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Charter School Brief: California

As of Sept. 22, 2020, S&P Global Ratings maintains 35 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, California is home to more than 1,200 charter schools that serve about one-tenth of the state's kindergarten through 12th grade (K-12) students. In California, there are many charter networks and 16 of our 35 ratings are for schools that are part of a charter network with more than five campuses. Overall, 31% 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, challenges for independent study schools, and other case-by-case factors.

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COVID-19 Effects And State Funding Deferrals

Given the COVID-19 outbreak and broader public safety concerns, the governor ordered counties on the state's coronavirus watch list to keep school campuses closed for fall 2020, at least to begin the school year, which for most schools began in mid-to-late August.

Effective Aug. 31, 2020, the administration unveiled the "Blueprint for a Safer Economy," which detailed revised criteria for loosening and tightening restrictions on activities. Reopening activities are categorized in a new color-coded system for counties based on coronavirus prevalence and testing rates. The four-tiered, color-coded system will identify county risk levels for the spread of infection and include Tier 1 (purple) for widespread, Tier 2 (red) for substantial, Tier 3 (orange) for moderate, and Tier 4 (yellow) for minimal. Each tier determines the extent to which a county's economy can reopen. The criteria to open under the July 17, 2020, School Reopening Framework remains in effect, except that Tier 1 is substituted for the now obsolete county data monitoring list. Schools in Tier 1 cannot reopen for in-person instruction. For the 38 counties starting in Tier 1 (purple), this means they will not have the ability to resume in-person instruction for at least three weeks, and counties that find themselves moving into in Tier 1 (purple) in the future will have at least a five-week wait for the option to return to in-person instruction.

The guidance applies to school districts, charter schools and non-public schools and ensured that the overwhelming majority of schools started the 2020–21 school year via distance learning. As of the time of this publication, all of our rated California charter schools have transitioned to distance learning using various virtual platforms for fall 2020. To date, most of our rated charter schools have reported expense savings and manageable increased expenses relative to transitioning to online education.

On June 29, 2020, the governor approved the state's 2021 budget, closing a massive $54.3 billion COVID-19-related budget shortfall. The adopted budget reverses the governor's initial budget proposal (a 10% funding reduction in the Local Control Funding Formula [LCFF]) and maintains apportionment funding at fiscal 2020 levels, but does not provide the 2.31% cost-of-living adjustment. Instead of imposing cuts, the budget relies on K-14 (K-12 including community college districts) apportionment deferrals totaling approximately $12.5 billion stretching from February to November 2021. The school aid deferrals represent an actual cut in payments made during the fiscal year, but the deferrals would be phased back in to school districts in future years to the extent that general fund revenue grew, or additional federal aid is received. Due to the significant drop in state revenues, the minimum requirement for Proposition 98 (the annual funding requirement for schools and community colleges) is down $3.4 billion in fiscal 2020 from the June 2019 estimates. In fiscal 2021, the minimum requirement drops by an additional $6.8 billion (8.7%) from the revised fiscal 2020 level to $70.9 billion. The $12.5 billion of deferrals represent about 17.6% of fiscal 2021 Proposition 98 funding. Given the magnitude of the deferral, in our view, charter schools will need to more closely monitor cash and use reserves or borrow funds as needed, to cover any cash deficits caused by these deferrals. The adopted state budget also provides that if sufficient federal funds materialize by Oct. 15, 2020, then up to $6.5 billion of the deferrals can be reduced. (For more details see "California’s Cash Position Remains Strong Despite Budgetary Deficit," published Aug. 20, 2020, on RatingsDirect.

Similar to other states, the California Legislature amended the attendance-reporting window to account for any unwarranted decreases in attendance due to the pandemic. Since state funding comprises almost the entirety of our rated state charter schools' operating revenues, flat per pupil funding could have various implications for charter schools that are growing versus those that are declining. For schools experiencing declining enrollment growth, there is a funding provision in the 2021 state budget that provides protection for charter schools (hold harmless provision), allowing them to use the higher of previous-year or current-year attendance as the basis of funding. Alternatively, for schools experiencing enrollment growth, they will likely face increased expenditures for additional staff, instructional materials, and capacity in facilities. To address this funding concern, the state recently passed an education trailer bill, Senate Bill (SB) 820, to accommodate school districts and charter schools with rising enrollments to claim higher levels of funding. The state will fund school districts and charter schools for additional enrollment if they can document their growth plans in a financial report filed last spring or in the 2020-2021 approved budget. However, funding will be based on the lower of the two options and non-classroom-based charter schools were excluded from funding for growth in enrollment. We believe this will be an added credit pressure for these charter schools that offer an independent study curriculum, of which we currently maintain six ratings (out of our 35 rated charter schools).

In addition, we understand four California charter school networks (including John Adams Academies [BB/Negative]) have filed a lawsuit against the state challenging the hold-harmless provision. These schools all have growing enrollments and expected higher funding. Despite SB 820 restoring some funding, we understand these schools still plan to move forward with the lawsuit. We continue to monitor developments for any potential credit implications.

California has many charter networks, and, in our view, these larger networks will likely be less affected by funding deferrals due to stronger reserves and an easier ability to access external borrowings for liquidity purposes. The average days' cash on hand for our rated California charter schools based on fiscal 2019 figures is 130 days', which we view as healthy. However, there could be potential effects from future deferrals or state funding cuts, which could pressure financial metrics and cause rating stress, particularly for speculative-grade rated schools. There is still considerable uncertainty regarding the duration and overall effects of the COVID-19 outbreak on our rated entities' performance, including the ability to continue delivering virtual instruction and absorb unbudgeted additional costs.

State Charter School Environment And Recent Legislation

Since the 2018 midterm elections, Democrats have a supermajority in both legislative houses and much attention has been placed on California, where the governor has supported increasing accountability and transparency of charter schools and the superintendent of public instruction has supported a hiatus on new charter schools. During 2019, the state experienced the most comprehensive overhaul to its charter school laws since they were first passed more than 25 years ago. Assembly Bill (AB) 1505 makes it more difficult for new or expanding charter schools to get approval from authorizers, although for high-performing charter schools it could mean longer renewal terms or a more streamlined application process. However, this remains to be seen for our rated universe.

We view these factors as neutral to negative for the sector's growth and expansion. For S&P Global Ratings' existing rated universe, the curbing of charter growth in already tight or competitive markets could be a positive factor for demand, and could improve credit quality. Generally, we view increased reporting and accountability positively as it increases the information available for evaluation of financial and academic outcomes. We note that in terms of financial flexibility, better transparency could prevent fraud or mismanagement that result in costly outcomes for schools, but onerous regulations could strain school finances by necessitating additional administrative services and increasing reporting expenses.

In terms of per pupil funding in California, the LCFF dictates funding for California schools and is the primary means of allocating Proposition 98 funds. To improve academic outcomes, the LCFF targets greater funds to school districts that serve high-needs students. The law also strives to give local school districts more authority to decide how to spend education dollars, and hold them accountable for getting results. According to state law, per-pupil funding is passed through to charter schools by their respective public school districts. These payments are disbursed throughout the year tied to enrollment. Funds from the LCFF account for about 80% of general funding that districts, and then charter schools, get from the state. The total California school districts receive on a per-pupil basis is just over $9,500, according to the U.S. Census Bureau Annual Survey of School Systems--which is below the national average of about $13,000. California's LCFF equalizes funding for charter schools and traditional school districts; and schools receive a supplemental grant for students who qualify for free and reduced-price meals or are English learners, homeless, or in foster care.

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. Relationships between authorizers and charter schools vary greatly, with some being supportive and some severely restrictive or antagonistic, given the inherent conflict of interest for school districts that compete for the same students and the related per-pupil revenue. 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.
  • Somewhat unique to California is that six of our 35 rated charter schools offer an independent study curriculum, which includes home schooling and online learning, and can range from full-time independent study to a mix of independent study and classroom time. To receive funding, state law requires these schools to certify that they have spent 80% on instruction, including 40% on teacher pay, before receiving their full per-pupil funding amount. Most classroom-based schools receive $1,184 per student in state funding toward facilities rent and lease expenses, up to 75% of the full cost through the SB 740 program. The independent study programs are not eligible for this lease aid.
  • Fourteen of our ratings are on schools authorized by the Los Angeles Unified School District (LAUSD), the second-biggest public school district and largest district charter school authorizer in the nation. More than 150,000 students attend LAUSD authorized charter schools, comprising a quarter of total public school students in the district. All LAUSD schools will be opening online for fall 2020.

Credit Fundamentals

Table 1

Fiscal 2019 California Charter School Medians
BBB BBB- BB+ BB BB-/B+
Enrollment (fall 2019) 8,291 1,922 1,612 2,341 1,162
Waiting list as a % of enrollment 42.9 28.2 14.0 6.2 41.3
Retention rate (%) 90.0 93.0 92.0 90.3 78.5
Lease adjusted MADS coverage (x) 1.20 1.53 1.85 1.34 1.07
Lease adjusted MADS burden (% of total revenues) 7.5 8.7 7.8 10.1 14.8
Days unrestricted cash on hand 177 123 137 89 128
Total revenue ($000) 110,483 20,287 24,838 20,823 13,599
Note: 'CC' medians are not included. MADS--Maximum annual debt service.

The presence of large networks in California is evident in enrollment and total revenue medians for our 'BBB' rated credits. The majority (26) of our 35 charter school ratings in California are for schools in a network with more than one campus. However, our criteria does not give credit uplift for charter networks unless there are a combination of factors including very large enrollment (above 10,000 students), a material number of campuses that are not geographically concentrated, and each school holding separate charters, or having separate authorizers to diversify risk. Of our rated California charter schools, only Aspire Public Schools (BBB/Negative) receives this one-notch uplift. While network benefits might be reflected in financial or enterprise metrics, or in other qualitative factors such as more sophisticated management teams, being a network in itself does not necessarily equate to a higher rating as the underlying metrics determine the rating.

Since S&P Global Ratings' first charter school bond ratings were assigned in the early 2000s, we have experienced only six defaults (we define defaults as a failure to make timely and full stipulated debt service payments) in this sector. None of these defaults occurred for our rated California charter schools. Given the solid financial profiles for the majority of our rated universe, we expect defaults to be relatively rare and case-specific, although we actively monitor for any sharp declines in finances, particularly state funding in the current recessionary environment, enrollment, academic outcomes, and how these could affect the charter in question.

What We're Watching

Population decline.  Los Angeles County's school-age-population projections indicate a 5.45% decline in the student-age population over the next five years. While much of L.A. County's enrollment growth at charter schools has come from students leaving district schools, we expect the general population decline could spell flat-to-depressed enrollment trends in the medium term for charter schools.

Liquidity and budgeting for potential deferrals in funding.  With the potential for future state funding deferrals or state funding cuts, schools' financial metrics such as debt service coverage or days cash on hand could be pressured and cause rating stress, particularly for lower-rated schools with limited financial flexibility. Management's ability to manage operations will be critical.

Equalization.  California law does not require school districts to share their extra voter-approved property taxes (parcel taxes) with charter schools, although select districts do. We anticipate some districts will turn to parcel taxes to fill in budget gaps. Districts also have incentive to share proposed tax dollars, since passing parcel-tax measures require a higher--66% voter-approval rate--requiring support from parents whose children might attend charter schools.

Pension funding levels.  Although not mandated by law, the majority of charter schools offer the state's retirement plans--California Public Employees' Retirement System and California State Teachers' Retirement System, which are funded at 70.05% and 72.56%, respectively. The state's 2021 budget plan repurposes previous pension payments to reduce pension costs by a larger amount over the next two years. Specifically, school districts, charter schools and community colleges will receive cost savings of approximately 2% of pay in fiscal 2021 and fiscal 2022.

Labor relations.  Teachers at most California charter schools currently do not belong to unions, although some have voted to unionize, including three Alliance network schools in 2018. In 2019, some charter teachers joined the LAUSD strike. We could see additional unionization occur at charter schools in light of increased regulations from the implementation of AB 1505, expected state funding deferrals, and continued pressure on teachers amidst COVID-19 and re-opening plans focused on health and safety.

Increasing regulations.  The LAUSD teachers' strike resulted in a district resolution asking the state to place a 10-month freeze on new charter openings; SB 126 requires charter schools to comply with the open meeting, conflicts of interest, and disclosure laws to which traditional school districts adhere; and AB 1505 was passed in 2019. In our opinion, these are all neutral-to-negative credit drivers for charter schools.

Table 2

California Charter Schools Rated By S&P Global Ratings As Of Aug. 31, 2020
Charter school Rating Outlook Enrollment (fall 2019) Enrollment (fall 2018) State revenues as % of total (2019) Days unrestricted cash on hand (2019) Lease adjusted MADS coverage (2019) Charter authorizer

Albert Einstein Academies

BB Stable 1,408 1,397 91.4 129 1.34 San Diego Unified School District
Alliance Patti & Peter Neuwirth Leadership Academy BBB- Stable 576 563 72.2 57 1.52 Los Angeles Unified School District

Alliance College-Ready Public Schools

BBB Stable 12,943 13,097 70.0 177 2.06 Los Angeles Unified School District

American Heritage Education Foundation

BBB- Stable 2,055 2,035 66.1 233 1.91 Escondido Union School District

Aspire Public Schools

BBB Negative 17,529 16,978 75.1 62 1.07 Los Angeles County Office of Education; various authorizers

Caliber Public Schools

BB+ Stable 1,616 1,532 55.3 150 2.74 Contra Costa County Office of Education

Children of Promise Preparatory Academy

CC Negative 379 400 74.3 83 0.52 Inglewood Unified School District

Classical Academy Inc.

BB+ Stable 4,678 4,550 64.0 127 2.93 Escondido Union High School District and Escondido Union Elementary District

Coastal Academy Charter School

BBB- Stable 1,516 1,509 67.0 181 1.30 Oceanside Unified School District

Fenton Public Charter Schools

BB+ Stable 2,924 3,049 69.1 168 1.78 Los Angeles Unified School District

Gertz-Ressler Richard Merkin 6-12 Complex

BBB Negative 962 972 73.2 36 1.09 Los Angeles Unified School District

Granada Hills Charter High School

BBB- Stable 5,124 4,698 84.3 99 3.58 Los Angeles Unified School District

Green Dot Public Schools

BBB- Stable 11,475 11,538 84.7 108 1.54 Los Angeles Unified School District

Grimmway Academy

BB+ Stable 1,445 1,345 74.8 147 1.87 Kern County Superintendent of Schools

ICEF View Park Preparatory Accelerated Charter High School

BB Stable 481 568 70.5 113 1.97 Los Angeles Unified School District

ICEF View Park Preparatory Accelerated Charter Middle and Elementary School

BB Stable 771 785 71.8 30 1.25 Los Angeles Unified School District

John Adams Academies Inc.

BB Negative 2,476 2,117 43.9 89 1.21 Loomis Union School District, Western Placer Unified School District, El Dorado County Office of Education

Julian Charter School

B+ Stable 1,753 1,640 71.4 193 1.11 Julian Union Elementary School District; various authorizers

KIPP SoCal Public Schools (KIPP LA)

BBB Stable 8,291 7,258 78.8 214 1.20 Los Angeles Unified School District, San Diego Unified School District

King Chavez Academies

BB+ Stable 1,640 1,804 85.0 146 2.43 San Diego Unified School District

Kipp Bay Area Schools

BBB Stable 6,191 5,766 56.0 476 4.03 Redwood City School District; various authorizers

Literacy First Charter School

BBB- Stable 1,788 1,668 93.3 137 1.03 San Diego County Office of Education

MPM Sherman Way LLC

BB Stable 3,892 3,957 93.1 161 1.03 Los Angeles Unified School District

New Designs Charter School

BB+ Stable 1,340 1,286 75.8 89 2.15 Los Angeles Unified School District

Nova Academy

BB Stable 411 425 91.0 216 1.23 Santa Ana Unified School District

Partnerships to Uplift Communities (PUC) Schools

BB Stable N.A. 4,996 73.0 78 2.20 Los Angeles Unified School District

Partnerships to Uplift Communities (PUC) Schools

BB Stable N.A. 4,996 73.0 78 2.20 Los Angeles Unified School District

Palmdale Aerospace Academy (The)

BB Negative 2,341 1,634 84.0 89 0.80 Palmdale Elementary School District

River Charter Schools

BB Stable 822 746 56.4 128 1.74 River Delta Unified School District, Washington Unified School District

River Springs Charter School

BB Stable 6,670 6,289 87.5 35 1.36 Riverside County Office of Education

Rocklin Academies

BB+ Stable 2,596 2,573 53.5 81 1.38 Rocklin Unified School District

Santa Rosa Academy Inc.

BB+ Stable 1,607 1,556 88.0 194 1.82 Menifee Union Elementary District

Urban Discovery Academy

BB- Stable 571 589 93.7 64 1.03 San Diego Unified School District

Value Schools

BB+ Stable 1,351 1,598 72.9 100 1.62 Los Angeles Unified School District

Vista Charter Middle School

BB+ Stable 884 813 65.2 109 1.74 Los Angeles Unified School District
N.A.--Not available

This report does not constitute a rating action.

Primary Credit Analyst:Robert Tu, CFA, San Francisco (1) 415-371-5087;
robert.tu@spglobal.com
Secondary Contacts:Jessica L Wood, Chicago (1) 312-233-7004;
jessica.wood@spglobal.com
Peter V Murphy, New York (1) 212-438-2065;
peter.murphy@spglobal.com
Research Assistant:Arpita Ray, Mumbai

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