With the First Interim reporting period concluding at the end of this month (October 2020), many local educational agencies (LEAs) are finding that, with no current or out-year cost-of-living adjustments (COLAs); severe limitations on the ability to lay off staff; additional expenses due to the pandemic with limited funding to offset it; increasing costs for pension contributions and additional employee leaves; and many other conditions impacting their budgets, they may not be able to file their First Interim reports with a positive certification.
The most recent information available for statewide budget certifications is from the 2019–20 Second Interim report—at that time, there were four school districts with a negative certification and 41 with a qualified certification. However, this was before the pandemic and wildfires impacted the economy, the state’s financial position, and LEA budgets. At that time, the economic outlook looked strong, and LEAs could plan on funded COLAs in the current and subsequent years of their multiyear projections.
Normally, school districts with a qualified or negative certification would work out a recovery plan with their county offices of education (COEs) and reestablish reserves over time. For districts with existing debt or plans to issue debt, a qualified or negative certification could produce some costly surprises.
In discussions with financial advisors, we are told that some district debt, particularly certificates of participation (COPs), may include covenants requiring the district to maintain a positive budget certification. Those covenants may carry penalties, including acceleration of the balances due if the district’s budget certification does not remain positive. It is all the more important for these districts to develop a viable recovery plan to maintain their positive certification.
Clearly, districts that issue debt with a less than positive certification will pay more for this borrowing. This includes COPs, Tax and Revenue Anticipation Notes (TRANs), and even general obligation bonds. Interest rates on the debt will be higher, or alternatively, the cost of insurance to buy-up to a triple-A rating will add to the cost of issuance. Recall that districts with a less than positive certification must secure approval from the COE before issuing TRANs or COPs.
We always recommend declaring financial status accurately and then dealing with the problem in an open and forthright manner. We also recognize that the timing of State Budget decisions makes doing so very difficult. With the continued impact of the pandemic on the economy, the State Budget situation and Proposition 98 funding hang in the balance (see “Proposition 98—The Road Ahead” in the October 2020 issue of the Fiscal Report.) How school funding will fare in the 2021–22 Governor’s State Budget Proposal is a significant unknown factor.
Some districts that are likely to move from a positive to qualified budget certification at the First Interim report may consider postponing issuance of long-term debt until the outlook of 2021–22 education funding becomes more clear, or until staffing reductions and/or budget cuts are implemented to improve the district’s budget certification. Our advice is to first confer with your financial advisor and bond counsel to determine how having a qualified certification might affect your district’s outstanding or planned debt. If you find that you have a problem, we encourage you to talk with your COE now to determine what options may exist for your situation. If your district has General Fund debt covenants, ensure your governance team is aware of the potential impact should your district find itself in qualified or negative certification territory. This will provide ample opportunity to work with staff in order to make adjustments as necessary.