As of March 13, 2023, S&P Global Ratings maintains 40 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 about 1,300 charter schools that serve approximately 12% of the state's kindergarten through 12th-grade (K-12) students.

Overall, 38% of California charter school ratings are investment grade compared with 44% for the sector as a whole. We believe this stems from more charter challenges on average due to the prevalence of district-authorized schools (81% of all charters), demographic challenges, and other case-by-case factors.

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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 (19) 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 a median rating of 'BB+'. The majority (35) of our 40 rated charter schools are networks with more than one campus supporting the comparatively higher median enrollment across the rating levels, including the largest network, Aspire Public Schools (BBB/Stable), which serves more than 15,000 students.

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Median days' cash on hand has almost doubled over five years, to 162 days in fiscal 2022 from roughly 87 days in fiscal 2017. This growth in liquidity has been supported by Elementary and Secondary School Emergency Relief (ESSER) funding (which totaled $26.4 billion for all public K-12 schools across California) and per-pupil funding increases. 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.

Charter schools have benefited from historic funding levels in recent years. Proposition 98 funding (which establishes the minimum funding level for schools and community colleges) grew to an all-time high in fiscal 2022. Then, the approved fiscal 2023 budget reflected another year of historic funding, including a 6.56% cost-of-living adjustment (COLA) and an additional 6.25% increase to the Local Control Funding Formula (LCFF). Looking ahead to fiscal 2024, the governor's initial fiscal 2024 budget proposes an 8.13% COLA for the LCFF, which includes charter schools. Charter schools and district schools are also entitled to supplemental grant increases equal to 20% of the adjusted base grant for the percentage of enrolled students who are English learners, eligible for free or reduced-price meals program, or in foster case. Additionally, the governor's budget includes a one-time $30 million Proposition 98 general fund investment for the Charter School Facility Grant program, which provides funding to charter schools to offset annual facilities costs.

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The 2021-2022 school year represented the first year of charter enrollment decline in decades (see chart 2), reflecting a combination of pandemic pressures and broader demographic trends within the state. We saw a similar trend in our portfolio of rated charter schools, with a median year-over-year decline of 1.7% in fall 2021. Pandemic relief funds and funding protections have helped mitigate short-term budgetary risks for schools experiencing declines. As approved under the state's 2023 budget, classroom-based charter schools can now utilize the average daily attendance (ADA) loss mitigation policy, in addition to receiving the fiscal 2022 year benefit of the greater of current-year or prior-year ADA for the purposes of determining funding through the LCFF. Based on preliminary enrollment information for fall 2022 in our portfolio of rated charter schools, we're seeing some stabilization with most schools reporting increases. We will continue to monitor for any signs of persistent weakening demand trends.

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, with both charter school and non-charter school enrollment declining by 1.8% in fall 2021 from fall 2020. Though we are seeing stable demand for most of our rated charter schools as of fall 2022, 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 fiscal year 2022, there were 20 charter school closures across the state; 18 of these closures were voluntary but two closed due to charter revocation or not meeting conditions of approval (these were all unrated charter schools). 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, which temporarily mitigates renewal risk, ongoing authorizer support in future renewal discussions will remain paramount in the coming years.

Political environment.   Increased competition for a declining school-age population could increase tensions between authorizing school districts and charter schools. In recent years there have been several anti-charter legislative proposals. Assembly Bill (AB) 1505, passed in 2019, 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. Implementation of AB 1505 has been on hold due to the pandemic. With the release of new data, we expect it to be implemented in 2024.

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

Labor challenges.    We continue to monitor the influence of inflationary pressures on labor costs and labor shortages, which could pressure school faculty operations. Not all schools have been affected by the teacher shortage equally, and we believe a charter school's ability to attract and retain talented faculty is key to the organization achieving its mission.

Pension funding levels.    The adopted employer pension contribution rates for fiscal years 2020 through 2022 were reduced from the originally projected rates under the California State Teachers Retirement System (CalSTRS) funding plan, providing schools with short-term relief. However, for fiscal 2024 the governor did not propose any additional funding for CalSTRS or California Public Employee Retirement System (CalPERS). Based on current assumptions, CalPERS employer contributions would increase from 25.37% to 27.00% in fiscal 2024, while CalSTRS employer contribution rates remain the same from prior year at 19.10%. We will continue to assess the state's assumptions and schools' contributions and assess how schools manage rising fixed costs.

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.

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