Overview

As of March 10, 2022, S&P Global Ratings maintains 38 public ratings on bonds secured by California charter schools. In 1992, California became the second U.S. state to enact a charter school law. Today, it is home to more than 1,290 charter schools that serve about 12% of the state's kindergarten through 12th-grade (K-12) students. Overall, 37% of California charter school ratings are investment grade compared with 44% for the sector as a whole. We believe this stems from more charter issues on average due to the prevalence of district-authorized schools (82.5% of all charters), demographic challenges, and other case-by-case factors.

Chart 1

Authorizer Framework

• In most cases, charter schools in California are authorized by the local school district for a maximum term of five years. The state's 40 county school boards and the state board of education may also authorize charter schools. Authorizers receive an oversight fee of up to 1% of revenue. Proposition 39 requires school districts to provide reasonably equivalent facilities to charter schools.
• We believe the state outlines a clear process for authorization, renewal, revocation, and appeal of charters, although it is more difficult to assess if individual local education agencies apply the process consistently or what criteria each uses to monitor adherence to standards during the charter term. State law requires charter schools to meet a minimum level of academic performance before receiving renewals, and annual site visits by the authorizer, which we view positively.
• Almost half of the charter schools we rate (18) are authorized by the Los Angeles Unified School District (LAUSD), the second-biggest public school district and largest district charter school authorizer in the nation.

Credit Fundamentals

California charter schools' credit profiles are characterized by ratings ranging from 'B+' to 'BBB', with the median rating of 'BB+'. The majority (33) of our 38 charter school ratings are networks with more than one campus supporting the comparatively higher median enrollment across the rating levels. The largest network, Aspire Public Schools (BBB/Negative), serves over 15,000 students, which helps explain the high median enrollment at the 'BBB' level. Our criteria give credit uplift for charter networks with a combination of factors present, including very large enrollment (above 10,000), a material number of campuses that are not geographically concentrated, and separate and distinct charters or separate authorizers to diversify risk. Of our rated California charter schools, only Aspire receives this one-notch uplift. We note, however, that networks often have larger revenue streams, higher levels of enrollment, more sophisticated management teams, and steadier operations supporting underlying credit fundamentals.

Table 1

Median days' cash on hand has increased from roughly 87 days in fiscal 2017 to 140 in fiscal 2021. This growth in liquidity is supported by ESSER funding (which totaled $26.4 billion for all public K-12 schools across California) and per-pupil funding increases over the last ten years, from $5,565 per student (average daily attendance [ADA]) in fiscal 2011 to $10,958 in fiscal 2020, per the state's Local Control Funding Formula (LCFF) (see Chart 2). Though schools' total debt is often higher in California due to higher capital costs, the medians show that stronger revenues help keep the lease-adjusted maximum annual debt service (MADS) burden somewhat in check.

In July 2021, California's governor signed the state's fiscal 2022 budget, which reflects significantly higher revenue and a large budgetary surplus relative to the original state forecast. This was favorable for charter schools as Proposition 98 funding (which establishes the minimum funding level for schools and community colleges) increased 5.07% under LCFF compared to fiscal 2021 levels. The fiscal 2022 budget also made whole on all K-12 deferrals, which was very positive for charter schools. The governor's initial 2022-2023 budget outlines an increase of 5.33% for LCFF, in addition to pandemic-related funding, so we expect median days' cash to continue to grow in fiscal 2023.

Chart 2

Across California, enrollment in charter schools has grown each year over the last seven years, compared to flat-to-declining enrollment across district schools (see graph two). In our rated universe, most schools saw a flat-to-increasing level of enrollment for both fall 2020 and fall 2021, which speaks to steady demand amid the pandemic. In California's 2021 budget act, the state enacted a hold-harmless provision helping traditional public and charter schools that experienced enrollment declines during the 2020-2021 and 2021-2022 school years maintain funding based on historical enrollment levels. Though this provision was not originally extended to charter schools for the 2022-2023 school year, there is currently a proposed bill in the legislature to address this discrepancy. Additionally, the legislature is weighing a change that would tie per-pupil funding to a school's enrollment level rather than ADA measured throughout the year. The expiration of the hold-harmless provision could pressure our lower-rated schools with weaker demand profiles come fiscal 2023. However, if the legislature approves the funding formula change, this could provide flexibility as struggling schools wouldn't be penalized for student attrition throughout the school year.

Chart 3

What We're Watching

Enrollment trends.  California's overall K-12 school-age population continues to decline, due to falling birthrates and other demographic factors. The pandemic exacerbated some of these enrollment trends at traditional public schools, with an average decline of 3.2% in fall 2020 from fall 2019. However, in most counties with the highest concentration of charter schools, charter school enrollment grew on average 2.3% during the same period. We will continue to monitor the state's K-12 enrollment trends and charter schools' ability to maintain their momentum in the competition for a shrinking number of students.

Charter renewal risk.  In 2021, there were 21 charter school closures across the state; 18 of these closures were voluntary but three closed due to nonrenewal. Though Assembly Bill 130, passed in July 2021, automatically extends by two years the terms of any charter school whose term expires on or between Jan. 1, 2022 and June 30, 2025, mitigating renewal risk temporarily, ongoing authorizer support in future renewal discussions will remain paramount in the coming years.

Changing modes of instruction.  The pandemic has heightened demand for flexible learning models nationwide. While virtual options exist, Section 59 of AB 130 extended the prohibition on the approval of new nonclassroom-based charter schools to Jan. 1, 2025. We will watch whether demand for remote learning translates to different legislation beyond 2025.

Labor relations.  Labor shortages, higher labor costs, and health-related mandates continue to pressure schools' faculty operations. The governor's vaccine-or-test policy prompted teacher and student walkouts across the state in October 2021. We think that these mandates could hit rural schools the hardest because more staff at those schools are resigning over pandemic-related regulations.

Midterm elections.  California's governor and many state representatives will be up for re-election in November. School board elections have also become highly politicized amid the pandemic, so we will be watching how changes in these positions will influence school choice policies.

Pension funding levels.  CalSTRS was made whole by the state's transfer of $297 million from its Rainy Day Budget Stabilization Fund Act funds in 2021. Also, the infusion of state funds provided districts with short-term relief, as the adopted employer contribution rates for fiscal years 2020 through 2022 were reduced from originally projected rates under the funding plan. While this has improved fiscal 2021 and expected 2022 operating results, we will continue to assess the state's assumptions and schools' contributions when one-time cash from pandemic relief ends.

Long-term use of one-time funds.  ESSER funds have flooded traditional and charter schools with cash. Many schools have used emergency funding to hire additional full- or part-time staff to address learning loss amid the pandemic. As the wave of federal relief expires in September 2024, schools will need to ensure that current spending is sustainable or prove willing to make cuts down the road.

Table 2