Medicaid cuts will pressure California’s public universities

Cuts to Medicaid in the federal budget reconciliation package bring a one-two punch for higher education, according to a Moody’s Ratings analyst who said the package is credit negative for the sector.

The Republican tax and spending cut package “is credit negative for the higher education sector and substantial cuts to Medicaid will have the largest negative effect,” said Patrick Ronk, a Moody’s associate vice president/analyst.

Moody’s had already assigned in March a negative outlook to the sector citing pressures from federal policies.

Cuts to Medicaid will not only affect universities like the University of California that operate hospitals, but may also bring cuts to other public universities if states slash their funding to plug the hole left by the reduction in Medicaid funding, Ronk said.

The proposed legislation will cut Medicaid spending by nearly $1 trillion over the next 10 years and leave up to 10.9 million Americans without healthcare coverage, according to the Congressional Budget Office, an independent non-partisan independent agency that is part of the legislative branch.

“The cuts will directly reduce revenue for academic medical centers and university health systems that serve a high share of Medicaid populations,” Ronk said.

The University of California Health System – comprised of six academic health centers, 21 health professional schools, four children’s hospital campuses and a Global Health Institute – is the largest provider of outpatient care to Medicaid patients and the second largest provider of Medicaid in-patient care in the state, according to a university fact sheet. Medicaid patients make up 35% of in patient days at UC hospitals..

Medicaid, known as Medi-Cal in California, is a joint federal and state program that provides health coverage for low-income residents.

“Indirectly, federal cuts to social programs may necessitate state budget tightening as they backfill funding or address needs, which could result in states reducing funding for public universities,” Ronk said.

Nationally, universities have already been experiencing challenges from enrollment declines and reductions in state funding.

“We went through the pandemic years and most states were providing increases to higher education,” said Michael Osborn, a Moody’s vice president and senior credit officer. “But across the country, many state budgets are feeling the pinch. At a high level, there are more funding reductions taking place than there were two or three years ago.”

For the most part, it represents a decrease in funding growth, Ronk said. So while state universities may have seen five or six percent growth in state funding, it has declined to 1 or 2%, or funding has been deferred to out years, he said. It varies state by state though, he said.

This potential for a reduction in funding applies to both the 10-campus UC system and the 22-campus California State University system.

“It’s largely highly rated public universities or privates that have academic medical centers,” Ronk said. “If a big share of revenue is from patient care – and a significant portion of that is from Medicaid, then it could affect medical university centers.”

Cuts to state funding would affect CSU more than UC because 40% of its operating revenue comes from the state, Osborn said. Roughly 10% of UC’s revenue comes from state funding. On the other hand, the UC system is, with its academic health centers, more directly exposed to Medicaid cuts because 41% of its revenue comes from patient care, he said.

Medicaid cuts will have a broader impact on areas with a higher concentration of patients who use the program, Ronk said.

The broad reach of the UC system, with campuses spread across the state would likely enhance its resilience.

UC has medical center pooled revenue bonds tapping the combined pledge of its medical centers, Osborn said. “If one is struggling it could receive a lift from one that is not,” he said. “That’s nice for bondholders.”

According to a January Fitch Ratings report, the UC system’s total bonded debt, which includes debt equivalents from pension and lease obligations, was about $30.5 billion at fiscal year-end 2024.

For the fiscal year 2023-24, the pledged revenues for the medical center pooled revenue bonds were $22.2 billion, according to information posted on its investor relations page.

Those bonds carry ratings of Aa3 from Moody’s and AA-minus from both S&P Ratings and Fitch. All assign stable outlooks

Lead managers Jefferies and Bank of America will price $1.5 billion in general revenue bonds on Aug. 17 for the UC Regents. UC’s general revenue bonds carry ratings of Aa2 from Moody’s and AA from S&P and Fitch. All assign stable outlooks.

On Thursday, Goldman Sachs and Jefferies priced for the CSU system $1.6 billion in Series A systemwide revenue bonds to yield between 2.35% for a 2026 maturity to 4.859% for a 2056 term bond.

The 22-bank syndicate also planned to price $113 million in taxable systemwide revenue bonds on Thursday.

Cooper Howard, director of fixed income strategy for Charles Schwab, said his team is cautious on the higher ed sector, because spreads are not that attractive for education issuers and they don’t justify the headwinds, which include an increase in university endowment taxes, reduced grant and federal funding, and the potential for some institutions to lose their tax-exempt status. 

As part of the budget bill, the largest private endowment pools in the country, like those at Harvard and Yale, will be charged an 8% tax on their investment income, up from the flat 1.4% rate imposed on all private college and university endowments in 2017.

The new tiered excise tax, at 1.4%, 4% or 8% depends on the size of the institution. Those with an endowment value above $2 million per student will pay the maximum 8% on investments, the Moody’s analysts said.

It benefits smaller institutions, however, because it only applies to schools with at least 3,000 tuition-paying students, up from a previous threshold of 500, they said.

Trump has threatened to take away Harvard University’s tax exempt-status over battles over diversity, equity and inclusion policies.

The challenges for the sector appear to be multiplying daily, Howard said. Those include both headwinds from recent federal policy shifts and longer-term trends like enrollment declines, he said.

“Where we have seen an increase in spreads is on the higher-rated AA and AA-plus,” he said. “The lower-rated (university bonds) are trading close to their three-year averages.”

The more highly-rated bonds are becoming more compelling, because the spreads have increased since early June when the reconciliation bill was first introduced in the House, he said, but they are still not attractive enough.

Howard first waved a caution flag in a report about the reconciliation bill on June 5.

Spreads have changed since then, and the higher-rated end of the sector is getting more attractive, but not enough, he said.

Though the endowment tax wasn’t as high as the threatened 20% for more affluent private universities, much of the risk brought from federal policies remains, Howard said. Those include threats to research funding and the reduction in federal student loans, he said.