Joseph Krist

Publisher

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WHEN GUTTING HIGHER EDUCATION IS A CREDIT POSITIVE

We understand that certain actions and events can be seen as having a positive effect  in a every discrete way for an individual credit. A revenue source dries up or is withdrawn and an institution takes clear somewhat radical steps to deal with the situation which serve to shore up the ability to pay debt service in the short run. Such a scenario is likely “credit positive”.  While that may be true n the very near term, there are times when it is hard to view such a credit in a positive light when viewed through the lens of its larger economic and policy impact.

The latest example of that dilemma is what is going on at the University of Alaska. The budget adopted by the Legislature at the behest of the new Governor restores the annual payment to each Alaskan resident funded by revenues in the State’s Permanent Fund. The payment had been reduced in response to lower oil production and prices and declining reserves of oil.  The payment had been reduced to balance the budget in the face  lower oil revenues.

In order to restore the payment to its prior level and maintain a balanced budget, significant cuts needed to be made. Among the entities targeted for cuts was the state’s university system. Under the budget adopted (even after a special session to reconsider the cuts) the state legislature acquiesced and allowed the Governor’s cuts to the University to stand. The result is a reduction of 41% in the states funding for the University effective as of July 1.

The university has represented that it has a moderate amount of liquidity but estimates that if it has to maintain spending at fiscal 2019 levels, it will deplete reserves by early 2020. So the only real response is to cut expenses. The overwhelming majority of expenses at most universities is related to personnel. Much of the expense stem from the tenure system governing faculty. That means that short term budget relief in the face of this magnitude of revenue reduction can only be dealt with extraordinarily. So it is the case in Alaska.

On July 22, the University of Alaska’s Board of Regents voted to declare financial exigency. This is a legal strategy to eliminate tenured positions in the face of extraordinary fiscal circumstances. The University has said that administrative positions will  be the first to be reduced but that efforts to implement cut to faculty including  tenured faculty will follow. In September, the Board of Regents will decide on a course of action.

In response to this action we see the Moody’s headline that says “University of Alaska’s financial-exigency declaration is credit positive”.  We understand that from a very narrow University of Alaska revenue bond standpoint it could be seen as positive. Moody’s notes that the action will force the University to deal with declining enrollment, loss of research competitiveness, a material reduction in liquidity and additional accreditor scrutiny as it implements changes over the next one to two years. This leads us to ask what exactly is credit positive about a credit which faces these aforementioned pressures?

Alaska is a state which because of its size and small population does not have a robust private higher education alternative. Significantly cutting back faculty, offerings, and research can only harm the economy of the State at a time when its major industries e under stress (the price of being resource dependent in an environment of climate change). The diminishment of higher education at a time when technology becomes more and more important to economic success seems  represent an unnecessary self-inflicted wound in the interest of short term gain.

Here’s where the rating agencies unwittingly put themselves in the middle of political debates. The headline “University of Alaska’s financial-exigency declaration is credit positive” will be seized upon by supporter of the cuts as some kind of outside endorsement of the action. Better the rating had been put on uncertain status with the potential for a downgrade than to take an action which could be misused for political ends.

At the end of the day, the cuts are bad for Alaska. Major state universities are not just sources of more reasonably priced higher education. The conduct and produce research which supports, government, industry, and small business. The loss of that capability and knowledge base can have only negative longer term consequences for the State. So we respectfully disagree with the idea that in the broader sense that this move is credit positive.

CALIFORNIA AUDIT

The federal government requires California to publish its Single Audit report, which includes the Comprehensive Annual Financial Report (CAFR), within nine months of the end of the fiscal year, or by March 31, 2019; however, the State Controller’s Office (State Controller) did not issue the State’s CAFR until June 2019, more than two months after it was due. One reason for the CAFR’s delay was that the State Controller did not implement a major new accounting and financial reporting standard for postemployment benefits other than pensions (OPEB) in a timely manner. It also chose a methodology for allocating OPEB liabilities to state funds in a manner that is inconsistent with how the State pays for OPEB benefits, which created the risk of a material misstatement to the CAFR.

Currently, the State pays for these benefits as they become due using the pay‑as‑you‑go method. Specifically, the General Fund initially pays health and dental insurance premiums for state retirees and their dependents, and is subsequently reimbursed by other funds for a portion of these costs based on their proportionate share of the healthcare and dental costs of active employees. However, the State Controller’s allocation methodology is based on the State’s recent efforts to prefund its OPEB liability by making financial contributions to OPEB plans based on pensionable compensation (the portion of employee pay used to calculate retirement benefits). However, these contributions cannot be used to pay benefits until the earlier of July 2046, or when an OPEB plan is fully funded. 

The CSA finding asserts that the methodology SCO used to allocate OPEB liabilities to State funds creates a risk that a material misstatement to the State’s CAFR could occur. However, later in the finding, CSA states the allocation did not result in a material misstatement in the FY 2017–18 CAFR. This was the first year of implementation of Governmental Accounting Standards Board Statement Number 75 (GASB 75), and SCO had to work with the most complete and accurate data available at the time. With the constraints on time and data accessibility, SCO moved forward with what it believed was a reasonable and rational approach, that could be supported by source documents, in allocating the State’s OPEB liability. SCO is not opposed to re-evaluating its allocation methodology in future years when additional information becomes available.

Press reports have expressed some surprise that this is not a big issue for investors. Reports like this one from the State Auditor are useful in terms of highlighting details of potential reporting shortcomings but it is not surprising to us that the discussion is effectively a nonevent in terms of its impact on the State’s credit. It has not been implied that the numbers ultimately generated were untrue. The reasons for the delay do not seem to reflect malfeasance so it really is not a big event.

PUERTO RICO

What we know is that Gov. Ricardo Rosselló resigned Friday as promised. We know that he used a recess appointment to name former non-voting representative to the US House of Representatives Pedro Pierluisi Secretary of State. Thus, Pierluisi automatically became Governor Rosello’s successor. He only promised to serve as governor until Wednesday, when the Puerto Rico Senate has called a hearing on his nomination. If the Senate votes no, Pierluisi said, he will step down and hand the governorship to the justice secretary, the next in line under the constitution.

Even if he retains the position, his options are limited by the short 18 month remaining time on his term. While it is heartening to see that he advocates privatization of the power system-a step we have advocated for since the immediate aftermath of Maria, he also is on record opposing several austerity measures demanded by the board, including laying off public employees and eliminating a Christmas bonus.

Until elections take place in November 2020,  it is hard to articulate a positive case for the Commonwealth’s credit. There will be bankruptcy ruling which will almost certainly be appealed, more maneuvering over the next 18 months for political power on the island, and no real end to the uncertain state of affairs. The Puerto Rico Senate ended Monday the special session convened by former Gov. Ricardo Rosselló to consider the nomination of Pedro Pierluisi as secretary of State. This means that Mr. Pierluisi has not been confirmed thus putting his governorship in legal peril. The Governor’s position? “Given that today the Senate did not cast a vote and that the vast majority of the Senators did not have the opportunity to express themselves concerning my governorship, with the utmost deference to the Supreme Court of Puerto Rico, I will wait for its decision, trusting that what is best for Puerto Rico will prevail.” 

On Sunday night, the Senate sued Pierluisi and the government of Puerto Rico, requesting Pierluisi’s swearing-in as governor be declared null. The Supreme Court gave the Senate, Pierluisi and the attorney general until noon Tuesday to present their arguments.

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