Enrollment pressures and financial stresses aren't limited to California's big school districts.
Recent teachers' strikes in Los Angeles and Oakland underscored the fiscal pressures on those big city districts.
But all of the state's school districts face large scheduled teacher pension contribution increases, limited control over revenues, and relatively low reserves in the face of elevated revenue volatility due to reliance on volatile state funding, said Karen Ribble, a Fitch Ratings senior director. That combines to create a challenging budget environment now, but could cause increasing strain during a recession, Ribble said.
Teachers also have been demanding salary increases to deal with the surging cost of living in California’s urban centers, said Andrew Ward, a Fitch director.
Of the 124 Fitch-rated California school districts, roughly 40% have only adequate gap closing capacity, placing them at a lower-tier investment grade BBB rating level in that credit criteria, analysts wrote in a Jan. 18 report. Fitch analysts wrote that they believe these schools could become stressed in a downturn with a number requiring intervention from the state or their county office of education to balance budgets.
Ward noted that state government and county offices of education can provide assistance using a number of tools, including providing financial expertise, before a district reaches the level of needing a state takeover.
The state has taken over only nine school districts since the state’s current structure of aiding financially failing school districts was created through Assembly Bill 1200 in 1991, Ribble said.
Districts with exceptional distress can get a loan from the state, but they have to pay it back and temporarily cede control to a fiscal advisor appointed by the county.
Enrollment declines have occurred at 65% of the state’s 1,200 school districts, said Michael Fine, chief executive officer of the state’s Fiscal Crisis & Management Assistance Team, an agency that monitors the fiscal health of school districts, investigates fraud, and works with county offices of education to manage troubled school districts.
Oakland’s enrollment has dropped to roughly 30,000 from 50,000 over the past two decades and the district has been discussing closing 24 schools, Fine said. Inglewood Unified School District, which has been under state control for several years, saw enrollment drop to 8,000 from 19,000 in 15 years, he said.
S&P downgraded Oakland USD to A from AA-minus in October, placing the ratings on credit watch with negative implications, citing projections of large deficits in coming years. The district has a BBB-plus rating from Fitch and A1 from Moody’s. Its teachers struck for seven school days in February.
In the state capital, the teachers' union at Sacramento City Unified School District is in a war of words with administrators as the district faces warnings about insolvency.
The district is projected to run out of cash by November unless steep cuts are made. The state’s 10th largest school district has 43,000 students on 76 campuses. Its enrollment has remained steady, but it shares LAUSD’s issue of having steep other post-employment benefit liabilities through a generous retiree healthcare program.
Sacramento City “entered into a collective bargaining agreement in December 2017 that they could not afford,” Fine said. “I am not critical of the labor agreement. It might be the right the thing for their labor partners, but they knew they could not afford it and needed to make changes to make room for the cost of the agreement, and they did not.”
FCMAT’s report released in December concluded that SCUSD needed to make $35 million in cuts by the time it adopted its 2019-20 budget or it would only have three to four months of cash remaining for day-to-day operations.
The Joint Legislative Audit Committee approved a request Wednesday by Assemblymember Kevin McCarty, D-Sacramento for an audit by the California State Auditor to evaluate what landed the district in its current position. According to McCarty’s letter, the district not only has to cut $35 million from the 2019-20 budget, but another $35 million in 2020-21.
An audit “would help stakeholders better understand the depth and cause of these troubles, as well as what the district can do to improve its financial condition and prevent this from reoccurring in future years,” McCarty wrote in his Jan. 18 letter to the committee.
Fitch downgraded some of SCUSD’s bonds, but not others, on Feb. 14, depending on whether or not the ratings agency has a legal opinion designating them “pledged special revenues” in a bankruptcy. It downgraded Series 2007 and 2011 general obligation bonds and 2012 GO refunding bonds to BBB-plus from A-plus and Series 2014A lease revenue bonds to BBB from A and gave them a negative outlook but maintained a triple-A rating on the district’s series 2017E and Series 2017C GOs with a stable outlook, based solely on the property tax pledge behind them, which is separated from the district's budget..
Moody’s Investors Service and S&P rate the district’s GOs A2 and BBB, respectively; both have negative outlooks. The district’s lease revenue bonds have a BB-plus junk rating from S&P.
SCUSD announced last week it is cutting 33 administrators to help close a $30 million deficit. The announcement came as it made its second interim financial report to the county office of education, which is monitoring the district.
The county agreed to give the district extra time to submit a cash flow report. District finance officials failed to respond to questions they asked be submitted in writing about how much savings the proposed cuts would bring, what other cuts it might be anticipating and when it planned to provide the county with the overdue financial report.
From 2012 to 2019, LAUSD’s K-12 enrollment declined by roughly 100,000 students, continuing a 16-year-long trend in which the district lost about 260,000 students, according to an S&P ratings downgrade report published Monday by analysts Dan Kaplan and Jennifer Hansen. S&P downgraded LAUSD to A-plus from AA-minus citing its structural imbalance, long term trend of declining enrollment and sizeable unfunded other post-employment benefits liability. The district expects to lose another 15,000 students in 2020 and 12,000 students in 2021, according to the report.
LAUSD’s board has approved a special election on June 4 asking for a parcel tax that would raise about $500 million a year. Voters must approve it with a two-thirds supermajority. The district’s fiscal advisory team, led by a special financial advisor appointed by the county, has until March 18 to submit a second interim fiscal stabilization plan.
“I would not describe Los Angeles Unified as being on the threshold for state takeover at all,” Fine said. “They had a strong budget going into collective bargaining. They have issues as a result of that collective bargaining, but it’s not an immediate problem.”
He said LAUSD’s problems are two years out, but if it doesn't take action now, the school district will have a more serious problem at that point.
Kroll Bond Rating Agency maintained LAUSD's AA-plus rating with a stable outlook following the teachers' January strike, which lasted six school days, though it estimated the union agreement would increase a projected $350 million deficit in fiscal year 2021 to $1.08 billion. The district holds an Aa2 rating from Moody’s and A issuer default rating from Fitch.
As the second largest school district in the nation, LAUSD has issues that are unique, because it is facing such a significant decline in enrollment and significant legacy costs, said Alan Gibson, a Fitch director.
The school district faces competition from charter schools on a level not experienced by other districts, said Gibson, in the form of “one of the most competitive charter systems any school district across the country has to deal with.”
Some of LAUSD's problems are shared more widely.
“It is facing the same demographic shift we are seeing throughout the California western seaboard resulting from aging populations and affordability issues that are making the area less attractive to younger families,” Gibson said.
The Fitch analysts said legislation that has been proposed to cap charter school growth isn't far enough along to be a credit consideration. The legislation doesn’t tackle the calls for a moratorium on charter school growth called for by LAUSD and OUSD teachers, both of whom went on strike this fall.
“The main risk to school district budgets and ratings flow from ongoing pension cost pressures, which are likely to continue into the next recession, and the risk that some school district policymakers may fail to cut classroom resources deeply enough to align spending with revenues,” Fitch analysts wrote. “Such failures have been relatively rare in California.”
Both the California Public Employees’ Retirement System and the California State Teachers’ Retirement System are in the midst of multiyear efforts to increase their funded ratios and to adapt to reductions in investment return assumptions and longer life spans, Ward said. CalSTRS has more than doubled rates since 2014 to move statutory contribution requirements into better alignment with actuarial needs of the plan. Contributions are scheduled to increase through 2021.
“We are seeing an increased degree of fiscal stress, which is unusual in the tax-supported sector outside of recessions,” Ward said. “The stress has yielded some high-profile labor strife and is forcing policymakers to make some very difficult trade-offs. These stresses are largely confined at this point to districts with declining enrollment and rapidly rising costs of living.”
