LOS ANGELES -- A U.S. Department of Education warning that California state legislation violates federal law is a credit negative for California school districts, according to Moody’s Investors Service.

The DOE told the California State Board of Education on Monday that legislation suspending federally mandated standardized testing violates federal law, potentially costing school districts at least $3.5 billion in federal funds.

The DOE warning is credit negative for the state’s school districts because of the significant amount of funding at risk for at least the 2014-15 fiscal year, according to Moody’s analyst Eric Harper.

The school districts are in the process of transitioning from traditional standardized tests to new examinations under a recently passed state law, Assembly Bill 484. The transition to new tests is set to begin in the spring of 2015.

The law removes the requirement that school districts conduct the traditional mathematics and language arts exams, and instead requires districts to conduct “field tests” in either subject, but not both.

The DOE says the move violates Title I of the Elementary and Secondary Education Act of 1965. The state received a warning about potential cuts before the passage of AB 484, but lawmakers still moved ahead and Gov. Jerry Brown signed the bill.

“Withholding various federal grants would affect mainly school districts with significant populations of low-income, special education, migrant and English-learner students,” Harper said in a report released Monday. “Although California school districts are funded primarily through state aid and local property taxes, federal funding accounts for 10% of total school district funding.”

The school districts rated by Moody’s that receive the largest amount of federal aid include Los Angeles Unified, which received $553 million in 2012, and Fresno Unified, which received $79 million and receives 12% of its operating revenue from federal funds.

A loss of $3.5 billion in federal grants would have a disproportionate effect on districts that rely more federal funds, Moody’s said. These include Palmdale Elementary School District, which receives 16% of its operating revenue from federal funds, and San Bernardino City Unified School District, which receives a 9% share.

“We expect any loss of federal funds to be temporary,” Moody’s said. “Because school districts are forward-funded by the federal government, the first loss of federal funds is unlikely to affect California school districts overall until fiscal 2015.”

In addition, state education officials and school districts still have time to negotiate a resolution with the DOE that could avoid the multi-billion-dollar cuts, analysts said.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.