Building With Your Hands Tied

University of Kentucky administrators think the institution makes enough money through tuition, research grants, private giving, and other non-state sources of revenue to fund about $200 million worth of construction over the next few years.

In most states, that would be a pretty natural conclusion. But unfortunately for the university, the state’s lawmakers don’t want the debt from those projects on the state's books.

Even though the university would fund its new debt through non-state revenues, lawmakers in the Kentucky state legislature, which wrapped up its budget process earlier this month, denied the state’s universities the authority to issue any bonds for the next two years, fearing that more debt by state institutions could hurt the state’s credit ratings.

Now the state’s universities will likely not be able to finance projects through debt until the legislature reconvenes in two years, and there is no guarantee that it lawmakers will approve bonds then. For the University of Kentucky, that means the university will put off several projects, and the already old infrastructure will continue to age, which administrators say could hinder student and faculty recruitment. The university could also lose out on historically low interest rates, which could have saved the university millions of dollars in the long run.

As states pull back higher education appropriations, public colleges and universities are increasingly financing construction through alternative means, with debt being one of the most prominent sources. But in states such as Kentucky, laws and politics hinder the ability of institutions to issue bonds. And at a time when debt is a dirty word in politics, and many politicians are reluctant to take on any more of it, public colleges find their hands tied as the backlog of necessary construction and maintenance gets longer.

“We are the oldest institution of higher education in Kentucky,” said Angie Martin, vice president for financial operations and treasurer for the University of Kentucky. “We need a tremendous amount of capital renewal.”

The degree of state approval that public universities require to issue debt varies on a state-by-state basis and often depends on the type of project for which the institution is seeking debt. Some states let colleges and universities issue debt without any legislative approval, particularly for projects such as housing and dining that have designated revenue streams outside of state funding. Maryland, for examples, requires state approval for academic buildings but not for auxiliary facilities such as dining and housing. Other states cap the debt-to-income ratio for the state system or each individual institution. And while some lawmakers are debt-averse, others are quick to embrace bond authority for universities, seeing debt as a way to advance higher education without putting short-term pressure on state appropriations.

Kentucky, however, requires full legislative approval on any bonds issued by state institutions, regardless of the funding source and how much the university already pays in debt service. Universities have no authority to bond projects themselves.

On top of the debt restrictions, Kentucky law also requires legislative approval for any university expenditure greater than $600,000, regardless of the funding source. So even if the university raised private dollars to finance one of the projects it hoped to fund with bonds, it would still have to wait for the next legislative session to get approval.

This year, the state’s Democratic governor asked for a total of $450 million in bonds for the state’s universities, $200 million of which would be for projects at the University of Kentucky. The university's wish list includes the renovation and expansion of its business and economics college, a new law school, a new classroom building, and renovation of the university’s student center. “Some of our buildings are just so old that the quality of space does not fit today’s learning environment,” Martin said. She noted that the university has experienced difficulty recruiting faculty in recent years because it can’t offer the kind of research space that other universities can. “We may have research space, but we don’t have the right kind.”

The state’s House of Representatives, controlled by Democrats, stripped the bond proposal out of the budget, worrying that Republican opponents would use it against them in the next election, said Rep. Robert Damron, a Democrat. They hoped to add the bond approval back in when House and Senate leaders met in a conference committee to reconcile their different versions of the budget, placing the blame on both parties. But the Senate, which is controlled by Republicans, declined to take up the matter during the conference.

A spokeswoman for Sen. David Williams, the Senate president, said the Republican caucus has taken the position that granting bonding authority to the universities puts more debt on the state’s books, which they are not willing to do at the moment. Lawmakers said they’re trying to keep the state’s debt-service level at about 6 percent.

Representatives from Moody's Investors Service said the ratings agency tends to subtract out the debt Kentucky universities pay on their own without state support from the state's overall debt level. But they noted that several university bonds carry an obligation that means that if the university were to fail, the state would pay off the bonds. So, if the universities were to show signs of trouble, the ratings agency might start to consider those bonds in its ratings.

Damron and university representatives said the decision to forgo bonding this year puts the universities at a disadvantage at a time when they could be making progress on campus development. “The legislature does a biennial budget in Kentucky. We don’t address debt authorization but every two years,” Damron said. “There can be significant changes from one year to the next. If the universities have good opportunities they can take advantage of they need to do so.”

Because of the sluggish economic recovery, interest rates and construction costs are low compared to the middle of the last decade. In recent months, the University of California, Ohio State University, the University of Southern California, and the Massachusetts Institute of Technology all issued 100-year bonds worth hundreds of millions of dollars. “It is a great time to be constructing things now with interest rates so low,” Martin said.

The restrictions on bonding are partly the result of the way the state tallies up its income and expenditures. Unlike most states, Kentucky counts all university revenues – including tuition, grants, auxiliary revenues, and private giving – and all university debt in its overall calculations. Only seven other states include debt related to university auxiliary services, such as dining or housing, in their total state debt, according to a 2004 analysis by Kentucky policymakers.

The universities have sought independent bonding authority in the past, but have not received it. For several sessions in a row, Damron, who works in financial services, has introduced a bill that would allow the state’s universities to issue bonds without legislative approval so long as they are not funded through state revenues. The law passed the House several times, but it has yet to receive approval from the Senate.

“The universities need to have the flexibility to issue their own debt, especially when there are no state resources coming in,” Damron said. “They all have sound leadership, and have boards of regents that are usually all business people.”

To get around the debt restrictions, the state's universities have started to finance projects through alternative means that won’t place more debt on their balance sheets. In particular they have struck public-private partnerships, in which private companies provide the capital for construction and receive some of the revenue from the auxiliary services. The University of Kentucky received legislative approval this year to begin the first phase of what it plans to be about $500 million worth of residence hall construction. Capital for the project will be provided by a private company the university is partnering with, Education Reality Trust, or EdR.

Martin said the restrictions partly drove the partnership. But she said the university also pursued the partnership because the company, which constructs residence halls across the country, can also complete the project faster and more efficiently than the university would be able to do on its own.

But only certain kinds of projects can be funded through such partnerships, particularly residence and dining halls that have funding streams through student fees. Academic buildings – which make up a large part of the University of Kentucky’s wish list – don’t have such funding streams.