California Community Colleges—Managing Cash in a Time of State Payment Deferrals

analysis full gutter California Community Colleges—Managing Cash in a Time of State Payment Deferrals December 2020 Summary Districts Began Preparing for State Payment as additional budget data becomes available. Deferrals Several Months Ago. To generate We recommend the Legislature place a high one-time state savings, the 2020-21 budget priority on using these one-time funds to eliminate package deferred $1.5 billion in state payments the K-14 deferrals. Even under our lower-end to the California Community Colleges (CCC) until Proposition 98 estimates, the state could retire 2021-22. (The budget package also deferred some of the K-14 deferrals. At roughly the midpoint $11 billion in state payments to school districts of our Proposition 98 estimates, the state could until 2021-22.) Specifically, the state is scheduled eliminate all of the K-14 deferrals. not to make certain payments to the community Legislature Has Options Regarding Timing. colleges from February 2021 through June 2021, Should the Legislature decide to rescind some or with payments instead being provided over the July all of the K-14 deferrals, it could (1) do so through 2021 through November 2021 period. Districts are immediate midyear action or (2) wait and rescind planning to handle these deferrals by using various as part of the 2021-22 budget package. Under the cash management strategies, including tapping first option, we encourage the Legislature to first their local reserves and borrowing externally from rescind the February through April 2021 deferrals investors. We estimate about one-third of CCC (totaling $7.2 billion in additional Proposition 98 districts are planning to borrow externally. Although spending), then reassess state revenues in April districts indicate deferrals are a major challenge, to determine whether to retain or rescind the May they generally believe them to be manageable this and June deferrals. The second option represents a year. more cautious approach. The first option provides Given Improved State Revenue Situation, greatest benefit to those community college Legislature Could Eliminate Some or All districts relying on their local reserves whereas the Deferrals. In our November 2020 fiscal outlook second option tends to provide greatest benefit to reports, we show that the state’s budget situation those districts relying on external borrowing from has improved considerably compared with June investors (as these districts would receive borrowed 2020 estimates. State revenue estimates have funds upfront that could be invested until needed). been revised upward, as have estimates of school If the Legislature decides to keep any deferrals in and community college funding requirements. place for 2020-21, it could revisit the repayment Particularly due to upward revisions for 2019-20 schedule, potentially paying off all the deferrals and 2020-21, we estimate that the state has a in July 2021 rather than extending repayments significant amount of one-time settle-up funds to through November 2021. The Legislature could spend on schools and colleges, though the exact make these repayment decisions as part of budget amount will not be known for several more months close-out in spring 2021. 2021-22 LAO Budget Series 1 analysis full gutter Introduction To help address the state’s large budget deficit deferrals included in the state’s 2020-21 budget as estimated in June 2020, the 2020-21 budget package, (3) explain how the CCC Chancellor’s package deferred a substantial amount of General Office is implementing these deferrals, (4) discuss Fund payments to schools and community how community college districts are responding, colleges. In this post, we (1) provide background and (5) present options for the Legislature to on community college cash flow and cash consider, particularly given the improved budget management, (2) describe the community college outlook. Cash Flow and Cash Management Cash Position Fluctuates Throughout the reliance on certain fund sources and the timing of Year. A district’s cash position reflects how associated receipts. Depending upon a district’s much cash (assets that are available to spend exact mix of state and local funding and its specific immediately) it has at any given point in time, costs in any given month, a district may have more based on when it incurs expenses and receives expenditures than revenues (resulting in a negative revenue. A district’s expenditures (the largest of cash position or cash deficit) or more revenues than which is employee salaries) are generally even expenditures (resulting in a positive cash position or throughout the year. The largest revenue source for cash surplus). most districts—state General Fund—is generally To Manage Cash Flow, Districts May Use aligned with the timing of expenditures. Districts Reserves and Internal Borrowing. Each district receive state General Fund allocations in monthly maintains a primary account (referred to as its installments, with 8 percent of their total allocations “general fund”) for most operating expenses. It provided in most months. The next largest also maintains separate restricted accounts for revenue source for most districts—local property certain activities that have special rules, such as tax—typically arrives twice per year (in December facility projects, categorical programs, and auxiliary and April), though arrangements vary somewhat enterprises (including parking and health services). by county, with some counties providing more When faced with a cash deficit, districts can draw installments per year. down reserves held in their primary operating Districts’ Cash Positions Throughout the account. Statute also allows districts to borrow Year Depend Partly on Mix of Revenue Sources. from other accounts to manage their cash position. Districts vary widely in terms of their reliance on Unlike with schools, statute does not place limits state General Fund and local property tax revenue. on the amount that community colleges can borrow In 2019-20, 10 of CCC’s 72 locally governed internally or the duration of these loans. districts received 85 percent or more of their Districts May Also Borrow From External apportionment funding (general purpose monies) Sources. Districts prefer to use reserves and from the state General Fund. At the other end of interfund borrowing to manage cash, as these the spectrum, nine districts received 85 percent options are no-cost or low-cost and administratively or more of their apportionment funding from local simple to use. If these options are not sufficient property tax revenue. (In 2019-20, seven of these to generate needed cash, districts can turn to nine districts were “excess tax” districts, meaning external options. One external borrowing option their local property tax revenue exceeded the available to districts is issuing tax and revenue entire amount they were entitled to receive under anticipation notes (TRANs). Investors purchase the main community college funding formula.) A TRANs, and districts pay them back with interest, district’s cash position can vary as a result of its typically within 13 months of issuance. Because 2021-22 LAO Budget Series 2 analysis full gutter each TRAN has issuance costs (including legal during the dot-com bust but relied much more fees and transaction fees), districts commonly form heavily on them during the Great Recession. The groups (or pools) to sell the notes. Historically, practice of deferring college payments peaked several organizations have administered TRAN in 2011-12, when the state deferred a total of programs for community colleges, including the $961 million in CCC payments—accounting for Community College League of California (an nearly 30 percent of CCC Proposition 98 General association representing CCC trustees and chief Fund support. When these deferrals were in effect, executive officers) and the California School Boards districts received state payments several months Association (which allows colleges to pool together late, leading districts to have unusually large cash with schools). In addition to borrowing from private deficits. investors, community college districts are permitted Districts Relied on TRANs to Handle Deferrals to borrow from county treasurers and county offices During the Last Recession. During the Great of education. In these cases, districts typically are Recession, a few districts had sufficient reserves charged the same interest rate for the borrowed and internal borrowing options to weather the cash as what the county agency would have earned deferrals without turning to external borrowing. had it retained the cash in a short-term investment Most districts, however, relied on TRANs to account. The availability of county borrowing secure enough cash to meet their expenditure options varies, partly because county agencies face commitments while awaiting state payments. As their own cash flow issues. with all TRANs, these TRANs came with issuance In Previous Recessions, State Deferred and interest costs that districts had to pay until Payments to CCC. In past recessions, the state they no longer needed to use the notes for cash has authorized some college spending in one flow purposes. Buoyed by a recovering economy fiscal year but not provided the associated cash and increased revenue from a tax increase on until the following fiscal year. These payment high-income earners (Proposition 30, approved in deferrals have allowed districts to maintain their 2012), the state eliminated all of these deferrals by programs—provided they can access the cash to the end of 2014-15—generally negating districts’ cover associated expenditures while awaiting state continued need to use TRANs to manage their cash funds. The state began using payment deferrals flow. Recent State Budget Actions Budget Package Relied on New Round spending cuts. Instead, the final budget relied of Deferrals. Proposition 98 constitutionally almost exclusively on deferrals. Specifically, the governs the minimum amount of funding provided 2020-21 budget maintained the 2019-20 deferrals to schools and community colleges each year. and added another $1.1 billion in CCC payment In June 2020, the state estimated that the deferrals from 2020-21 to 2021-22. (It also deferred Proposition 98 minimum guarantee had dropped $9.2 billion in state payments for schools—for a notably for both 2019-20 and 2020-21 relative total of $10.3 billion in K-14 deferrals.) Combined, to assumptions it had made one year earlier (in $1.5 billion in Proposition 98 funds intended for June 2019), prior to the pandemic. To adjust community colleges in 2020-21 is not scheduled to the lower 2019-20 minimum guarantee, the to be paid until the first half of the next fiscal year. revised 2019-20 budget included $330 million (Under the 2020-21 budget package, $791 million in CCC deferrals (and $1.9 billion in deferrals of the $1.5 billion was to be rescinded if the state for schools). For 2020-21, the Legislature received additional federal relief funding by October rejected the Governor’s May Revision proposal to 15, 2020, but no such funding was received by reduce Proposition 98 spending for community that date.) In the box at the end of this section, we colleges through a combination of deferrals and discuss the potential limit to additional deferrals 2021-22 LAO Budget Series 3 analysis full gutter were the state budget to deteriorate significantly Budget Includes Deferral Exemption. Trailer over the next couple of years. legislation permits the state to exempt a community Districts to Experience a Series of Late college district from deferrals if it meets certain Payments. Trailer language contains the exact financial hardship criteria. The qualifying criteria amounts and timing of the newly instituted deferrals for such an exemption are the same as those (Figure 1). Deferrals are to start in February 2021. used to qualify a district for an emergency loan For the February deferrals, districts are scheduled from the state—generally that a district would to wait nine months (until November) to receive otherwise be unable to meet its payroll expenses. their payments. Regarding which programs to pay Districts seeking an exemption must submit an late, provisional language directs the Chancellor’s application to the Chancellor’s Office at least two Office to defer districts’ apportionment payments, months in advance of the scheduled deferral. and, if necessary, categorical program payments. Trailer language allows the state to provide a total Given the deferrals authorized in 2020-21, the state of up to $30 million per month in exemptions (up will pay only about 75 percent of Proposition 98 to $60 million under certain circumstances). By General Fund to colleges on time. In effect, the August 1, 2021, the Chancellor’s Office must notify state is set to send a large amount of cash to the Joint Legislative Budget Committee of the districts in 2021-22 for programs they will have districts requesting and receiving exemptions for already operated in 2020-21. 2020-21. Figure 1 Budget Relies Heavily on Deferring Payments to the California Community Colleges Deferrals Included in 2020-21 Budget Package 2021 Feb Mar Apr May June July Aug Sept Oct Nov $300 Million $300 Million $300 Million $300 Million $300 Million $300 Million $300 Million $300 Million $253 Million $253 Million 2021-22 LAO Budget Series 4 analysis full gutter The Limits of Deferrals When we began researching this summer how community colleges were responding to the latest round of Proposition 98 payment deferrals, many budget makers were wondering whether the state would need to enact additional deferrals in 2021-22. Since this summer, the state’s budget outlook has improved considerably. The very large difference between the June 2020 and November 2020 revenue estimates, however, reflects the greater uncertainty the state is facing due to the pandemic. Were the state to see another large swing, but in the negative rather than positive direction, it might find itself once again contemplating Proposition 98 payment deferrals. Below, we identify several issues for the Legislature to consider were additional deferrals to be pursued in the future. Likely a Practical Limit to Additional Deferrals. As deferrals mount, the borrowing burden on schools and colleges increases. Typically, once the state is deferring several months of payments, many districts, especially those with low reserve levels, must turn to external borrowing. These districts incur issuance and interest costs to maintain their programs as long as the deferrals remain in effect. In advance of issuing tax and revenue anticipation notes (TRANs), districts need time to prepare several documents, including a cash flow analysis. Districts tend to need three to four months advance notice to complete all the steps entailed before receiving TRANs proceeds. Taking into account these factors, we think the state likely could defer no more than about eight months of Proposition 98 payments before districts encountered administrative obstacles. Some Investors’ Appetite for TRANs Is Limited. As deferrals mount, TRANs also can become less attractive to investors. For example, the state deferring eight months of Proposition 98 payments could signal that its reserve levels had shrunk and its fiscal management had worsened, with ripple effects for schools and colleges. At this point, some investors might get out of the TRANs market and decide to turn to safer, more promising short-term investment options. While some investors might remain in the TRANs market, the interest cost that districts incurred for TRANs likely would increase. Though these costs are historically low today, they could be higher the next time the Legislature adopts new deferrals. Deferrals Impose Challenge for Budget Moving Forward. Deferrals allow the state to generate one-time savings while allowing districts to sustain program spending for one year. As deferrals mount, being able to fill the gap between program spending and funding becomes less likely. If revenues and the Proposition 98 minimum guarantee do not grow enough the following year to fill the funding gap, program cuts or other budget solutions such as tax increases are required. In this situation, the deferrals give only a one-year reprieve from program cuts, with cuts delayed but likely not avoided. Moreover, having to double-up payments in the future to eliminate deferrals and get payments back on schedule comes at the expense of other budget priorities. Effectively, the state at that time is having to use available funds to support programs that districts already have provided rather than supporting new or expanded programs. As deferrals mount, future budget options thus become less attractive. 2021-22 LAO Budget Series 5 analysis full gutter Implementation of Deferrals Apportionment and Some Categorical a disproportionate impact of the deferrals on Payments Are Being Deferred. To comply with districts that rely heavily on state funding. Under the deferral amounts and months specified in the the Chancellor’s Office’s methodology, each 2020-21 budget package, the Chancellor’s Office district is to receive at least 83 percent of its total plans to make no apportionment payments to apportionment amount—from local and state districts from February through June 2021 (unless sources combined. If a district receives more a district receives a deferral exemption). This action than this resulting apportionment amount entirely results in a total of $1.1 billion in payment deferrals. from local sources, it will not receive any state To achieve the statutorily required $1.5 billion in apportionment payments in 2020-21. (All districts deferrals, the Chancellor’s Office is also deferring will reach 100 percent of their total 2020-21 to 2021-22 just over $400 million in payments apportionment amounts once the last deferred from a categorical program (the Student Equity payment has been made in 2021-22.) and Achievement Program). The Chancellor’s Chancellor’s Office Has Created an Office selected this program as it is the largest Application for Hardship Exemption. In October, categorical program whose funds are allocated the Chancellor’s Office released a form and primarily based on enrollment. As a result, deferring instructions on how districts can request a deferral associated program payments impact districts exemption. The process requires a district to submit more or less proportionally. (In an effort to improve a cash flow projection showing that it cannot meet districts’ cash position, the Chancellor’s Office is its financial obligations without an exemption from using its administrative flexibility to provide about one or more of the upcoming deferrals. In reflecting $300 million in certain other categorical program available resources, the projection is to include the funds to districts earlier than otherwise—in the district’s revenues, unrestricted reserves, and the first half rather than the latter half of 2020-21, as availability of any funds accessed through TRANs normally would be the case.) or other loans (including interfund borrowing). Chancellor’s Office Is Spreading Impact The first application—a request for an exemption Across All Districts. In making apportionment from the February 2021 deferral—was due to the payments from July 2020 through January Chancellor’s Office by December 1, 2020. The 2021 (a total of $1.6 billion in payments), the Chancellor’s Office did not receive any first-round Chancellor’s Office is using an approach designed applications. The second application—a request for to even out the impact of the deferrals among an exemption from the March 2021 deferral—is due districts. Specifically, the Chancellor’s Office to the Chancellor’s Office by January 1, 2021. intends to minimize what would otherwise be District Responses Districts Using a Variety of Means to Handle perspective. Although several districts cited Deferrals. Throughout summer and fall 2020, deferrals as the greatest financial challenge facing we contacted more than two dozen community them this year, none of the districts we heard from college districts to learn how they were responding said the deferrals were unmanageable. Districts to the newly instituted deferrals. The districts we indicated they are planning to use a combination of contacted varied by size, geographic location, both internal and external sources to manage cash reserve levels, and reliance on General Fund for in 2020-21. their apportionment payments. We also spoke with Many Districts Have Applied for a TRAN… the Chancellor’s Office for a broader systemwide Districts indicated they prefer to use internal 2021-22 LAO Budget Series 6 analysis full gutter sources to manage their cash to avoid the time 1 percent. Rates are so low that districts will and cost of external options. Due to the size of the likely have an opportunity to generate short-term scheduled deferrals, though, a number of districts investment earnings that can fully offset their costs we heard from indicated they were seeking a of borrowing. This is because districts receive all TRAN. Districts have several TRANs programs to their TRAN proceeds upfront. In turn, they typically choose from this time, including longer-established invest these proceeds in county investment pools programs offered by the Community College until they need the cash to cover monthly operating League of California and California School Boards costs. Currently, county investment pools generally Association, as well as new programs created by are earning more than half of 1 percent. In some the California School Finance Authority (a unit of cases, county investment pools are earning more the State Treasurer’s office) and the Foundation than 1.5 percent—well above typical borrowing for California Community Colleges (the official costs for TRANs. nonprofit auxiliary of the Chancellor’s Office). For County Options Seen as Less Viable by most of these TRANs programs, districts had until Districts. In on our conversations with districts, a October or November 2020 to apply for the first couple indicated they are seeking a loan from their issuance. Based on our discussions with these county treasurer. Most districts, however, do not programs, we estimate that about one-third of see this as a viable option, explaining that (1) their CCC districts—a mix of small, medium, and large county prefers to provide loans only within a fiscal districts—applied for a TRAN in this first round. year, not across fiscal years; (2) they may have to Currently, the programs are in the process of compete for county loans with school districts, working with these districts to analyze their cash which also are subject to deferrals in 2020-21; and flows to help determine the appropriate amount of (3) some counties appear to be facing their own TRANs to issue. The programs indicate they may cash challenges due to wildfires and coronavirus offer subsequent application rounds in the first few disease 2019-related costs. No district we heard months of 2021. from was reaching out to a county office of …And Can Expect Relatively Low Costs of education as a possible lending source. County Borrowing. According to TRAN program staff offices of education are subject to K-12 deferrals, we contacted, borrowing costs for districts are so they may be experiencing their own challenges expected to be very low. Based on current market accessing cash. conditions, interest rates are less than half of Options to Consider Since the state adopted the 2020-21 budget Below, we identify issues for the Legislature to in June 2020, it has received updated data on tax consider regarding these deferrals. collections and program spending. In our recently Unprecedented Rebound in the Outlook released reports, The 2021-22 Budget: California’s for Proposition 98 Funding. Our recent Fiscal Outlook and The 2021-22 Budget: The Fiscal budget reports show that state revenues are Outlook for Schools and Community Colleges, on track to be much higher than the June we show that the budget situation has improved 2020 estimates. The much higher revenue considerably compared with June 2020 estimates. projections contribute to much higher estimates Continued uncertainty about the course of the of the Proposition 98 minimum guarantee. Prior pandemic and underlying economy, however, to 2020-21, the largest upward revision to the clouds our forecast. As the Legislature thinks minimum guarantee (relative to the enacted about its budget priorities within this revised fiscal budget) was $6.3 billion (10.3 percent) in outlook, it likely will want to assess the possible 2014-15. Compared with the estimates of the implications for Proposition 98 payment deferrals. minimum guarantee in the June 2020 budget 2021-22 LAO Budget Series 7 analysis full gutter plan, we estimate the 2020-21 guarantee is up the scheduled current-year deferrals but eliminate $13.1 billion (18.5 percent). We project that the them going forward as part of the 2021-22 budget. Proposition 98 increase is sustained in 2021-22, Below, we discuss these two options. with the guarantee that year a little higher than If Legislature Desires Midyear Action the 2020-21 guarantee. When combined with on Deferrals, Recommend Using Cautious changes in the 2019-20 guarantee and certain Approach. Our estimate of state revenues— other adjustments, we estimate that the state and the resulting Proposition 98 guarantee and has about $13.7 billion that it needs to provide to availability of one-time Proposition 98 funds in settle up to the higher estimates of the guarantee. 2020-21—is subject to notable uncertainty. If the The Legislature could use these settle-up funds Legislature decides to take early action (option 1), for any one-time school or community college we thus would suggest a cautious approach. In purpose. Although we are relatively confident that January 2021, the Legislature could call off some, 2020-21 revenues will exceed June estimates, but not all, of the scheduled monthly deferrals. actual revenues could come in below our November For example, it could rescind the February estimates. In this case, the 2020-21 minimum through April 2021 deferrals (which total about guarantee—and the resulting amount of one-time $7.2 billion between K-12 and CCC) but leave Proposition 98 funds to spend—also would be intact the deferrals scheduled for May and June several billion dollars lower than our November 2021. Even under our lower-end estimates of the estimate. guarantee for 2020-21, we estimate the state Legislature Could Eliminate Existing could accommodate the additional Proposition 98 Deferrals. Regardless of the exact amount spending associated with undoing the February of one-time Proposition 98 funds available, through April deferrals. Depending on spring tax the Legislature will face a key decision about collections, the state then could decide in April how to allocate these funds. Any amount of whether to retain or rescind the May and June $12.5 billion or more would be sufficient to deferrals. Under this two-step approach, some eliminate all the K-14 Proposition 98 payment districts might still need TRANs (if their internal deferrals. (Eliminating deferrals requires a borrowing options are insufficient to cover the one-time Proposition 98 payment, as well as a smaller remaining May and June deferral load), but Proposition 98 minimum guarantee that is high the amount of external borrowing statewide would enough to accommodate the ongoing program be much less than otherwise. spending moving forward.) We recommend the Legislature Would Need to Act Soon Should Legislature place a high priority on eliminating K-14 It Choose Midyear Option. The Legislature would deferrals. Eliminating all or part of these deferrals need to take budget action in January 2021 since has several advantages. Notable advantages are the first payment deferral is set to begin in February reducing districts’ need for internal and external 2021. Some advance action is required because borrowing, reestablishing the link between ongoing districts need to finalize the amount of TRAN program costs and ongoing funding, and giving the proceeds they require before the notes are sold to Legislature more budget tools to respond to future investors in February. Once TRANs are sold, any economic downturns. (Other options for using subsequent decision by the Legislature to rescind one-time Proposition 98 settle-up funds include or reduce the remaining deferrals will not eliminate addressing student learning loss and reducing the borrowing costs for the districts. Once issued, districts’ unfunded pension liabilities.) TRANs have a fixed maturity date and cannot be Two Main Options Regarding Timing. Should paid off early. the Legislature decide to prioritize available Option 1 Would Benefit Many, but Not All, one-time funds for deferral paydowns, its next Districts. Specifically, this option would benefit decision involves timing. The Legislature could the approximately two-thirds of CCC districts (plus (1) rescind the deferrals (either partially or fully) many school districts) that are planning to use through immediate midyear action or (2) retain their reserves or borrow internally in response to 2021-22 LAO Budget Series 8 analysis full gutter the deferrals. By rescinding some of the deferrals That is, option 2 benefits those districts pursuing and receiving associated on-time payments from TRANs while not benefiting those districts relying the state, these districts would not need to draw on their reserves and internal borrowing. Under down their reserves or borrow internally to cover option 2, the districts receiving TRANs could their monthly operating costs. They therefore would benefit from additional investment earnings whereas remain in better fiscal health and earn more interest districts needing to draw down their reserves would on their reserves than had the deferrals been earn less than otherwise. kept in place. Perhaps surprisingly, rescinding the Under Either Option, Legislature Could current-year deferrals would not necessarily benefit Accelerate Repayment. If the state were to leave those districts that otherwise would have obtained some deferrals in place in 2020-21, it might be a TRAN. Though not the intended objective of able to accelerate the schedule for repayment. For TRANs, many, if not all, districts pursuing TRANs example, rather than repaying the May deferral in might benefit from the transaction, as they August, as originally scheduled, the state could would receive TRANs proceeds upfront and their repay in July. Even if the Legislature pursued option short-term investment earnings could exceed their 2 and left all the deferrals in place in 2020-21, borrowing costs. it still might be able to repay all deferrals in July Options 2 Also Has Benefits and Drawbacks. 2021 rather than stretching repayments from Option 2—paying off deferrals as part of the July 2021 through November 2021, as currently 2021-22 budget package—reflects an even more scheduled in statute. The Legislature could make cautious approach than option 1, with the state these repayment decisions as part of budget keeping all the deferrals in place through June close-out in spring 2021. At that time, it would have 2021. The trade-offs entailed in option 2 are updated data on its tax collections and available basically the reverse of those entailed in option 1. cash. LAO Publications This report was prepared by Paul Steenhausen, and reviewed by Jennifer Pacella and Anthony Simbol. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. 2021-22 LAO Budget Series 9