Bill Would OK Risky Debt for ECSU | Eastern North Carolina Now

    Publisher's note: This post, by Bob Luebke, was originally published in the Education section of Civitas's online edition.

    Last week, by a vote of 114-1, the NC House passed House Bill 620. The bill provides a routine legislative blessing for annual UNC capital projects, which campuses fund with their own revenues or receipts and not General Fund appropriations. Such votes are considered perfunctory. Nevertheless, a number of capital projects at Elizabeth City State University (ECSU) caught my attention and deserve a closer look.

    ECSU has five projects included in the legislation totaling about $10 million. The projects include demolition and renovation of dorms and a complex of buildings, as well as updating the campus master plan. But first some relevant background.

    ECSU is a small, historically black institution located in Elizabeth City in northeast North Carolina. Like many similar institutions, in recent years it has struggled with declining enrollment and financial problems. In recent years the state has taken steps to address these problems. Last year ECSU was included in the group of three institutions participating in the NC Promise Scholarship, which charges students $500 tuition per semester in hopes of bolstering enrollment. In addition, included in the Senate budget for FY2017-18 is $2.8 million in "stabilization funds" for ECSU to "hire temporary faculty, to anchor core programs, provide start-up funds for an aviation science program, and support student success initiatives."

    It appears the ECSU capital projects are intended to address the anticipated boost in enrollment resulting from the Promise Scholarship program and other efforts to reverse enrollment decline. For example, the dormitory renovation is scheduled to add a net 547 beds to the campus by FY 2021-22. But here's where the questions start.

    In order to move ahead with the projects, ECSU planned to borrow $20.4 million at an interest rate of 3.75 percent. Half the funds would be used for the demolition work; the other half would be used to reduce older loans held by the ECSU Housing Foundation LLC. ECSU planned to finance the projects through the Community Facilities Direct Loan Program of the United States Department of Agriculture. Borrowers have fixed rates for up to 40 years. The ECSU Housing Foundation would finance the project because USDA determined ECSU did not meet the loan requirements, but the Foundation had a better chance of doing so. The Foundation would then lease the dormitories to ECSU, which would operate the projects, collect revenue and pay off the debt to USDA on behalf of the foundation.

    Such plans raised several red flags. The accompanying fiscal note by the non-partisan Fiscal Research Division articulates several of them:

• ECSU currently has about $26.4 million in existing debt. The addition of the $10 million in new projects would be an increase of approximately 40% in the total debt for the school. According to the credit profile from Moody's, ECSU faces credit challenges due to enrollment and tuition revenue declines over multiple years and anticipated decreases in auxiliary revenue. ECSU's bond rating is Baa1 with a negative outlook from Moody's. This rating is the lowest across the UNC system. Fiscal staff cannot speculate on how the rating agencies or bond market will react to the additional debt proposed in this bill.
• ECSU's debt to obligated resources ratio is currently above the ceiling recommended by the Debt Affordability Study. This ratio measures ECSU's debt to its funds legally available to service the debt. The upper limit advised by the Study is 2.25 and the target ratio is 2.00. Currently, ECSU has a ratio of 2.48 ($26,445,000 in debt divided by $10,671,405 in obligated resources). With no new debt, ECSU's ratio will fall below the ceiling ratio of 2.25 in FY 2018-19 and fall below the target ratio by FY 2020-21. With the additional $10 million in new debt, ECSU's debt to obligated resources will likely remain above the upper limit ratio of 2.25 throughout the 2017 Debt Affordability Study's time frame ending in FY 2020-21.

    Again, the previous text was provided by the non-partisan Fiscal Research Division of the North Carolina General Assembly. As I said before, HB620 was approved by the House by a vote of 114-1. The comments made by FRD staff regarding the ECSU capital projects have been largely ignored. Legislators ignored ECSU's low bond rating (Baa1) - the lowest across the UNC System -and "negative" outlook, which usually is an expectation that the rating will be downgraded in the future. And legislators ignored the red flags raised when you combine debt expansion at an institution mired in a cycle of tuition and revenue declines.

    I don't know if it is common practice for an institution to secure financing through a third party (i.e., ECSU Housing Foundation LLC) when traditional methods are declined. This shouldn't sit well with those concerned about sound financial practices, however. It's also troubling that the debt used for the ECSU projected is used primarily for demolition and for completion of a master plan. Such practices are not consistent with how debt is incurred across the UNC System. Finally, the worst offense of the entire project is that ECSU proposes to repay debt over a 40-year span, but much of it will go toward construction of buildings that will likely need renovation or replacement by then. Institutions should not be paying for debt on projects after the useful life of the project. In doing so, ECSU violates a basic tenant of borrowing.

    Despite these violations and questionable practices, the House still overwhelmingly approved HB620, 114-1.

    The argument will be made that North Carolina's new plan for $500-a-semester tuition will help reverse ECSU's decline. The additional debt is an investment in making the campus more attractive in hopes of bringing more students to ECSU. It's an argument. I don't believe however, it's compelling if in hopes of trying to stabilize your finances you're forced to use questionable financial practices to incur more debt.

    If we can't expect legislators to look closely at such questionable practices, who will?