Navigating The Curve

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April 28, 2025

Focus on Fundamentals amid Changes to K-12 Sector

April 28, 2025

Focus on Fundamentals amid Changes to K-12 Sector

Navigating The Curve

Focus on Fundamentals amid Changes to K-12 Sector

April 28, 2025

Despite significant uncertainty with federal funding we remain confident in the sector as it represents a small portion of the overall funding for most K-12 school districts, though we remain highly focused on any potential changes especially for the unique cases of higher federal funding revenue concentration.”

Investors are weighing the significant and quickly evolving impact of President Trump’s executive order to dismantle the U.S. Department of Education (DOE) on the K-12 sector¹. Our Municipal Credit Research team is continuously monitoring how these policy changes may affect our portfolio holdings.

Exposure to Federal Aid
It is important to understand that Trump administration cannot unilaterally dismantle the DOE, because it was created through an act of Congress and would require an act of Congress to dismantle it. Additionally, major educational programs are protected by law and the president cannot cut funding for these programs without a Congressional vote. The Senate would require a 60-vote majority to make any federally protected changes, and we believe that would be highly unlikely.

The majority of K-12 funding comes from state and local government sources, while the federal government generally plays a smaller role. In fiscal year 2022 (2021–2022 school year), only 13.7%² of public education revenue came from the federal government. However, we believe this figure is somewhat inflated by pandemic stimulus money to support school districts. On average, since 2020, federal government aid has tracked closer to 9% of total public education revenue, with large variances by both state and individual district. For example, according to U.S. Census Bureau data, federal aid in 2022 accounted for 23% of total public education revenue in Mississippi, while in New York it represented a mere 7%. The differences on the district level are even more drastic. A Moody’s study points out that in 2022 federal aid to Palo Alto (California) Unified School District made up only 2% of revenue, while federal aid to Detroit Public Schools was over 20%.

DISPLAY 1

Dependence on federal aid for education varies greatly across states

Federal funding includes aid from all sources, including meal programs administered by the Department of Agriculture.
Sources: U.S. Census Bureau and Moody's Ratings.

Risks to K-12 Sector
President Trump’s executive order to dismantle the DOE has quickly created tangible impacts that may hinder the department’s performance. Mass layoffs at the DOE have halved staffing to around 2,200. These cuts created uncertainty in the DOE’s ability to function properly, including ensuring stability in K-12 funding programs. Additionally, the Trump administration has spoken publicly about potentially moving functions of the DOE to other departments, such as Health and Human Services. Any changes to administering these funds could lead to operational risk and potential for delays.

The Trump administration has also taken a more aggressive approach to enforcing civil rights issues in K-12 programs, which could lead to funding cuts. On April 3, the DOE sent a letter requiring K-12 school districts to certify their compliance with the government’s anti-discrimination obligations to continue receiving federal funds. Additionally, the Trump administration is investigating some of the country’s largest school districts. The state of Maine was recently placed under investigation for violation of Title IX³ and an administrative proceeding was initiated to eliminate the Maine Department of Education’s federal K-12 funding, including formula and discretionary grants.⁴

Addressing Risks
Our team evaluates public K-12 school districts through two lenses, either individually or as a function of a state school district enhancement programs. For school districts on an individual basis, we identify the source and stability of each revenue stream. We prefer districts with strong revenue raising ability through property taxes and per-pupil funding from states, as well as those with strong general fund balances, to help mitigate any disruptions that may be caused by the Trump administration. The combination of the two gives districts flexibility in creating solutions to manage any shortfall due to policy changes. We actively monitor changes at the state and local levels which typically have a greater impact on districts than changes at the federal level. Despite significant uncertainty with federal funding, we remain confident in the sector as it represents a small portion of the overall funding for most K-12 school districts, though we remain highly focused on any potential changes especially for the unique cases of higher federal funding revenue concentration.

Our research team only gives credit to state school enhancement programs that we believe have strong legal frameworks. In our view, these programs remain stable at this time, and there should not be any significant impact based on possible federal funding reductions.

Additionally, many school districts are emerging from a period of strength, as pandemic stimulus funds have bolstered reserves. Balance sheets have significantly improved, giving more districts the flexibility they may need to weather the impacts of policy changes. A study of S&P-rated school districts shows that reserve fund balances, as a percentage of revenues, grew to 28% in 2023, up from 23.5 pre-pandemic.

DISPLAY 2

School Districts Reserve Fund Balance as % of Revenues

Source: S&P Global, as of Dec. 31, 2023

Bottom line: While navigating ongoing changes, it is essential to remember that only an act of Congress can dismantle the DOE. We remain focused on idiosyncratic risks, and that is why we believe in-depth credit analysis will remain fundamental to choosing issuers that will perform well.

¹ The K-12 sector refers to the educational system encompassing kindergarten through 12th grade, encompassing both public and private schools.
² USAFacts
³ Title IX is a federal civil rights law, enacted as part of the Education Amendments of 1972, prohibiting sex-based discrimination in education programs and activities receiving federal financial assistance.
⁴ Formula grants are awarded based on predetermined formulas and eligibility, while discretionary grants are awarded through a competitive process.

Municipals Team

The Municipals team is one of the largest municipal bond-focused teams in the industry with decades of experience. They strive to meet the income and return goals of investors by offering strategies spanning the entire yield curve and credit spectrum.

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