- About half of US public school districts reported operating deficits in 2025, a sharp increase from 33% in 2024, according to a new report from S and P Global Ratings. Performance turned negative across every rating category for the first time since the pandemic.
- Downgrades and negative rating actions on districts outnumbered upgrades by three to one. The share of districts carrying a negative outlook rose to 6% in August from 4% a year earlier, and S and P expects credit pressure to continue.
- Analysts led by Jane Ridley and Sarah Sullivant identify the core problem as operating leverage working in reverse. Districts are funded by student numbers, but as they note, losing 5% of students rarely permits a 5% reduction in spending because costs are spread across instruction, facilities and operations.
- Costs are rising at the same time, driven by staff and insurance expenses and by special education obligations. Falling birth rates and competition from alternative school options are shrinking the student pool, and federal pandemic aid concealed these longer-term pressures while it lasted.
What Happened?
S and P Global Ratings published findings showing a broad deterioration in school district finances through 2025. The deficit share rose by roughly 17 percentage points in a single year, and the rating agency describes structural rather than cyclical pressures behind it. The combination is enrollment-based revenue declining while fixed costs rise, with pandemic-era federal aid no longer available to bridge the gap.
Why It Matters?
This is a municipal credit story before it is an education story, and it matters for anyone holding school district paper in a tax-exempt portfolio. School district bonds have historically been treated as among the safest municipal credits and are often bought for the tax exemption without close credit work, which is precisely the kind of holding that gets repriced when a sector turns. An important distinction protects bondholders here and should not be glossed over: most district general obligation debt is secured by dedicated property tax levies rather than operating revenue, so an operating deficit does not translate directly into debt service risk. What it does produce is downgrades, and downgrades widen spreads and mark portfolios down regardless of whether a single payment is ever missed. A three-to-one ratio of negative actions to upgrades means that repricing is already underway. The more consequential point is that this deterioration does not mean-revert. Birth rates and school choice competition are demographic and policy trends, not a cycle, so the analysts expectation of continued pressure is a structural forecast rather than a cautious one. Districts have been drawing on reserves, and reserves deplete. For allocators the practical implication is that individual district credits now require the same scrutiny as any other stressed issuer, and the historical assumption of uniform safety across the sector no longer holds.
What Next?
Watch the share of districts carrying negative outlooks, currently 6% against 4% a year ago, since outlooks precede actual downgrades and that series gives the earliest warning of where the next wave of rating actions lands. Reserve levels are the specific metric that determines how long individual districts can absorb deficits before cutting, and S and P has previously documented districts leaning on reserves. Enrollment figures for the current academic year will show whether the decline is steepening, and those numbers flow directly into next year funding. State legislative sessions are where any relief would originate, so proposals to change funding formulas or provide supplemental aid are worth tracking by state. For portfolios, the concrete action is to identify holdings in districts with declining enrollment and thin reserves before the rating actions arrive rather than after, since municipal secondary market liquidity thins considerably once a downgrade is published.
Source: Bloomberg
