SAN FRANCISCO - A number of California school districts could see their credit quality weaken if a bill that would cap their permitted fund balances becomes effective, Fitch Ratings said.
Last week, Gov. Jerry Brown signed a budget-related bill that would limit the amount of school districts' reserves to two or three times the state's minimum reserve requirement for economic uncertainty.
The current minimum is 3% of expenditures.
The legislation would only go into effect if a proposed constitutional amendment to the state's rainy day reserve — which includes a school funding reserve — gets approved by voters Nov. 4.
The cap would be triggered when the state deposits money into its own state level school reserve. If approved, it is not expected to be implemented until after fiscal 2018.
"Even before the cap is triggered, Fitch expects some increased pressure by stakeholders to draw down reserves in anticipation of the cap being applied, which may result in some credit quality deterioration," Fitch Ratings said.
The cap would limit most school districts' assigned and unassigned general fund balances to 6% of expenditures, Fitch said.
"The cap would be well below the median Fitch-rated California school district balance of 20% and we view it as low, given the volatile history of California's K-12 funding system," analysts said. "Fitch believes that could also result in liquidity pressures."
Moody's Investors Service also recently noted that most of its 330 rated school districts have about a 20% fund balance, but stopped short of saying whether or not the specific legislation would have any credit implications.
Fitch analysts said that there are potential mitigants to the risks associated with the legislation. The school funding reserve should dampen funding volatility somewhat, reducing the concern about lower fund balances, they said.
In addition, both budgetary and cash flow concerns could be mitigated by districts' ability to maintain reserves outside the general fund, to which the cap would not apply.
"Finally, districts may apply for exemptions from the cap if they provide a reason for needing additional funding, such as for capital or other long-term needs," Fitch said.
The legislation has received support from teachers' unions, which say it would channel more dollars into the classroom by capping the amounts districts are able to hold back in budget reserves.
School officials, however, have voiced concern that the bill would leave districts without a safety net and vulnerable to unanticipated financial developments.
