California Charter Schools: How Might Political Shifts Affect Credit?

Legislation under consideration in Sacramento could influence future authorizations of charter schools.

(This article is from the forthcoming third-quarter 2019 edition of The Muni Quarterly.)

The U.S. charter school sector has grown significantly over the past five years, with municipal bond issuance increasing from $1.1 billion in 2013 to $2.7 billion in 2018, according to data from Bloomberg. Charter schools now account for 5.3% of the high-yield municipal market. While California charter schools represent a relatively small portion of the high-yield municipal market, charter school bond issuance in the state has increased from $102 million in 2013 to $245 million in 2018. Given recent developments in California, we thought it would be valuable to provide an update regarding proposed charter school legislation in the state.

In 1992, California was the second state in the United States to adopt public charter school legislation. Today, it has the largest number of charter schools of any state—approximately 1,300—with more than 650,000 students enrolled in FY 2018–19, representing nearly 11% of the total public school population in California. While total public school enrollment (including traditional public schools [TPS] and charter schools) in California has declined by nearly 1% over the past five years, charter school enrollment has grown 20%. Los Angeles Unified School District (LAUSD)— the largest public school district in California—saw a 10% decline in TPS enrollment over this time period, while charter school enrollment in the district increased by 8.4%.

Chart 1. California Charter Enrollment Grows While That of Public Schools Decline
Change in traditional public school enrollment versus that of charter schools, 2015-2019

Source: California Department of Education. Data as of July 31, 2019.

Chart 2. Traditional Public Schools are Losing Students
Enrollment numbers, Los Angeles Unified School District (LAUSD), 2014-2019

Source: California Department of Education. Data as of July 31, 2019.

Declining enrollment was one major factor behind the LAUSD teachers’ strike in January 2019. The teachers’ union raised concerns that the growth of charter schools has resulted in lower enrollment – and funding – for the school district, even going so far as to call for a moratorium on new charters. Political leaders in California responded by creating a task force to study charter schools and introducing new legislation that could affect the charter school industry in the state. We view these developments as signs that the political landscape is quickly changing.

Some Background: The Charter Authorization Process Varies Across States
One of the defining credit factors in the charter school sector is the relationship a particular school has with its charter authorizer. (We examined the key elements of analyzing charter-school bonds in an earlier Muni Quarterly article.)  In some states, such as Texas and Arizona, a state agency serves as the authorizer. In others, such as California and Florida, the local public school district that the charter school operates in may serve in that capacity. In the latter group of states, there is the potential for conflict of interest. Why? Local school districts compete for state aid with the charter schools, so there may be a disincentive for the authorizing body to approve a charter if overall enrollment rates are declining. While the new charter school legislation in California could offer a good case study of this issue, it is important to note that there are many schools in the state that have good relationships with their local districts and do not face charter renewal issues.

Task Force Report and Legislative Developments in California
Following the LAUSD teachers’ strike in January 2019, Governor Newsom instructed the California Department of Education to study the fiscal impact charter schools have on traditional public schools and inconsistencies in how charter schools are authorized throughout the state.

On June 6, 2019, the California Charter School Policy Task Force delivered a set of recommendations to the Governor. Some legislators have indicated they will use the report to determine how they will vote on several bills that would impose restrictions on charter schools.  In our view, the task force recommendation to provide school districts with additional discretion when considering new charter school authorization is potentially a credit negative for charter schools. For example, the task force recommended giving local school districts the ability to consider saturation (i.e., the appropriate number of schools in the district), and allow districts to deny charter authorizations if they believe there are too many schools in the district.

In March 2019, Governor Newsom signed into law SB 126, legislation that will require charter schools to follow the same transparency standards as traditional public schools. In addition, a package of bills was introduced in the California Assembly and Senate in March 2019. Generally speaking, the proposed legislation would give school districts broader discretion to deny a new or renewing charter, allow districts under financial strain to deny charters based on the fiscal impact of the charter on the authorizing district, and prohibit a charter school from being established outside its authorizing district. In our view, legislative attempts to impose caps on new charters likely will not pass in 2019, but could be considered at the next legislative session.

The proposed legislation could make the authorization process more challenging for new and existing charter schools. Charter schools must be authorized in order to conduct operations and to receive state funding. Typically, state funding is by and far the largest revenue stream for a charter school, and is used to fund a school’s operations as well as pay debt service on the bonds and other debt obligations.

While it remains to be seen if these bills will be approved, it is clear that charter schools in California will need to be monitored closely. Those charter schools that have strong relationships with their related public school districts are less likely to be affected by potential legislation. In our view, charter schools located in states that receive authorization from state agencies (such as Texas and Arizona), are better positioned to avoid competitive pressure from their related public school districts.