CHICAGO – Nearly four dozen Michigan school districts have suffered credit erosion this year and the trend shows no signs of waning, Moody's Investors Service said in a new report.
The numbers are expected to climb as the current fiscal year continues. "We have downgraded 47 of the 206 districts we rate this year and anticipate that number rising during 2016," Moody's said. Michigan school districts account for seven of 20 systems Moody's now rates in junk territory, highlighting the sector's struggles.
The in-depth report on the fiscal position of the state's school districts published Monday illustrates the toll posed by ongoing enrollment declines, stagnant per-pupil state funding that hovers around 2009 levels, and pension funding pressures. Modest state funding increases in fiscal 2016 are unlikely to stem the tide, Moody's said.
Add in a tumbling tax base and growing debt burdens and the pressures bearing down on districts' balance sheets and their fund balances are formidable. Districts' lack of flexibility on the revenue side further fuels the strains, Moody's said in the report, "K-12 Public School Districts: Michigan Schools' Widespread Credit Weakness Persists."
The 47 downgrades of the 206 of the state's school districts it rates bring to 150 the number of districts downgraded by the rating agency since 2009. Of the 47, 41 lost ground on their general fund reserves over the last five years with the median decline at 47%. The median general fund balance as a percentage of revenues for rated Michigan districts was at just 9.7%, compared with a national median of 19.1%.
"The loss of fund balance serves as the largest driver of credit stress and downgrades," Moody's analyst Andrew Van Dyck Dobos said. "From fiscal 2005 through fiscal 2014, traditional Michigan school districts have lost 46% of their aggregate general fund reserves."
"The current funding environment makes it extremely difficult for districts to significantly rebuild fund balances given the sector's lack of revenue-raising flexibility, decreasing enrollment, and increased fixed costs, including increases to annual pension contributions," added Van Dyck Dobos who authored the report with fellow analysts Matthew Butler, Henrietta Chang, and Naomi Richman.
Statewide, the Michigan Department of Education has reported that 58 traditional districts and charter schools ended fiscal 2014 with a general fund deficit. Based on recently released fiscal 2015 audits, 36 of the districts remained in a deficit position.
Moody's rates eight of the 36 with a rating of Baa1 or lower. Detroit Public Schools, at the junk level of Caa1 with a negative outlook, leads the pack with a $216 million deficit that equates to 32.7 % of revenues. Four other districts have higher deficits based on a percentage of revenues.
The state's districts don't fare well compared with their peers nationally. Ratings span from a top mark of Aaa to deep in speculative territory at Caa1, with credit blows over the last several years highlighting Michigan's worsening position. The median rating for Michigan schools is A1, one notch below the national sector. The state has the distinction of having a lower percentage of Aa-level credits and higher percentage of speculative-grade ratings than peers. About 72% of Michigan school districts are rated A1 or below, compared to 47% for the nation.
Districts are pressured on multiple fronts. Where state funding is concerned, the minimum per-pupil basic funding allowance has increased four consecutive budget cycles, since being reduced $450 in fiscal 2010. It remains just $75 higher per pupil than the minimum funding allowance in fiscal 2009.
Enrollment declines are also a leading factor in some districts' struggles, with statewide enrollment falling by 12% over the last decade due to charters and an overall drop in school age children. The impact of school choice that allows some students to attend schools outside their residential district has been beneficial to some, while hurting others.
Statewide, 10% of Michigan students attend charters while 7% participate in the so-called Schools of Choice program. "Uncertainty around enrollment and state funding hurts budgetary reliability," the report says.
Another central strain is rising pension contributions, which are consuming more of a district's budget as districts are forced to pay up to tackle skyrocketing growth of unfunded pension liabilities.
Since 2007, the Michigan Public Schools Employees Retirement System's funded ratio plummeted to 59.5% in 2013 from 88.7%, with unfunded obligations rising to $25.8 billion from $5.8 billion. That's driven up statutory contributions from 15% of payroll in 2005 to about 25% in 2014, resulting in a $1 billion increase.
Pensions make up 10% of Moody's general obligation methodology when assessing an issuer's credit profile.
On the revenue side, districts are hampered by an inability to seek voter approval to increase levies to increase locally raised revenue. Spending cuts, including modifications to union pacts, stand out as the best option to ease budgetary pressures.
"Districts have been forced to make difficult cuts and use innovative solutions to maintain adequate finances," Moody's notes. "Recent agreements with unions have involved adjustments to salaries and benefits favorable for district finances." The union concessions are especially notable as the state as labor is considered a strong force in Michigan.
Through cuts and concessions and other maneuvers some districts have successfully navigated through their budget obstacles. Of 58 districts that ended 2014 with a deficit, 41 improved or eliminated it in fiscal 2015, highlighting what Moody's calls the "moderate effectiveness" of the state's deficit elimination plan.
The rated districts -- Warren Consolidated Schools, Mt. Clemens Community School, and Brighton Area Schools -- have achieved success under the program, which provides districts with guidance on balancing costs and revenues and appoints and auditor or inspector to review the plan.
While a majority of districts with deficits have made progress, 14 districts have increased their deficits, Including DPS which saw its gap grow by $46.5 million.
A downside for districts that have managed through ongoing pressures through spending cuts is that they now have fewer options.
Moody's sees some positives on the horizon although they may not translate into credit restoration.
"While financial stressors remain, other key credit factors could begin to stabilize. A return to tax base growth, which is happening for a few districts already, will help to moderate debt levels over time, while statutory caps on annual pension contributions will lead to more consistency in annual pension costs," the report says.
But any sector-wide improvement of reserves is expected to remain modest and "over the near-term, most of our downgraded credits are unlikely to regain their credit ratings achieved prior to the trend of downgrades beginning in 2009."
The state has sought to intervene earlier for struggling districts. In September Michigan said it would launch reviews into 16 school districts under a new early-warning system signed into law in July that gives the treasurer power to oversee struggling districts.
Under the new law, the state treasurer will launch a financial review of the 16 districts and ask them to submit new deficit elimination plans. The treasurer also has the ability to declare a financial emergency and recommend an emergency manager. Three of the 16 districts, including Detroit, are already under state-controlled emergency management.
All 16 districts have had deficits for five years or more. That's one of the new triggers for transferring a district to treasurer control. The list included Detroit Public Schools. Gov. Rick Snyder has proposed a sweeping overhaul of the district that would, in effect, create a new system and governance structure with existing debt remaining with a shell of the district to be repaid by local taxpayers. The effort is stalled at the legislative level.
