Analyzing Recent Changes to State Support for Fiscally Distressed Districts

Analyzing Recent Changes to State Support for Fiscally Distressed Districts MAC TAYLOR LEGISLATIVE ANALYST DECEMBER 2018 Summary In 1991, State Created Formal Process for Supporting School Districts in Fiscal Distress. This system provides escalating tiers of support and intervention to districts based on their fiscal health. All districts are subject to ongoing fiscal oversight from their county office of education (COE). Districts exhibiting signs of fiscal distress receive special COE assistance. Districts facing exceptional fiscal distress and unable to pay their bills can request an emergency state loan in exchange for temporarily ceding control to an outside administrator. Prior to 2018, these administrators were appointed and overseen by the state Superintendent of Public Instruction. Recent Legislation Changed This Longstanding Process. Trailer legislation adopted as part of the 2018-19 budget package made three notable changes to the process for supporting districts in exceptional fiscal distress. First, it authorized special grants to supplement the loans already provided to the Inglewood and Oakland Unified school districts. Second, it shifted takeover responsibilities from the state to county level. Third, it established a new process for appointing outside administrators. Some of the Recent Changes Undermine the Strengths of Longstanding Process. Under the state’s historical district oversight and takeover process, relatively few districts required emergency loans and those that did typically returned to fiscal health and repaid their loans ahead of schedule. By providing special grants to two fiscally distressed districts, the state likely has weakened incentives for all districts to make the tough decisions necessary to balance their budgets. In addition, shifting takeover responsibilities from the state to county level could weaken oversight, as the state is better positioned to provide the independent, external perspective necessary for fiscally distressed districts to recover. Recommend Returning to Historical Process. We recommend supporting the Inglewood and Oakland Unified school districts within the traditional loan process. If additional support for these districts is deemed necessary, we recommend providing loan payment deferrals in exchange for greater state oversight. In addition, we recommend shifting takeover responsibilities back to the state from the county level. INTRODUCTION Recent legislation made several changes to the report, we provide background on how the state state’s system for intervening in fiscally distressed historically has intervened in fiscally distressed school districts. These changes could have significant districts, describe and assess the recent implications for districts moving forward. In this changes the state made, and offer associated recommendations. analysis full gutter AN LAO REPORT HISTORICAL OVERSIGHT AND and resubmit their budgets until they are approved by their COE. (In rare circumstances, districts can TAKEOVER PROCESS appeal to an outside authority to resolve budget Below, we discuss the state’s historical process disputes with their COE.) During the fiscal year, all for conducting routine oversight of school district districts are required to submit two budget updates budgets, then discuss emergency state loans and to their COE—one in the fall and the other in the takeovers. This process was adopted in 1991 and spring. For each of these budget updates, COEs continued until altered by trailer legislation in 2018. assign a positive, qualified, or negative certification. Figure 1 explains each of these terms. Oversight of District Budgets Districts Struggling to Balance Their Budgets Prior to 1991, State Had No Formal Process Receive Targeted COE Support. Districts with for Overseeing District Budgets. Lacking any qualified or negative certifications receive additional formal oversight process, many school districts COE oversight and assistance. In these cases, during this period went years without resolving COEs choose from a menu of possible interventions budget imbalances. Some ultimately faced major (see Figure 2). COE interventions are designed fiscal crises. Between 1979 and 1991, a total of to escalate as problems persist or become more 26 districts requested and received emergency severe, such that districts with negative budget state loans. One large district (Richmond Unified) certifications may receive both a first- and declared bankruptcy. The Richmond bankruptcy second-level intervention. Historically, most districts spurred legal challenges, and, in Butt v. California, receiving targeted COE support have quickly the California Supreme Court ruled the state is restored their fiscal health. obligated to assist districts in fiscal distress. The Fiscal Crisis and Management Assistance State Created Oversight Process in 1991. Team (FCMAT) Gives Districts Expert Advice. The state’s formal oversight process is named after To assist COEs in supporting districts in fiscal its initiating legislation—Chapter 1213 of 1991 distress, AB 1200 created a team of fiscal experts (AB 1200, Eastin). Under the AB 1200 process, all to conduct in-depth studies of district budgets and districts are subject to ongoing fiscal monitoring recommend specific steps for improving their fiscal and districts experiencing fiscal distress are offered escalating tiers of assistance and intervention. Below, we describe Figure 1 these aspects of the process in COEs Assign Each of Their Districts a Budget Rating more detail. All Districts Receive Ongoing COEs review the fiscal health of their school districts at least two Fiscal Monitoring by County times per year. Based on these reviews, each district receives one of Offices of Education (COEs). the following budget ratings: Before the start of each fiscal year, all districts are required to submit Positive: the district will meet its fiscal obligations for the 59% their projected budgets to their current and upcoming two years. 60% COE for review. COEs are tasked with approving, disapproving, Qualified: the district may be unable to meet its fiscal or conditionally approving obligations for the current or upcoming two years. these budgets. In making their determinations, COEs are to Negative: the district will be unable to meet its fiscal obligations for the current or upcoming years without examine several indicators of corrective action. district fiscal health, such as district reserve levels and salary and benefit costs. Districts with COEs = county offices of education. disapproved budgets must revise 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT health. The Kern COE manages FCMAT through a board members in these districts lose all state contract. decision-making authority and any compensation. (A district receiving a particularly small state loan is Emergency State Loans and Takeovers exempted from these takeover conditions.) Districts in Exceptional Distress May Request District Bears Costs of Loan and Oversight. an Emergency State Loan. In rare cases, School districts receiving state emergency loans districts lack the cash necessary to pay their bills. are responsible for paying the associated issuance These districts may request a state loan. Prior to and interest costs. Districts’ loan payments typically requesting a state loan, a district’s local governing are scheduled over a 20-year period. These board must invite FCMAT to make a presentation districts also must pay for the salaries of fiscal on associated trade-offs, including the loss of local experts, the outside administrator and trustee, control that accompanies a state loan (discussed auditors, and other employees who have been hired below). The board must then adopt a formal to provide assistance to the district. The authorized request for state assistance. The Legislature and loan amount is intended to provide the district with Governor must then consider whether to approve sufficient funds to pay its regular bills as well as the loan, with authorization given through a state meet these special loan-related obligations. appropriations bill. Districts Remain Subject to COE Oversight Upon Receiving an Emergency Loan, District Even After Receiving State Loans. A district Cedes Authority to an Outside Administrator. managed by an outside administrator still must Historically, the state Superintendent of Public submit projected budgets and budget updates Instruction has appointed and overseen this to its applicable COE for review. Retaining this administrator. The administrator has full control review step ensures COEs remain aware of all fiscal over the district’s budgets and policies. School developments within their districts. Figure 2 County Offices of Education Are Required to Assist Districts in Fiscal Distress First-Level Intervention for Qualified and Negative Districts For All Qualified and Negative Districts, COEs Must: • Review a third budget report (submitted by district at the end of the school year). • Review and comment on proposed district collective bargaining agreements. • Approve issuance of certain types of district debt. In Addition, COEs Must Do at Least One of the Following: • Assign a fiscal expert to the district. • Conduct a study of the district’s financial condition. • Require a report on the district’s financial projections. • Require an update of the district’s cash flow and expenditure estimates. • Require that the district submit a proposal to address its fiscal health. • Assign FCMAT to review the district’s management of its teacher workforce. • Withhold compensation from the district superintendent or governing board members if they do not provide all requested information. Second-Level Intervention for Negative Districts COEs Must Do at Least One of the Following: • Assign a fiscal advisor to the district. • Develop and impose district budget revisions in consultation with the state Superintendent of Public Instruction and local governing board. • Overturn local governing board action. • Assist in developing district budget or financial recovery plan. COEs = county offices of education and FCMAT = Fiscal Crisis and Management Assistance Team. www.lao.ca.gov 3 analysis full gutter AN LAO REPORT Districts Must Demonstrate Good 2021-22. The districts’ operating deficits will be Management Before Returning to Local Control. determined by FCMAT, with the concurrence of After the district receives a state loan, FCMAT the Department of Finance. The operating grants sets performance standards for that district in five have some associated requirements, but those key areas: (1) financial management, (2) student requirements are no more stringent than those achievement, (3) personnel management, already imposed as a condition of receiving state (4) facilities management, and (5) community loans. Specifically, Chapter 426 requires both relations. Upon meeting the standards in a districts to update their operational and facility certain area, the administrator gives associated plans by March 1, 2019. By March 1 of each year management control back to the local governing through 2021, FCMAT, with concurrence from the board. After the board regains control in all five two applicable COEs, is to report to the Legislature areas and the administrator determines the district and the Department of Finance on progress is likely to comply with its recovery plan, the these districts have made to improve their budget administrator leaves. This process of regaining local conditions. control typically takes several years. Shifts Takeover Responsibilities From State to Trustee Remains With District Until Loan Counties. Chapter 426 shifts the responsibility for Retired. After the administrator leaves, the state appointing and overseeing the outside administrator Superintendent of Public Instruction appoints a from the state Superintendent of Public Instruction trustee to oversee the district. The trustee serves to the applicable county superintendent of schools. until the district has repaid its loan in full. During Establishes a New Process for Appointing this period, the trustee has the power to overturn Administrators and Trustees. Under the new local governing board decisions that jeopardize Chapter 426 process, FCMAT prepares a list of the district’s fiscal health. The power of the potential candidates and discloses the list for trustee, however, is weaker than that of a state public input. From this list, the applicable county administrator, as a trustee cannot make decisions superintendent of schools makes the appointment, proactively on the district’s behalf. with the concurrence of the state Superintendent of Public Instruction and the president of the RECENT CHANGES State Board of Education. Historically, the state Superintendent of Public Instruction made Recent Trailer Legislation Makes Three appointments through an informal and confidential Changes to Emergency Loan and Takeover process. Process. Chapter 426 of 2018 (AB 1840, Committee on Budget) makes three changes ASSESSMENT to the process for overseeing districts receiving state loans. One of these changes applies to two Below, we discuss our assessment of the specified districts over the next few years, whereas state’s fiscal oversight process and the changes the other two apply to all districts receiving state recently made to it. Bottom line, we believe the loans moving forward. AB 1200 process generally was effective and Authorizes Grants (Not Loans) to Cover a caution against most of the recent changes made Portion of Two Fiscally Distressed Districts’ to it. Operating Deficits. For the Inglewood and Historical Oversight Process Has Oakland Unified school districts, Chapter 426 authorizes three years of state grants to Worked Well to Date supplement the state loans the districts previously Most Districts Have Found Local Solutions received. Specifically, the state authorizes grants to Fiscal Challenges. As Figure 3 shows, a totaling 75 percent of each district’s operating small share of districts typically receives qualified deficit in 2019-20, 50 percent of their deficits or negative certifications. The share of districts in 2020-21, and 25 percent of their deficits in struggling to balance their budgets, however, tends 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT to increase during economic Figure 3 recessions. From 2008-09 through In Most Years, A Small Share of Districts 2012-13, for instance, the share Have Poor Budget Ratings of districts with qualified budget ratings was significantly higher than during stronger economic 20% times and the share of districts with negative ratings was 15 somewhat higher. Despite the ebb and flow of districts with Qualified qualified and negative ratings, 10 most districts receiving one of these poorer budget ratings have quickly returned to fiscal 5 health without requesting state Negative loans. This suggests the AB 1200 system has helped districts 01-02 05-06 09-10 13-14 17-18 address budget imbalances and regain their fiscal footing. Relatively Few Districts Have Received Emergency State districts continuing to face declining enrollment and Loans. As Figure 4 shows, only nine districts rising pension costs. have received emergency state loans since Districts Have Typically Paid Back State AB 1200 passed in 1991. By contrast, 26 districts Loans Ahead of Schedule. As Figure 4 shows, received state loans in the 12 years preceding the first district to receive an emergency loan under 1991. Of the nine districts that received loans in AB 1200 took about 20 years to retire it. The next the AB 1200 era, only three requested loans in four districts to receive emergency loans, however, the immediate wake of a recession—suggesting all retired their loans substantially ahead of most districts requiring loans have systemic issues schedule—after fewer than nine years on average. that go beyond dealing with a tough economic The four districts to receive state loans more environment. Notably, no district during the past recently still are paying off their loans. six years has requested a state loan, despite many Figure 4 Nine Districts Have Received State Loans Since 1991 Total Year of Current Loan Amount Loan School District Legislation Oversight (in Millions) Pay-Off Year Inglewood Unified 2012 Administrator $29 2033 South Monterey County Joint Union High 2009 Trustee 13 2028 Vallejo City Unified 2004 Trustee 60 2024 Oakland Unified 2003 Trustee 100 2023 West Fresno Elementary 2003 — 1.3 2010 Emery Unified 2001 — 1.3 2011 Compton Unified 1993 — 20 2001 Coachella Valley Unified 1992 — 7.3 2001 West Contra Costa Unified 1991 — 29 2012 www.lao.ca.gov 5 analysis full gutter AN LAO REPORT Credit Rating Agencies View California’s predictable series of steps before seeking state Oversight Process as Model. The agencies that support. By contrast, the state’s recent actions provide school districts with credit ratings tend to create precedent for aiding districts at unscheduled view the AB 1200 process as a model for state times and for unspecified reasons. This approach oversight and intervention. Rating agencies cite creates more uncertainty for both districts and the two features as particularly important to AB 1200’s state, with both parties less able to predict when success: (1) its predictability, as the state and intervention will come, the form it will take, and COEs offer escalating levels of support following what will be the associated costs. If even a few a uniform monitoring and evaluation process; and large districts unexpectedly sought state grants, (2) its “carrot and stick” approach, under which the cost pressure on the state budget likely would districts receive state aid only in exchange for be notable. agreeing to pay all recovery costs and temporarily Providing Grants Undermines Principles of ceding local control. These features ensure districts Core School Funding Formula. Since 2013-14, are aware of their fiscal issues and have the California has provided most school funding incentive to resolve those issues at the local level. through LCFF. One principle of LCFF is that all districts should receive equal state funding based Providing Grants Undermines on student need. Providing extra state grants to Historical Oversight Process just two districts undermines this equity principle. We estimate the proposed operating grants for FCMAT Believes the Two Districts Could 2019-20 would increase per-student funding to Balance Their Budgets Without State Grants. Inglewood by 4 percent and Oakland by 15 percent Although both the Inglewood and Oakland Unified as compared to other districts with similar student school districts face serious fiscal challenges, populations, such as the Compton and Hayward FCMAT has identified feasible options for both Unified school districts. districts to balance their budgets absent special state grants. These options include adjusting New Takeover Process employee benefits, consolidating schools, and Has Notable Weaknesses downsizing administrative overhead. Though such decisions are difficult, the state has notably eased The State, Not COEs, Holds Ultimate both districts’ fiscal condition by providing them Responsibility for Districts With State Loans. substantial funding increases under the Local Under the Supreme Court’s ruling in Butt v. Control Funding Formula (LCFF). Under LCFF, California, the state is ultimately responsible for per-student funding has increased by 57 percent assisting school districts in exceptional fiscal at Inglewood and 46 percent at Oakland since distress. Consequently, the state acts as lender 2012-13. These two districts’ per-student funding of last resort. Upon the Legislature and Governor grew more significantly over this period than a large authorizing a state loan, the state assumes majority of districts statewide. responsibility for ensuring the loan is repaid. Providing Grants Sends Wrong Message Historically, the state has protected this public to Other Districts in Fiscal Distress. If other interest by providing direct oversight of districts districts and unions believe the state might offer while they have outstanding loan amounts. Under them special grants too, they are less likely to the changes in Chapter 426, the state is delegating agree to the difficult decisions necessary to balance this key oversight role to COEs, which may not their budgets locally and manage their operations share the state’s interests or feel the same level of responsibly. This could lead more districts to obligation to retire the state loan. circumvent the traditional oversight process in favor State Offers Independent, External of direct appeals for state assistance. Perspective to Districts in Fiscal Distress. Providing Grants Undermines Predictability Districts seeking state loans typically have of Oversight Process. The state’s traditional deep and persistent budget and management oversight process requires districts to follow a challenges. Some of these challenges reflect 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT powerful constituencies who are unwilling to agree Requiring Concurrence on Administrator to necessary cutbacks. Counties are more likely Selection Could Improve Decision Making . . . than the state to be enmeshed in the political Allowing one elected official to select an challenges facing their distressed districts. Even administrator unilaterally—as was historically counties that have constructive relationships with the case—might result in decisions made their fiscally distressed districts may not want to be for narrow political or personal reasons. For heavily involved in imposing deep district budget example, a superintendent connected to a fiscally reductions. By contrast, the state is more likely to distressed district might be reluctant to appoint provide an independent, external perspective. an administrator willing to impose the deep cuts Shifting Control to Counties Unlikely necessary to balance that district’s budget. These to Address Recent Concerns About State political risks can be mitigated by requiring other Administrators. In proposing the changes to figures, such as other elected officials representing the takeover process, the Brown administration competing political constituencies or nonelected indicated it was concerned with the frequent officials, to concur on administrator appointments. turnover of state administrators assigned to . . . But Also Could Result in Delays and the Inglewood Unified School District. We have Weaken Accountability. Building concurrence spoken with many stakeholders involved in this among parties with competing views often requires state takeover and believe the circumstances in time. Consequently, the new process may result in that district are anomalous. Although the state delays during which the state’s most challenged has experienced some challenges attracting districts are left without a leader. In addition, and retaining effective administrators, these requiring concurrence among multiple parties challenges are unlikely to be overcome by shifting means no single party can be held fully accountable administrator responsibilities to COEs. Takeover for the appointment decision. Moving forward, administrators face a uniquely challenging job, as the Legislature could have difficulty identifying they are solely responsible for making the tough and correcting the causes of poor appointment decisions necessary to recover districts from decisions. serious fiscal distress. Relatively few individuals in the state are both willing and qualified to accept RECOMMENDATIONS such a challenge, and COEs seem no more likely than the state to identify and attract these To Extent Deemed Necessary, Support the individuals. Inglewood and Oakland Unified School Districts With Loan Modifications. We recommend the New Appointment Process Legislature rescind authorization for special Raises Issues for Consideration operating grants to the Inglewood and Oakland Unified school districts over the 2019-20 through Requiring Additional Disclosure Likely to 2021-22 period. If the Legislature wishes to Dissuade Qualified Administrator Candidates provide additional time for these districts to make From Applying. Requiring FCMAT to seek public necessary budget adjustments, we recommend input on a list of administrator candidates will likely considering loan payment deferrals rather than dissuade sitting district superintendents and other grants, as this would preserve the historical qualified persons from applying for these positions. expectation that districts are responsible for paying Few candidates for any job wish to disclose their fiscal recovery costs. We recommend consulting interest to current employers before receiving a new with FCMAT to determine whether the existing job offer. In conversations with successful former repayment schedules for these districts are realistic state administrators, most told us they would not before providing any loan deferrals. have applied had they been required to publicly Attach Meaningful Conditions to Any New signal their interest prior to receiving a job offer. State Support. The state’s historical oversight process has worked in part because it requires www.lao.ca.gov 7 analysis full gutter AN LAO REPORT districts to weigh the benefit of state loans against Remove Disclosure Requirement for the cost of temporarily ceding local control. We Administrator Candidates. Regardless of recommend preserving this trade-off as a condition whether the Legislature chooses to have the of making loan modifications. Specifically, we state or county superintendent of schools appoint recommend the Legislature consider exercising administrators and trustees, we recommend greater state oversight as a condition of providing removing the requirement that FCMAT seek public any loan payment deferrals to the Oakland Unified input on administrator candidates. Relatively few School District. (Unlike the Inglewood Unified individuals have both the experience and interest School District, which is still managed by an to serve as effective administrators and requiring outside administrator, the Oakland Unified School all candidates to publicly disclose that interest will District has been back under local control since likely discourage most potential candidates from 2008.) To help determine what control to take back, applying. the Legislature could ask FCMAT to conduct a review of the district in the five core management CONCLUSION areas. If FCMAT were to find that the district was no longer meeting performance expectations in For schools to keep their doors open, school one or more of those areas, the state could appoint districts must maintain good fiscal health. Local an administrator to assume associated governing school boards are the ones tasked with keeping control. their districts in good fiscal health. These boards are to balance their district budgets each year, even Shift Takeover Responsibilities Back to the when—especially when—doing so requires difficult State. We recommend the Legislature return to trade-offs and decisions. The state’s historical the historical practice of having the state oversee process for overseeing district budgets—giving districts with emergency state loans. The state local boards early warning signs of fiscal problems is likely better equipped than most counties and having COEs help local boards make fiscal to provide effective oversight by offering an corrections—has worked to date to keep the vast independent, external perspective. The state also majority of districts on positive fiscal footing. We is the entity that holds ultimate responsibility for the encourage the Legislature to maintain this system district both retiring its loan and reinstituting good and work within it to help struggling districts. management practices. Although we recognize We are concerned that recent changes could the Legislature may wish to ensure some local weaken the system and result in poorer local fiscal control over fiscally distressed districts, we note management. COEs have historically continued to serve a role in reviewing district budgets even after those districts fall under state control. LAO PUBLICATIONS This report was prepared by Ryan Anderson and reviewed by Jennifer Kuhn. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 8 LEGISLATIVE ANALYST’S OFFICE