LOS ANGELES— Downgrades have outpaced upgrades for California school districts under Fitch Ratings' revised criteria.
Though the bulk of ratings changes were downgrades, Fitch affirmed 80% of school districts under new criteria adopted in April 2016.
In comparison, Fitch's local government portfolio has experienced more upgrades than downgrades with the criteria change.
Fitch found that some school districts are at a greater risk in a downturn due to thinning reserves.
"California school districts have little independent legal control over revenues, which are primarily driven by relative enrollment rather than the local economy, and comparatively high revenue volatility due to the state's funding framework," Fitch analyst Karen Ribble wrote.
The state's dependence on income taxes – and capital gains – from high-net residents ties revenues to the ups and downs of the stock market.
"Expectations for elevated volatility increase the financial cushion necessary to offset future declines," Ribble wrote. "This inherent volatility, when compounded by a trend of thinning reserves observed in some districts, weakens the assessment of financial resilience through the cycle."
Most districts have experienced solid revenue growth in recent years from adoption of the Local Control Funding Formula, Ribble wrote, but the program is at full implementation. The LCFF gave school districts more discretion on how it spent state funding for high-needs students, English learners and foster kids.
Future growth revenue is expected to be more closely tied to average daily attendance numbers, Ribble wrote.
The ability of school districts to independently raise revenues is constrained by Proposition 13, approved by voters in 1978 to cap property tax assessments and rates. Districts can't raise property tax rates and can only raise a per-property parcel tax by going to voters and obtaining a two-thirds supermajority.
In districts that have experienced enrollment declines "the confluence of limited revenue flexibility and weaker revenue growth prospects has been the central credit factor in many downgrades," Ribble wrote. "This includes situations where the local tax base and economy are strong but enrollment is declining due to factors such as demographic changes and competition from charter schools."
Fitch also began rating the general obligation securities of certain California school districts in September 2016 above the level of the issuer rating based on its assessment that bondholders are legally insulated from any operating risk of the district.
In these cases, Fitch analysts wrote, the general obligation bond rating is based on a dedicated tax analysis without regard to the district's financial operations, "because there is a reasonable basis for concluding that the tax revenues levied to repay the bonds would be considered pledged special revenues in the event of a district bankruptcy."
