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California K-12 credits remain stable despite enrollment drop, Fitch says

Record state spending on California’s K-12 education will enable schools to retain stable credit quality despite a several-year drop in enrollment, Fitch Ratings said.

The state’s schools experienced their sixth year of declining enrollment in fiscal 2023, dropping below 6 million students for the first time in 20 years, said Fitch’s report, released Thursday. The decline in birth rates and people moving out of the state were cited by Fitch for the drop.

Total enrollment from transitional kindergarten through grade 12 hit 5.85 million, based on a moment-in-time headcount from Oct. 5 that factored in more than 900 school districts, 58 county offices of education and about 1,300 charter schools, said a California Department of Education report released April 5.

Enrollment fell 0.67% for academic year 2022-23 compared to the previous year, a loss of 36,696 students, the CDE report showed. But the school district has experienced declines the past three years, resulting in a total loss of 310,000 students, according to the report.

California Gov. Gavin Newsom’s proposed fiscal year 2024 budget includes some of the highest levels of K-12 per pupil spending in the state’s history, even as the state faces an estimated budget gap of $22.5 billion in the 2023-24 fiscal year.

“This is despite weaker projected state revenue growth and declines in overall K-12 funding in fiscal year 2024 relative to fiscal year 2022, which was elevated as a result of pandemic aid,” Fitch wrote.

Per pupil funding captures teacher and staff salaries, educational programming, classroom spending, and administrative costs, but excludes construction and other capital spending.

The budget includes total funding of $128.5 billion for all K-12 education programs, providing $23,723 per pupil, according to the budget summary.

K-12 per pupil funding growth is largely attributable to the structure of the state’s school funding minimum guarantee formula, Fitch said.

Schools receive funding “through a combination of state general fund and local property tax revenue. Proposition 98, a 1988 voter approved constitutional amendment, ensures a K-12 ‘minimum guarantee’ funding level from the state, which is allocated according to the Local Control Funding Formula that adjusts base per pupil funding by grade level and student educational needs,” Fitch said.

“The minimum guarantee is the greater of three ‘tests’: approximately 38% of the state’s general fund revenues plus local property tax revenue allocated for school funding; the amount received in the prior year, adjusted for changes in attendance and per capita personal income; or the amount received the prior year adjusted for changes in attendance and per capita general fund revenues plus 0.5%,” Fitch said.

The first test has determined school funding for the last few years given enrollment declines, and is likely to prevail for the foreseeable future, given projected declining enrollment over the next decade, Fitch said.

The California Legislative Analyst’s Office estimates the minimum guarantee will increase by an average of 3.9% per year from fiscal year 2024 through fiscal year 2027 along with the state’s projected growth in general fund revenues.

Even though school district credit profiles are supported by a strong funding framework, Fitch said, districts with rapidly declining enrollment and materially reduced revenue bases face escalating budgetary challenges unless timely adjustments are made in response to enrollment losses to right size operations and expenses.

California’s reliance on taxes that are highly sensitive to changes in the economy also leaves the state’s revenue forecast susceptible to downside risk, Fitch said.

But the state also has $9.5 billion in a school funding reserve that it can tap to lessen the impact on per pupil funding if revenues fall.

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