Education Funding

Financial Crisis Now Striking Home for School Districts

By Michelle R. Davis — October 21, 2008 6 min read
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Because of a production error in last week’s issue, the inside portion of this front-page story was omitted.

The crisis besetting U.S. and world financial markets is hitting school districts hard, as they struggle to float the bonds needed for capital projects, borrow money to ensure cash flow, and get access to investment funds locked up in troubled institutions.

•In Cumberland County, N.C., school officials froze plans to build a $20 million elementary school in the 53,000-student district after a neighboring county failed to find buyers for $454 million of its own construction bonds.

•The state of Maine has delayed 12 major school construction projects totaling $348 million in 11 school districts. In other states, even districts able to borrow money are paying higher interest rates while bracing for yet another drop in property-tax revenue.

•And in San Mateo County, Calif., officials in some two dozen districts are unable to get hold of millions of dollars invested with Lehman Brothers, the now-bankrupt Wall Street investment firm. They face the prospect of recovering just a fraction of that money through the bankruptcy process.

“It’s just plain unhappiness all over the place,” said Lee Buffington, the treasurer of San Mateo County, which lost $155 million in local money—about 40 percent of it from the county’s 26 school districts—invested with Lehman Brothers.

Some schools districts depend heavily on borrowed money to pay for capital projects such as new schools and even to tide them over while waiting for property-tax revenues to roll in.

But the various investment instruments used to borrow that money are under pressure from the global freeze in the credit markets that drove the $700 billion financial-rescue package approved by Congress and signed into law by President Bush on Oct. 3.

The impact of that plan remained unclear even last week as the stock market continued to seesaw amid gloomy economic news. The situation leaves school district finance officials with a basket of worries—both short-term and long-term.

High on the list is the overall economic outlook and the effect a recession could have on already-slack tax receipts, which have led to budget shortfalls in at least 31 states. (“Hard Times Hit Schools,” Aug. 27, 2008, and “States’ K-12 Efforts Feeling Budget Sting,” Oct. 22, 2008.)

“Will creditors use those types of falling receipts as a factor of credit-worthiness? What will happen to bond ratings? Are there going to be new guidelines for public entities?” asked Deborah Rigsby, the director of federal legislation for the National School Boards Association, based in Alexandria, Va.

In the short term, some districts already are being squeezed when it comes to borrowing the money they need for day-to-day operations, such as meeting their payrolls.

For example, the 2,000-student Cold Spring Harbor, N.Y., district borrows money for relatively short periods of time while it awaits property-tax money, which it receives once a year in a lump sum in December or January.

Credit Crunch

School districts and state and local governments are feeling pressure when it comes to borrowing money for short- and long-term spending needs. Here are some of the terms to watch for in following the fiscal crisis.

Municipal bonds

Bonds issued by school districts, or local governments on their behalf, in exchange for cash payments with the promise to repay, with interest, the investors who provide the cash. Repayment periods can be 30 or 40 years or longer. Districts typically issue municipal bonds to pay for capital projects such as new construction. Because these bonds are tax-exempt, investors usually accept lower interest payments than on other types of borrowing.

Tax Anticipation Notes

Short-term debt securities issued in anticipation of future property- tax money provided by the local government to districts. These are typically shorter-term loans, sometimes repaid within months. Many school districts receive property-tax money only once or twice a year and need this money to ensure a steady cash flow from month to month.

Local Government Investment Pools

A way for school districts and other government entities to invest idle funds until they need them, to make payroll, for example. These pools are supposed to be highly liquid, meaning that districts can draw money out at any time. The funds are usually invested in short-term, highly rated government and nongovernment securities.

Bond Rating

An indication of how likely it will be that a debt issuer, such as a school district, will be able to repay a bond on time. Companies such as Moody’s Investors Service and Standard & Poor’s assign school districts a rating that signals to investors a district’s financial health. Ratings can range from AAA, which means a district is highly unlikely to default, to D, or in default.

Source: Education Week

Earlier this month, the district closed a sale on $7 million in what are known as tax anticipation notes to come up with that short-term cash. The district got an interest rate of 3.23 percent, said William Bernhard, the district’s interim assistant superintendent for business, “but if we’d done it a month ago, it would have been around the low twos.”

He said that spike of about 1 percentage point will cost an extra $49,000 or so over the life of the loan—the cost of hiring a teacher or making an educational upgrade. But Mr. Bernhard wasn’t complaining.

“We’re just happy that we had enough bidders to show some interest in our school district,” he said, citing the district’s AAA bond rating—the highest.

In California, many districts may soon be seeking to borrow money to help with cash flow, said John B. Mockler, the president of John Mockler and Associates, an educational finance consulting firm in Sacramento.

An interest-rate increase of just half a percentage point on such loans can be significant—about $1.2 million in extra payments on a $250 million, six-month loan, Mr. Mockler said. “That’s a lot of teachers,” he said.

Wall Street Impact

Some districts have more immediate problems linked directly to the collapse of investment giants on Wall Street.

Many school districts, such as those in California’s San Mateo County, put their cash into what are known as local government investment pools until they need it. The money San Mateo lost with Lehman Brothers included some funds for district capital expenditures, as well as some operating funds.

Mr. Buffington, the San Mateo County treasurer, said it’s possible that the county could recover anywhere from 20 percent to 60 percent of the investment a year from now, after bankruptcy proceedings take place, or that the county could receive some reimbursement under the federal rescue package.

“In the meantime, there’s a world of hurt out there,” he said.

One potential problem: California requires school districts to keep a 3 percent cash reserve on hand, and the loss of the investments is going to make that difficult in some districts, Mr. Buffington said.

Patrick Gemma, the superintendent of the 8,200-student Sequoia Union High School District, estimates the district lost about $6 million in the county’s Lehman Brothers fund. Some of that money was slated for capital improvements now likely to be delayed, and some for district operations—a loss that could lead to layoffs, Mr. Gemma said.

“We’ve hit the perfect storm,” he said, citing California’s budget woes. “Added on top of that is this shortfall in funds.”

The recent bankruptcies and mergers among financial giants have also caused some nail-biting elsewhere.

Several states, including Texas, require that any money school districts have in banks over the $100,000 Federal Deposit Insurance Corp. insured limit—now upped to $250,000 by the rescue legislaton—be collateralized. In essence, that means the banks themselves must insure the funds, said Art Martin, the assistant superintendent for financial services in the 28,600-student Lubbock Independent School District.

Keeping Watch

Still, district financial managers are keeping a close watch even on those investments typically considered safe.

Mohsin Dada, the assistant superintendent for business and the treasurer of the Schaumbug School District 54 in Illinois, said his district receives two installments of local property-tax money a year. He said the district invests the money in certificates of deposit, or in funds that mature the day payroll is due, to get the most interest possible.

If the district had trouble getting access to those funds or investment vehicles—even for a short period—it could cause turmoil, Mr. Dada said. For now, however, he is comfortable with the district’s investments, he said.

“We are alert, but not concerned,” Mr. Dada said.

The credit crisis is also being felt in ways that could have long-term effects in many districts, especially when it comes to construction and other capital projects.

In some states, school districts sell bonds themselves. In others, a state or local entity arranges the sales of bonds and passes the money on to the districts.

In Maine, officials decided to delay the 12 planned projects because interest rates on the bonds needed to finance them would have been significantly higher than budgeted, said Jim Rier, the director of finance and operations for the Maine Department of Education.

A recent sale of state bonds came at an interest rate of 5.25 percent, and Mr. Rier said his department had counted on districts, which deal with the bond issues themselves, getting an interest rate of around 4.8 percent for their bonds.

“It’s significant,” he said of the difference. “Over the term of 20 years, the payments would be much higher.”

In North Carolina, Cumberland County officials put their prospective bond sales on hold after nearby Wake County failed to find buyers for its fixed-rate bonds, most of which would have gone to school projects.

Cumberland County school officials are facing cash-flow concerns, since they’d already gotten bids on their $20 million project for a badly needed elementary school slated to open in 2010.

The county “can’t find the underwriters to acquire that debt on our behalf,” Mr. Lopes said. “We’re scrambling to come up with a Plan B.”

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A version of this article appeared in the October 22, 2008 edition of Education Week as Financial Crisis Now Striking Home for School Districts


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