July 26, 2021 Breaking News, Latest News, and Videos

SMa.r.t. Column: SMMUSD’s Financial Performance and Underlying Issues

There has been much discussion regarding the SMMUSD’s financial performance.  The Board recently issued a statement noting that they have “Fortified our financial reserves, balanced our budget and Improved our credit rating.”  All good things.  Unfortunately, none of these outcomes are the result of proactive and prudent District financial management.  They are the result either of externally imposed financial oversight discipline or the ability to raise resident taxes. 

As background, of the many district funds that comprise overall spending, the key fund used to measure District financial health by external regulators and credit rating agencies is the Unrestricted General Fund (UGF).  

While publicly accessible published District data is incomplete, there is enough available to obtain a high-level view of the financial situation.

Structural Deficits

The UGF section of the District’s March 5, 2013 Second Interim Budget (i.e., forecast) presentation for the Fiscal Year 2013 (year ending June 30, 2013) noted that “the district has a budget ‘problem’ that requires action.”  It went on to state that “The District spends about $5.8 million more than it takes in annually and fills the gap by dipping into its reserve.”  

In the seven Adopted UGF budgets from FY14 through FY20, all have been in deficit.  The unaudited actual outcomes for those years indicate deficits in 4 of the 7 years.   The most recent completed year of FY2020 had an Adopted UGF budget deficit of ($7.0) million.  The unaudited financial results for FY2020 ended at a ($0.2) million deficit.  Cost savings by the District to narrow the loss comprised up to 80% of the improvement and included foregoing textbook purchases and reducing other operating costs such as legal, travel, and consultants.  Unbudgeted revenues from Measures GSH and Y also contributed to the improved outcome.  

In the current FY2021 financial year, the Adopted Budget was a ($7.2) million deficit while the latest forecast (March 4, 2021 Second Interim Budget) indicates a ($5.5) million deficit.  This may not reflect one-time assistance from state and federal Covid-19 support and/or the American Recovery Plan that could eliminate this year’s operating deficit.  

District Financial Supervision by Los Angeles County

Under California’s County Board of Education structure, County Offices of Education (COE) are tasked with approving the budgets and forecasts of school districts within the County.  SMMUSD is supervised by the Los Angeles COE (LACOE).  A draft resolution for the December 12, 2019 SMMUSD Board Meeting noted that “In a letter dated September 13, 2019, from LACOE, our District is being required to reduce spending to retain fiscal solvency. Based on current projections, our District will need to reduce spending by a minimum of $3 million in 2020-2021 and $6 million in 2021-22 to meet its financial obligations.…” The Board noted in its March, 5, 2020 Second Interim Budget presentation “The District must address deficit spending through the FSP (Fiscal Stabilization Plan) or it will risk future positive (LACOE) certifications. “   

The June 25, 2020 FY21 Adopted (UGF) Budget remained in deficit by ($7.2) million but indicated breakeven performance in the FY2022 and FY2023 projections from implementation of the mandated FSP savings.  Achieving the projected years’ breakeven required unidentified placeholder savings of ($4.7) million in FY2022 and ($2.9) million in FY2023.  Moreover, up to $3.5 million of the total FY2022 and FY2023 FSP savings appear to be only “postponements” of discretionary expenditures and not structural cost reductions.

In the Second Interim Budget presentation of March 4, 2021, the District’s UGF reverted to a deficit projection in FY2022 of ($1.1) million with a slight surplus in FY2022 of ($0.7) million.  These outcomes include related FSP retains placeholder savings amounts of $4.0 million in FY2022 and $3.5 million in FY2023.

While the FY2021 deficit may be avoided with one-time state and federal support, the projections indicate that the structural deficit remains.  

Growing Revenues

These ongoing structural deficits continue despite revenues increasing by an estimated $38.3 million annually (47%), to $119.2 million in FY2020 from around $80.9 million in FY2014.  That growth increment is set to become an estimated $46.1 million (57%) by FY2023, to $127.0 million, under projections included in the March 4, 2021 Second Interim Budget Report. 

Unfunded Pension and OPEB Liabilities

These operating financial issues do not address the long-term unfunded pension and other employment-related benefit liabilities of $234 million (FY2020 reported YE) that has been driven in part by staffing costs and the absence of aggressive accelerated paydown plan in full knowledge of the growing unfunded liabilities.  

Credit Ratings

The Board references a credit agency upgrade as evidence of sound fiscal management.   According to published District data, the upgrade was noted in Moody’s May 17, 2017 Credit Opinion, increasing the rating on general obligation bonds one notch, from a Aa1 to Aaa.  In determining the rating, the credit agencies take the pension liabilities and operating spending into account.  

So how can the ratings improve despite deficit spending and growing pension and other employment-related long-term liabilities?  It turns out that the main driver of ratings is the growth in the District’s property tax base (~5.7% compound annual growth since 2011) and in the district’s “other” revenue sources.  

The May 2017 Moody’s opinion noted that “The district will start receiving new revenues from a half-cent sales tax increase approved by the voters of Santa Monica in November 2016, with a companion measure directing the city to provide a portion of the tax to the school district. The sales tax has no sunset and will provide the district with a significant, unrestricted revenue source.”  

Standard and Poors (S&P) noted in their August 21, 2019 credit opinion that ”In addition to its basic-aid status, we view supplemental revenue, which is unusual in the state, as a credit strength. The district currently has the following revenue streams available: 

  • A parcel tax with no sunset date that generates $12 million annually, or 7.4% of general fund revenue;
  • The two sales tax measures, with no sunset dates, that generated $16 million annually, or 9.9%
  • A facility lease through 2022 that generates $9 million annually, or 5.6%
  • The lease-rental revenue from several district-owned properties that generate $2.5 million annually, or 1.5%
  • A foundation that, since fiscal 2015, has averaged about $2 million annually, or 1.2%

These sources generated a combined 25.6% of general fund revenue in (FY)2018.”

In that same report, S&P also cites expenditure flexibility from “…high levels of permitted students, which totaled about 12%-14% of enrollment including outside-the-district students.”  The report opined that “…the district has the flexibility to reduce enrollment and expenditures by tightening transfer criteria.”

That said, spending does play a role in credit agency determinations.  In their November 10, 2020 credit report, Moody’s noted that “…deficit spending and use of reserves consistent with 2021 budget” could lead to a credit downgrade.   

Conclusions

From published District budget presentations, annual revenues have grown almost 45% from FY14 to FY20, at a compound annual rate of 6.7%, significantly greater than inflation.  By FY23, District projections show an increase over FY14 of almost 57%.  Consequently, these ongoing deficits are primarily a (controllable) spending issue.  And, this issue had been identified as far back as 2013, eight years ago.

Balancing budgets under LACOE-mandated FSP spending cuts to avoid both the possible loss of future positive budget and forecast certifications and potential rating agency downgrades reflects an entirely reactive financial management approach.   

The significant reported variances between the budgets and outcomes reflect significant in-year cost projection swings.  While these primarily cost-driven changes may indicate spending flexibility, excess cost budgeting can also discourage clear prioritization and reduce focus.   This approach can also place significant performance strains on teachers and administrators when approved budgets are subject to unplanned mid-year reductions, reducing overall program effectiveness.  

Claiming credit for rating agency upgrades without also noting that they are basically driven by the ability to increase resident taxation is disingenuous.  This should also give pause to residents when they hear proposals to upzone residential sections of the city, that being a prelude to increased property taxation.  

Living within our means is a challenge everyone faces these days.  However, the instability of a reactionary fiscal management approach reduces overall effectiveness.  It is unfortunate for the residents that the School Board feels the need to embellish reality.  This does not help build the necessary stakeholder trust this community so desperately needs.

By Marc L. Verville for SMa.r.t. (Santa Monica Architects for a Responsible Tomorrow)

Thane Roberts, Architect, Robert H. Taylor AIA; Ron Goldman FAIA, Architect; Dan Jansenson, Architect, Building and Fire-Life Safety Commission; Samuel Tolkin Architect; Mario Fonda-Bonardi, AIA, Planning Commissioner; Marc L. Verville M.B.A., CPA (inactive); Michael Jolly, AIRCRE

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