Back‑to‑School Challenges Are Serious, But They Shouldn’t Scare Municipal Investors
Back-to-school season is normally an exciting time of year, when cooler weather signals the start of academics, fall sports, and new beginnings. But with the U.S. still in the throes of the COVID-19 pandemic, students, parents, instructors, and administrators are navigating a hodgepodge of re-opening scenarios, while investors have questions about municipal K-12 and higher-ed credits. Our view: Although health concerns may prompt sporadic backtracking and confusion, most municipals should be able to withstand these stresses.
Mode of learning should not affect credit
Generally speaking, K-12 school districts can choose how to re-open based on guidelines set by state and local public health agencies. School districts planning for in-person learning will likely see intermittent closures, as we saw in Georgia in August, when COVID-19 cases spiked, quarantines were ordered, and schools were forced to close almost immediately.
But this isn’t necessarily bad news for investors; we do not expect intermittent closures to equate to municipal credit stress. U.S. schools are funded primarily through property taxes and/or state aid appropriated for the school year, regardless of the learning model. Further, we expect to see many states provide some type of “hold-harmless” guarantee, which aims to protect the upcoming year’s school funding should enrollment decline. This is done by basing state aid on prior-year enrollment levels.
K-12: States attempting to limit funding cuts, credit selection remains crucial
The credit outlook for K-12 school districts varies across the country. Within each state, the credit quality of school district obligors depends largely on their funding status and current financial condition. We believe it is unlikely that the pandemic’s impact on K-12 will be widespread in fiscal 2021, thanks in part to federal CARES Act funding that will help offset increased expenditures related to virtual learning, as well as health and safety measures. Many states are also drawing heavily on reserves and trimming other spending in order to limit the immediate cuts to K-12 funding.
Yet, the possibility of mid-year cuts looms, should state revenue trends deteriorate and additional federal aid for state and local governments fail to materialize. In addition, K-12 still faces significant longer-term risks that carry a high degree of uncertainty. Among them: a prolonged recession that could prompt more sweeping cuts to state education funding, the impact of market volatility on pension funds, and costs associated with permanent enrollment decline and the indirect effects of learning loss.