K‑12 municipal bonds show broad credit stability despite enrollment shifts. Limited federal dependence and state equalization funding help stabilize revenues.
Recent market perspectives on the U.S. K-12 public school sector have highlighted risks stemming from declining enrollment, potential reductions in federal funding, and isolated cases of fiscal mismanagement. While these concerns warrant monitoring, Thornburg continues to view the sector as fundamentally stable, with a very low probability of widespread credit deterioration or default. In our view, the school districts experiencing significant financial strain represent the exception rather than the rule.
One challenge in assessing the sector is its breadth and diversity. There are more than 13,000 public school districts nationwide, with only approximately 3,300 rated by Moody’s Investors Service. Each district possesses unique demographic, economic, and governance characteristics, resulting in a wide range of credit profiles. Broad generalizations, therefore, tend to overlook the underlying strength that characterizes much of the sector and create opportunities for active fundamental investors.
From a credit perspective, K-12 public school districts remain among the strongest sectors in the municipal market. The median rating for U.S. public school districts is Aa3, and the majority of districts carry ratings of A1 or higher. Only a limited number of school districts currently maintain negative outlooks or are under formal ratings review. Historical default experience further reinforces the sector’s resilience. According to Moody’s municipal default study covering the period from 1970 through 2024, K-12 public school districts accounted for just 1.8% of all municipal defaults, with an overall default rate of less than 0.1%.
Defaults Are Rare in K-12 vs. The Broad Municipal Market
Defaults By Municipal Sector from 1970 through 2024.
General Obligation
Revenue
Source: Moody’s as of 12/31/2024.
Structural Characteristics Support Already High Credit Quality
Most school district debt is issued as general obligation bonds secured by dedicated property tax pledges. In many cases, these revenues are legally restricted for debt service purposes, insulating bondholders from operational pressures and budgetary imbalances within the district. This separation between operating finances and debt repayment provides investors with a strong layer of protection.
School districts are generally subject to state-imposed debt limitations and frequently require voter approval before issuing debt. These requirements help constrain leverage while also ensuring that capital projects and borrowing initiatives maintain local community support.
State governments continue to prioritize educational funding. In some states, constitutional or statutory provisions require minimum levels of educational appropriations, reinforcing the essential nature of the sector. Furthermore, state equalization formulas in many jurisdictions help stabilize school district revenues by offsetting fluctuations in local property tax collections. When local tax revenues weaken, state aid often increases to maintain funding levels on a per-pupil basis. Conversely, state aid may decline when local revenues strengthen. This mechanism helps reduce revenue volatility and supports long-term financial stability.
While future federal education funding remains an area of uncertainty, school districts generally maintain limited direct dependence on federal sources. In most cases, federal funding represents less than 10% of total revenues, providing an important degree of insulation from potential federal policy changes.
Another favorable development has been the continued expansion of state credit enhancement and intercept programs. Currently, twenty-five states provide some form of support mechanism for school district debt. Many of these programs are designed to ensure timely debt service payments prior to default, while some states provide direct guarantees for eligible bonds. These programs can materially strengthen bondholder protections and reduce overall credit risk. Within our portfolios, these protections remain an important consideration in our pursuit of risk adjusted returns.
As with any sector, however, credit selection remains critical. Not all districts are equally positioned to navigate demographic and fiscal pressures. Our investment process emphasizes in-depth fundamental analysis designed to identify issuers with durable financial and economic characteristics.
Key attributes we favor include:
- Strong unreserved fund balances and liquidity reserves
- Stable or growing enrollment trends
- Consistently balanced operating performance
- Limited reliance on federal funding sources
- Healthy tax base growth
- Diverse local economies and employment bases
- Manageable debt burdens and capital needs
The K-12 public school sector is not without challenges. Declining enrollment trends in certain regions will likely place pressure on a subset of districts over time. Nevertheless, the sector’s strong support provisions, historically low default rates, and substantial state-level aid mechanisms continue to provide a solid foundation for credit stability.
We believe careful security selection and disciplined credit analysis remain the most effective tools for navigating the evolving landscape. By focusing on districts with strong fundamentals and resilient financial profiles, we believe the vast majority of school district bonds will continue to perform well despite isolated areas of stress.
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