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U.S. Local Governments Credit Brief: California School Districts

Overview

Despite the effects of the COVID-19 pandemic, California school districts demonstrated generally stable credit quality in fiscal years 2020 and 2021, and S&P Global Ratings expects this will continue in fiscal 2022. State revenue significantly outperformed budget during fiscal 2021, and the enacted budget for fiscal 2022 provides the highest funding per pupil in the state's history. Nevertheless, if school districts that are more reliant on state funding and have experienced enrollment declines do not prepare accordingly, they could face budgetary challenges in fiscal 2023 with the expiration of provisions that have held them harmless against enrollment declines during the pandemic.

S&P Global Ratings maintains general obligation (GO) ratings on 662 school districts in California. Fifty-seven percent of California school districts are in the 'A' category, 42% are in the 'AA' category or above, and fewer than 1% are in the 'BBB' category or lower. In addition, 97% of the ratings have a stable outlook, while approximately 2% have a negative outlook. One school district has a positive outlook.

What We're Watching In 2021 And Beyond

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School funding held steady in fiscal 2021; boost coming for fiscal 2022

We believe state funding during fiscal 2022 will provide financial stability for districts that have maintained stable-to-positive enrollment trends in the past two fiscal years. For the fiscal 2022 enacted budget, California is providing the highest funding per ADA in its history, a 0.3% increase over the fiscal 2021 level and an 18.0% increase over the fiscal 2020 level. In particular, the state budget includes a compounded cost-of-living adjustment (COLA) of 5.07% and boosted funding for special education. This follows stable funding in fiscal 2021, although the state balanced its budget by making $12.9 billion of cash deferrals to school districts rather than funding reductions. With the deferrals in fiscal 2021, some school districts issued tax and revenue anticipation notes (TRANs) to manage cash flow and others participated in the new state aid intercept program that allows districts to borrow against the deferred school state aid. Full repayment of the deferrals is included in the fiscal 2022 enacted budget.

Proactive approach necessary to maintain credit quality if ADA declines loom

For most districts, ADA, adjusted for specific student demographic criteria, continues to represent the most important factor influencing operating revenue under the state funding framework. California's fiscal 2021 budget allowed districts to use their pre-pandemic ADA for school funding rather than lower ADA that generally reflected parents' reluctance to enroll students as a result of public health concerns. Under the fiscal 2022 enacted budget, districts can continue to use the higher of the fiscal 2020 or fiscal 2021 ADA. As a result, districts that experienced enrollment declines during this period were held harmless. However, these districts could experience a sharp decline in revenue for fiscal 2023 given that revenue for that period will be based on then-current ADA that might reflect multiyear declines as artificial support is withdrawn. Based on our conversations with management teams across the state, districts are aware of this potential funding shift and are making action plans that include updating multiyear projections, factoring in attrition to reduce headcount to match enrollment, managing personnel expenses, and, in some cases, using reserves to smooth potential effects.

Spotlight On Environment, Social, Governance Factors

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School districts are exposed to various environmental physical risks related to climate change, including wildfires, drought, and sea-level rise, and are also susceptible to natural disasters such as earthquakes. Although the risks vary by region, our rating analyses incorporate an issuer's mitigation plans through review of long-term financial and capital planning documents as well as any specific resiliency plans. Furthermore, the state has modified its building code to bolster construction against earthquakes, and we view this positively. We are monitoring pervasive drought conditions and other environmental risks that could stall population and economic growth throughout the state.

We consider California's social risks elevated compared with those of other states given a shortage of affordable housing and high social service costs as a result of income disparity. California is addressing this for school districts through increased funding to concentration grants to provide additional aid under LCFF and to rectify income disparity in the long term. Furthermore, declining birthrates resulted in the state's first recorded population decline in 2020. Should this trend continue, it could significantly affect school districts that depend on state funding and that require stable-to-positive enrollment to cover operating costs.

Finally, state oversight of school districts' financial health is a governance opportunity, particularly given California's history of providing direct assistance during periods of financial distress by appointing a state administrator to replace the district's superintendent and school board. This oversight allowed affected school districts to steadily recover and return to financial stability.

For more information on California's ESG factors, see "ESG U.S. Public Finance Report Card: California Governments And Not-For-Profit Enterprises," published June 16, 2021, on RatingsDirect.

California School Districts Data

Table 1

California School Districts: Medians
Rating
AAA AA+ AA AA- A+ A A- BBB+ or lower
Household EBI (%) 210 182 148 126 98 83 84 108
Market value per capita ($) 661,635 384,090 251,665 155,997 114,046 103,421 142,454 107,011
Available general fund (%) 31.7 25.3 19.2 21.6 19.4 20.1 30.1 6.3
Debt per capita ($) 7,119 5,648 3,946 3,008 2,334 2,517 3,337 3,827
Debt as % market value 0.7 1.9 1.6 1.8 2.0 2.1 2.9 3.5
Pension ARC + OPEB as % expense 8.3 6.8 8.1 8.4 8.2 8.0 7.7 9.6
EBI--Effective buying income. ARC--Annual required contribution. OPEB--Other postemployment benefits.

Table 2

California School Districts: Financial Management Assessment
Rating
AAA AA+ AA AA- A+ A A- BBB+ or lower
Score (%)
Strong 5 3 2 0 0 0 0 0
Good 82 73 71 58 45 30 31 0
Standard 14 22 27 41 55 68 69 75
Vulnerable 0 0 0 0 0 0 0 25
Not available 0 3 0 1 1 3 0 0

Chart 3

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This report does not constitute a rating action.

Primary Credit Analyst:Brian Phuvan, San Francisco + 1 (415) 371 5094;
brian.phuvan@spglobal.com
Secondary Contacts:Tim Tung, CFA, San Francisco + 1 (415) 371 5041;
tim.tung@spglobal.com
Jane H Ridley, Centennial + 1 (303) 721 4487;
jane.ridley@spglobal.com
Bianca Gaytan-Burrell, Centennial + 303-721-4617;
bianca.gaytan-burrell@spglobal.com
David G Hitchcock, New York + 1 (212) 438 2022;
david.hitchcock@spglobal.com

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