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Fitch: California Schools Remain Financially Vulnerable

LOS ANGELES - California school districts will remain financially vulnerable, despite some recent improvements in state funding, according to Fitch Ratings.

In a nine-page report released Monday, analysts said that recent positive trends are expected to result in stabilization in the near-to-medium term, but significant cost pressures could cause downward ratings pressure on the school district sector in the longer term.

“Fitch views California school districts’ credit quality as confronting considerable pent-up cost pressures after years of service reductions, wage stagnation, and substantial pension underfunding,” analysts wrote. “These pressures in some cases could neutralize or overwhelm recent state funding improvements and potential out-year gains.”

In recent years, school districts faced reductions in state funding, funding deferrals, mid-year trigger cuts, and rising pension liabilities.

Since funding reductions began in fiscal 2010, Fitch has downgraded the ratings on 21 California school districts out of the 90 it rates. Four were upgraded.

After the state education formula funding hit its recessionary bottom in fiscal 2012, it began to grow due to state revenue growth and the passage of voter-approved state tax increases that prevented a mid-year trigger funding cut.

“Although the funding growth has improved districts’ liquidity and reduced immediate budgetary pressure, much of the growth has been absorbed by one-time expenditures and the voted sales and personal income tax rate hikes will sunset in fiscal years 2017 and 2019, respectively,” analysts said.

Some school districts will be negatively affected by the state’s overhaul of school funding through the new local control funding formula, or LCFF, that changes the distribution of funding but not the size. It requires that substantial portions of new growth dollars be spent on targeted low-income students, English learners, and foster youths.

“Overall, Fitch views LCFF as mixed for credit quality, with positive to negative effects varying by school district,” analysts said.

Through fiscal 2021, the state assumes moderate to significant Proposition 98 funding growth, including a $6.4 billion gain in fiscal 2015. Prop. 98 requires a minimum percentage of the state budget to be spent on K-12 education.

The state legislative analyst’s office projects even higher state revenue levels through at least fiscal 2018.

Fitch, however, is taking a more cautious approach given revenue and expenditure concerns, including aggressive economic expansion projections, state revenue volatility, and the coming sunsets of the Prop. 30 tax hikes.

Other revenue and expenditure concerns include a likely California State Teacher’s Retirement System contribution hike, California Public Employees’ Retirement System rate increases, and wage hikes.

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