could make the institutions more stable.

But people like Jones say that casting about for new models because of a few years of poor state appropriations likely isn’t a good idea. “I’m not sure that the unreliability of a state is necessarily an argument for sending institutions in search of new funding partners,” Jones said. “These are public institutions trying to do the public good.” Moving away from state funding, he said, can lead to problems down the road.

Planning on IOUs

Budget administrators in Illinois and other higher education observers said it would be preferable to face significant budget shortfalls rather than the kind of uncertainty Illinois universities have seen since 2009.  “Even in a fiscally challenged state such as California, college leaders at least have the benefit of a predictable funding forecast. It’s predictably bad, but at least it’s predictable,” Hurley said. “State money for higher education will be there, on time, albeit there may be less. In Illinois, in contrast, college leaders don’t even have that benefit.”

That lack of predictability can be a major problem. It calls into question whether the university will have enough cash on hand to pay its own bills on time, which could lead to a downgraded rating.

“The state’s college and university leaders are in a remarkably difficult position,” Hurley said. “How can they plan for the future when so much is unknown with respect to the state’s ability to hold up its funding responsibilities? It is hard to imagine any private sector business trying to function with so much uncertainty in its revenue streams.”

It can also upend how the university balances its books. “There are limited ways of carrying forward money from one fiscal year to the next,” Weber said. “As a consequence of the delay in the cash flow, we have moved a lot of those monies into permanent improvements, such as capital reserves, which allow us to carry forward appropriations from one fiscal year to the next. If you look at the official numbers in books, there has been a huge increase in permanent improvements.”

In an effort to prevent a ratings decrease and make sure it could meet its bills on time for the 2011 fiscal year, the University of Illinois system increased its pool of “unrestricted net assets,” an accounting term for money that does not have a contractual restriction placed on it, such as endowment funds -- though most funds have some planned purpose. But carrying that large pool can have other risks. Having a large pool of unrestricted net assets has gotten universities in trouble with lawmakers in other states, such as Michigan, where legislators have questioned why the university needs to increase tuition if it has so much “unrestricted” cash on the books.

Delayed payments present a headache for yearly planning, but also pose a deeper challenge. Jones, of the National Center for Higher Education Management Systems said Illinois's unwillingness to cut appropriations in the budgeting process has hindered its universities’ ability to adapt to changing times in the way universities in other states have.

“Most states, when they say they’re going to cut appropriations, what they fundamentally do is force the institutions to change internally in a way that will leave it with a balanced budget,” Jones said. “They end up cutting all kinds of things. But when Illinois doesn’t cut the appropriation, the institution fundamentally stays the same.” The universities are in for a rude awakening when lawmakers decide to right-size the budget, he said.

The state is closer to being on track this year, though budget administrators said the universities are still receiving less than expected. As of the end of December, administrators said they had received about 36 percent of their total appropriation for the 2012 fiscal year.

 

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