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California ballot holds credit risk for school districts

By Jim Christie

SAN FRANCISCO (Reuters) - If voters in California next week reject ballot measures to raise taxes, school districts in the Golden State will be among the first victims of spending cuts - a major concern not only for teachers and parents but also bondholders.

According to the latest polls, support for Proposition 30, the measure Governor Jerry Brown proposed to raise personal income and sales taxes, stands at below 50 percent for the November6 vote. A rival measure - Proposition 38, which would also increase taxes - appears to be backed by even fewer voters.

If Proposition 30 fails, the state government will impose $6 billion in so-called "trigger cuts" that mostly fall on education spending to try to keep its books balanced.

New spending cuts in the middle of the new school year may be devastating for many school districts with already cash-strapped budgets, said John Deasy, superintendent of the Los Angeles Unified School District.

Deasy's district, California's largest, has already cut $2.7 billion over the past three years. "It's dire," he said.

The $3.7 trillion U.S. municipal bond market has already been roiled by three bankruptcy cases filed in California this year, and two major rating agencies, Moody's and Fitch, are concerned about the two tax measures.

Credit downgrades could follow for the state's school districts if voters reject the measures.

Deeper education spending cuts would "amplify existing fiscal challenges and could result in a heightened level of downgrades over the next one to two years as districts adjust to potentially lower baseline funding levels," Fitch Ratings said in report seen by Reuters that will be published on Thursday.

Moody's Investors Service expects as many as 150 of the 327 California school districts it rates to suffer extra budgetary pressure if voters reject both Proposition 30 and Proposition 38. The 327 districts have approximately $43 billion in total outstanding debt. Moody's ratings on the districts range from 'Aa1' to 'Baa1.'

"Further options for expense reductions are diminished," Fitch analyst Scott Monroe said.

NO MORE 'LOW HANGING FRUIT'

California's school districts have lost a total of $20 billion in state funds over the last five years as the state tried to put its finances in order.

Spending for non-classroom activities has already been slashed to the bone so the only option is to cut funds for teachers and reduce teaching time, said Molly McGee Hewitt, head of the California Association of School Business Officials.

Teachers should brace for furloughs as districts may need to cut the school year by up three weeks to help reduce expenses if Proposition 30 fails, McGee Hewitt said.

"There's no low hanging fruit left. We're talking about cutting the school year," she said.

San Diego's school district, the second largest in the state, already has a plan in place to furlough teachers for 14 days if voters reject Brown's tax measure, said Bernie Rhinerson, the district's chief of staff.

By contrast, officials for Palo Alto's school district believe they will be able to avoid cutting the school year given its strong reserves, said Kevin Skelly, superintendent of the 12,000-student district neighboring Stanford University.

"We've built our budget on the basis of the measures not passing," Skelly said. "We'll dip into reserves if either of the measures don't pass."

Tapping rainy-day funds for many districts will, however, be a one-time solution and their finances will be under pressure again in the next school year, Skelly said.

Fitch agrees. While most districts have sufficient resources to weather cuts over the near term, in the longer term they face a number of challenges on top of reduced state funds, according to Monroe and fellow Fitch analyst Alan Gibson.

Those challenges include inflation and wage pressures, deferred capital needs, school enrollments that could rebound while state funding remains lean and rising health care costs and retirement related expenses.

The $155.3 billion California State Teachers' Retirement System faces a $64.5 billion unfunded liability, which is the difference over 30 years between the value its assets and its obligation to its members.

(Reporting By Jim Christie; editing by Andrew Hay)

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