Chart 1

Positive Impact Of State Support On Public Universities

Increased state support since the great recession has helped many public universities across the country weather financial challenges over the past decade but have proved particularly helpful over the past five years. In late 2020, prior to the impact of two major federal stimulus packages, public universities were facing significant rating pressure as 39% of S&P Global Ratings' rated issuers had a negative outlook and none had a positive outlook. As of the date of this commentary, over 90% of outlooks for public universities are stable and there are more positive outlooks than negative. This compares favorably with private universities, at 83% stable, which do not benefit from state funding and are highly dependent on student revenue. Despite median full-time equivalent (FTE) enrollment declines and the depletion of federal funds prior to fiscal 2023, state support has increased fairly significantly over the past few years, helping to more than offset those pressures.

Chart 2

In the past two fiscal years, the average state appropriation for publicly rated universities increased over 5%. At the same time, many states have not tied increases in state appropriations to total enrollment, meaning that some schools received more funds even when their enrollments declined. States distribute annual appropriations using various formulas; some states use performance-based metrics at least partially to distribute funds while others use a more incremental approach. In addition, some states are able to distribute one-time funds for specific initiatives. We do not see a consistent pattern between funding per FTE for large flagship universities versus regional universities as it varies between states. Although flagships typically receive greater funds and are of strategic importance to the state, regional universities also serve a specific purpose often catering to students unable to get into the more prestigious school. While many regional universities have lost students in the past several years, states have typically not reduced funding for those universities. Therefore, public university funding models across the U.S. are a mixed bag of states that prioritize appropriations to their large flagships and others that cater to smaller regional schools.

State Support In Various Forms

State support has been distributed to public universities in a variety of ways. In addition to significant increases in annual operating appropriations, we have also seen many states support schools with capital needs in recent years. In many instances, states preferred this method of support over the past few years given they received one-time federal funds and many often take an incremental approach to state appropriations. Given this pattern, they did not want that support to become more permanent. Some states have supported specific projects with direct funding while others have made commitments to pay debt service payments related to certain projects. In addition, we have seen states like Michigan and Illinois attempt to use federal monies to pay down unfunded pension and other postemployment benefit commitments over the past couple of years. This helps reduce long-term liability risks, which we view favorably.

Case Study: Illinois

Illinois has gone through several challenges over the past decade that led to credit rating actions. In April 2020, we revised the state outlook to negative and affirmed our 'BBB-' rating as there was at least a one in three chance that we could lower the rating to speculative grade. However, since then there have been several positive state rating actions, and the state is rated 'A-' as of this writing, with a stable outlook. While there is not necessarily a direct relationship between the state and university ratings, in general the state's ability to support its universities with timely appropriations is a key credit factor, particularly if a large part of the university's total adjusted operating revenue comes from state appropriations. In Illinois, public universities that have relied on the state for a fairly large portion of their revenue, have been affected significantly by the state's improved credit quality, and have had positive rating actions when the state rating improved. (See table 1.)

Table 1

What We're Watching

In general, state budgets look relatively stable in fiscal 2025; however, if economic activity begins to wane, state revenue could prove more sensitive to those broader macroeconomic trends, which could affect budgets. For example, California state legislators agreed to make cuts to the University of California System and the California State University System, and Arizona has also passed a budget with cuts to its major universities in fiscal 2025. For more information see our recently published article, "U.S. States' Fiscal 2025 Budgets Navigate Evolving Risks As Economic Growth Prospects Wane," published May 28, 2024, on RatingsDirect.

In the past we have seen protractions in state revenue lead to cuts in higher education budgets, particularly during the Great Recession. According to S&P Global Economics, the chance of a sustained downturn is growing and our assessment of recession risk in the next 12 months is now at 40%. We would see schools face more operating risk if states were to cut funds. State appropriations now account for a median of just over 22% of total adjusted operating revenue, higher than it has been for many years. Overall state stability should help the public universities for the time being, but if pressured state budgets lead to cuts, it could affect the public university sector at a time when demographic challenges increase, and students continue to question the value of higher education.