Danger zone for deferrals?

More may push districts over edge

For three consecutive years, the Legislature has added billions of dollars in IOUs to K-12 schools and community colleges. They did so on the assumption – which school districts share, for the most part – that payments deferred are better than payments denied: straight budget cuts.

But how much is too much? What is the tipping point for deferrals, when school districts can no longer carry the state’s burden, when they can no longer borrow externally, and budget deferrals become straight budget cuts – when, at the extreme, districts that can no longer meet payroll will turn to the state to bail them out?

That’s a question that legislators must consider this week, as they weigh the consequences of an all-cuts budget, for failure to compromise to extend temporary state taxes after July 1. Their instinct will be to turn to deferrals.

The Democrats did that, by $3 billion, in their budget on June 15, which Gov. Jerry Brown vetoed and Controller John Chiang declared unbalanced and unfit.

That prospect has some people in the know worried.

“We fear that at some point, the market will balk at loaning ever-increasing amounts to the districts while the state continues to struggle with a structural budget deficit,” said Jim Thomas, deputy superintendent for business services at the San Joaquin County Office of Education.

“Some districts will get to a point where they will no longer have credit worthiness to borrow. When it happens – and I am not sure when it will be – we will have cash insolvency,” said Joel Montero, CEO of FCMAT, the state Fiscal Crisis and Management Assistance Team, the agency that oversees districts that need to be bailed out.

What makes predictions difficult is that each district’s situation is different, depending on to its size, its credit worthiness and the interest rate it’s charged, its ability to borrow internally and the proportion of money it gets from the state under Proposition 98 – more on that key factor in a moment.

Property-poor districts bear burden

But nearly all districts have been hurt by the state’s failure to pay its bills on time.

K-12 deferrals have grown from $1 billion in 2007-08 to $7.5 billion this year. Click to enlarge. (Legislative Analyst's Office, Feb. 2011)

K-12 deferrals have grown from $1 billion in 2007-08 to $7.5 billion this year. Click to enlarge. (Legislative Analyst's Office, Feb. 2011)

In 2007-08, the state owed $1 billion in deferrals to K-12 districts.  According to the Legislative Analyst’s Office, that grew to $7.4 billion by this year, which means that 17 percent of Prop 98 program funds are financed using funds borrowed from the next fiscal year. (School Services of California, which advises districts on finances and other matters, puts the figure at $8.3 billion, closer to 20 percent.)

But this average figure is deceptive, because districts get their Prop 98 funds through a combination of local property taxes and the state’s General Fund. Deferrals affect only the state’s portion, so those districts that depend on the state for most of their revenue get hit harder. For districts like Stockton Unified (17 percent of revenues from property tax, 83 percent from the state),  close to a third or more of their money has been deferred.

Update: (I should have mentioned that charter schools are the most adversely affected since they cannot get short-term notes at low interest rates of 1 to 4 percent, called TRANs (Tax and Revenue Anticipation Note) – that districts can obtain and so are paying 15 to 20 percent interest on borrowed money, according to Jed Wallace, president and CEO of the California Charter Schools Association. Under the Gates Foundation compact between Los Angeles Unified and high-performing charter schools, the district agreed to include charter schools under the district TRANs, but that hasn’t happened yet.)

In his initial budget in January, Brown proposed adding $2.1 billion more in cross-year deferrals, which would have brought the total to close to $10 billion – nearly a quarter of K-12′s Prop 98 money, and, for some districts, closer to 40 percent. But in his optimistic May revise, which assumed tax extensions would pass, Brown had second thoughts. Including deferrals in his “wall of debt” that must be disassembled, Brown proposed not only to rescind the new deferral but to pay back nearly $3 billion in existing deferrals. According to the California School Boards Association, about half of districts responding to its survey have built their budgets for next year on Brown’s May promises.

If there are more deferrals …

But suppose there is no deal with Republican legislators to extend taxes, and the Legislature reinstates the $2.1 billion deferral Brown proposed in January – or an even larger one. The Legislative Analyst’s Office got a good indication in a February report, “Update on School Finance in California,” based on a survey of school districts.

Before this year, 74 percent of districts said they responded to deferrals by drawing down district reserves; 45 said they borrowed from internal funds; 28 relied on external borrowing, and 20 percent made budget cuts because they couldn’t borrow or it was too expensive.

Asked what they’d do if the 2011-12 budget included more deferrals, 64 percent said they’d draw down districts funds and 50 percent said they’ve borrow from internal funds while 44 percent would borrow externally and 42 percent –more than double before – would make cuts because they’d have no access or prohibitively high access to outside loans.

One might assume that the districts facing the most difficulties would be the 143 districts – about one in seven – that self-reported financial troubles in this year’s Second Interim Report, based on their status as of Jan. 31. They include 13 “negative” certifications – those that said they’d have trouble meeting expenses this year or next – and 130 “qualified”  certifications, meaning they’d have trouble meeting expenses one or two years out. They’re more likely to pay higher interest rates – 3 to 4 percent on temporary loans they borrow, called TRANs,  if they can get access to outside loans at all.

Higher revenue estimates for the state – $6.5 billion more projected next year – improves the outlook for districts’ borrowing. However, districts will spend the last of their federal stimulus money by this September, and the one time “Edujobs” cash ($1.2 billion for California) by September 2012. Districts had been able to borrow unused dollars in both funds.

Spokespeople of two of the larger districts with the Qualified status, Stockton Unified and Los Angeles Unified, told me that they’d have no trouble obtaining TRANs at under 1 percent interest next month. LAUSD reported it would sell $550 million worth of TRANs – 36 percent of the money the state will owe it next year based on the May revise – at only 0.32 percent interest.

Montero said that the status on the first and second interim reports is only one factor comprising a district’s credit rating. Small districts that face higher fees for TRANs and lack internal funds to borrow from are more likely to face higher interest and to be shut out of outside money.

What keeps him awake nights, Montero said, is the likelihood that districts not even on the negative or qualified lists will not be able to make payroll if there are additional deferrals and cuts.

“I don’t have a clue how many,” he said, “but yes, more districts will go insolvent.”

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1 Comment

  1. To add to the worries is that this very, very weak recovery is looking more and more like it will turn into another downturn and sooner rather than later.  Our good friend Rosy Scenario is out and about and there is entirely too much (unspoken) reliance on a continuing and strengthening recovery.  Nice if you can get it, but if things go down again?
    We have had two “once-in-a-lifetime” financial bubble crises (dot-com and housing) 7 years apart.  We’re 3 years off from the end of the last bubble so the next one (student loans?  pension plans?) should be four years off.  Even if it doesn’t turn into another crisis, we could end up with 10 years of on-again-off-again oil shocks with stagflation like the 1970′s or the 20 years of Japan’s ‘lost (2) decades’.

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